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Post-ROE-P/B curve steepening strategy
Japan Quantitative Strategyp g gy
Nomura Securities Co., Ltd.
Akihiro MurakamiSee Appendix A-1 for analyst
certification, important disclosures and the status of non-US analysts.
Any authors named on this report
Akihiro Murakami Chief Quantitative Strategist, JapanNomura Securities Co., Ltd.+81 (0)3 6703 1746akihiro murakami@nomura com Any authors named on this report
are research analysts unless otherwise indicated.
May, 2013
Summary
Current investment environment in the Japanese equity market :J it t f d f d t ti f t・ Japanese equity quant fund performance and representative factors
・ Who are buying Japanese stocks?
Our investment strategy :(a) Major buyers of Japanese equities are nonresident investors( ) j y p q・ Strategy utilizing non-resident investors’ stock selection skills
(b) Reliability of analyst forecasts improving・ Earnings revisions focusing on the ROE-P/B curve
(c) The BOJ continues to be a major buyer of ETFs
1
・ Contrarian to the passive fund trading
Who are buying Japanese stocks?
Trading by trust banks, insurance and nonresident investors
TOPIX(b Y )
1,250 1,500 1,750
30 35 40 End-2010/12 = 0% (bn Yen)
250500 750
1,000
10 15 20 25 Nonresidents (rhs)
-500 -250
0 250
15-10 -5 0 5
-1,500-1,250
-1,000 -750
35-30 -25 -20 -15
Great East Japan European Resurgence of Change of Government
Trust banks & Insurance (rhs)TOPIX (lhs)
-2,000 -1,750 1,500
-45 -40 -35
10/1
2
011/
3
011/
6
011/
9
11/1
2
012/
3
012/
6
012/
9
12/1
2
013/
3
(yyyy/m)
2011 Q1 Q2 Q3 Q4 Q22012 Q1 Q3
pEarthquake
pFinancial crisis
gEuropean
Financial crisisQ4 2013 Q1 Q2
g&
Abenomics-Driven Rally
2Note: Shows trust banks‘, insurance cos’ and nonresident investors' (bottom graph) trading value, taken from equity purchases by investor category data (right axis) and TOPIX return(left axis). Sample
period is January 2011 through 10.May.2013 . Source: Nomura, from TSE's equity trading value by investor category data
20 20 20 20 20 2 0 20 20 20 20
As part of monetary easing, the BOJ also keeps buying Japanese ETFs
BOJ's ETF purchases and the TOPIX
TOPIXEnd-2010/12 = 0% (bn Yen)
30
40
2530 35 40 End 2010/12 0% ( )
BOJ's ETF purchases (rhs)
10
20
510 15 20 25
-10
0
-10 -5 0 5
-30
-20
-30 -25 -20 -15
Great East JapanEarthquake
EuropeanFinancial crisis
Resurgence of European
TOPIX (lhs)
Change of Government&
-40 -40 -35
2010
/12
2011
/3
2011
/6
2011
/9
2011
/12
2012
/3
2012
/6
2012
/9
2012
/12
2013
/3
(yyyy/m)
2011 Q1 Q2 Q3 Q4 Q22012 Q1 Q3
Earthquake Financial crisis European Financial crisis
Q4
&Abenomics-Driven Rally
Q22013 Q1
3Note: Shows the actual amount of ETFs purchased by BOJ (right axis) and TOPIX return(left axis). Sample period is January 2011 through 10.May.2013 . Source: Nomura, based on BOJ and other data
2 2 2
Japanese equity quant funds started to recover since the change of government
End-2010/12 = 0% Cumulative return
Average performance of Japanese equity quant funds
5
10
-5
0
15
-10 Quant FundChange of Government
-20
-15
2011 Q1 Q2 Q3 Q4 Q22012 Q1 Q3
Great East JapanEarthquake
EuropeanFinancial crisis
Resurgence of European
Q4 2013 Q1 Q2
Abenomics-DrivenRally
Government16th. Dec. 2012
-25
2010
/12
2011
/3
2011
/6
2011
/9
2011
/12
2012
/3
2012
/6
2012
/9
2012
/12
2013
/3
(yyyy/m)
Earthquake Financial crisis European Financial crisis
Abenomics Driven Rally
4
Note: Shows daily average return (Jensen's alpha), on an indexed basis, on 23 funds (domestic publicly offered investment trusts and nonresident investor funds) that invest in Japanese equities using a quant-based approach. Sample includes long-only, individual stock long-short, and market-neutral (long on individual stocks, short on index futures, for example) funds. Sample period is January 2011 through 10.May.2013 .
Source: Nomura
Mimic portfolio’s performance of quant funds
Average performance of Mimic portfolio and Quant funds
End-2010/12 = 0% Cumulative return
5
10
Mimic Quant Portfolio ( E/P + Revision + B/P + Reversal)
-5
0
15
-10 Quant Fund
-20
-15
Great East JapanEarthquake
EuropeanFinancial crisis
Resurgence of European Abenomics-Driven Rally
2011 Q1 Q2 Q3 Q4 Q22012 Q1 Q3 Q4 2013 Q1 Q2
-25
2010
/12
2011
/3
2011
/6
2011
/9
2011
/12
2012
/3
2012
/6
2012
/9
2012
/12
2013
/3
(yyyy/m)
Earthquake Financial crisis European Financial crisis
y
5
Note: Shows daily return of mimic portfolio (the composite factor of E/P, B/P, Revision and reversal(past 3month return)) and daily average return (Jensen's alpha), on an indexed basis, on 23 funds (domestic publicly offered investment trusts and nonresident investor funds) that invest in Japanese equities using a quant-based approach. Sample includes long-only, individual stock long-short, and market-neutral (long on individual stocks, short on index futures, for example) funds. Sample period is January 2011 through 10.May.2013 .
Source: Nomura
Value factors worked as the main driver for the Q4 quant recovery But…..
Daily performance of E/P and B/P
End-2010/12 = 0% Cumulative return
15
20Cumulative return
0
5
10 E/P
-10
-5
0
-20
-15B/P
2011 Q1 Q2 Q3 Q4 Q22012 Q1 Q3Great East Japan
E h kEuropean Resurgence of
E
Q4 2013Q1 Q2
Abenomics-DrivenRally
-25
2010
/12
2011
/3
2011
/6
2011
/9
2011
/12
2012
/3
2012
/6
2012
/9
2012
/12
2013
/3
Earthquake financial crisis European financial crisis
(yyyy/m)
Abenomics Driven Rally
6
Note: Universe of TOPIX500 stocks is divided into 5 quintiles, with an equal number of stocks in each quintile, by factor value. Portfolios are rebalanced at the beginning of each month. Cumulative spread return (#5 – #1) is calculated on a daily basis (end-Dec. 2010 = 0). We did not take transaction costs into account. Analysis is based on historical share prices and does not guarantee future performance. Sample period is 4 Jan. 2011 – 10.May.2013.
Source: Nomura
2 2 2 (yyyy/ )
B/P factors were driven by credit risk factor
Factor performance for B/P and 5-year CDS spreads
E d 2010/12 0%
10
20End-2010/12 = 0% Cumulative return
B/P
0
B/P
-20
-10CDS5Y
-302011 Q1 Q2 Q3 Q4 Q22012 Q1 Q3
Great East JapanEarthquake
Europeanfinancial crisis
Resurgence of European
Q4 2013Q1 Q2
Abenomics-Driven Rally
-40
2010
/12
2011
/3
2011
/6
2011
/9
2011
/12
2012
/3
2012
/6
2012
/9
2012
/12
2013
/3
(yyyy/m)
financial crisis
7
Note: We divided the universe of TOPIX 500 stocks into five groups in terms of both B/P and 5-year CDS spreads at the beginning of each month. Figure shows cumulative monthly returns on a strategy of going long on the group of stocks with the highest factor values and short on the group of stocks with the lowest factor values, for each factor. We did not take transaction costs into account. Analysis is based on historical share prices and does not guarantee future performance. Sample period is January 2011 through 10.May.2013.
Source: Nomura
2 2 2
Credit risk factor may no longer be a driver for B/P factors
CDS spreads for high-B/P and low-B/P stocks
(bp) CDS spreads for high‐B/P and low‐B/P stocks
350
400
( p) p g / /
High B/P
250
300
150
200
Low B/P
50
1002011 Q1 Q2 Q3 Q4 Q22012 Q1 Q3
Great East JapanEarthquake
Europeanfinancial crisis
Resurgence of European
Q4 2013Q1 Q2
Abenomics-Driven Rally
0
2010
/12
2011
/3
2011
/6
2011
/9
2011
/12
2012
/3
2012
/6
2012
/9
2012
/12
2013
/3
Earthquake financial crisis European financial crisis
8Note: Universe is TOPIX 500 stocks for which 5-year CDS spread data were available. We divided the universe into five groups on the basis of B/P factor values at the beginning of each month, and
calculated the median 5-year CDS spread for the groups of stocks with the highest and lowest B/P, respectively. Sample period is January 2011 through 10.May.2013 . Source: Nomura
2 2 2
We expect profit-based factors to emerge as the next main driver
End-2010/12 = 0% Cumulative return
Daily performance of ROE, revision and recurring profit growth
20
30
End 2010/12 0% Cumulative return
Revision
0
10 ROE
-20
-10
Recurringf
-40
-30 2011 Q1 Q2 Q3 Q4 Q22012 Q1 Q3Great East Japan
EarthquakeEuropean
financial crisisResurgence of
European financial crisis
Q4 2013Q1 Q2
Abenomics-Driven Rally
profit growth
-50
2010
/12
2011
/3
2011
/6
2011
/9
2011
/12
2012
/3
2012
/6
2012
/9
2012
/12
2013
/3
(yyyy/m)
financial crisis
2 2 2 (yyyy/m)
9
Note: Universe of TOPIX500 stocks is divided into 5 quintiles, with an equal number of stocks in each quintile, by factor value. Portfolios are rebalanced at the beginning of each month. Cumulative spread return (#5 – #1) is calculated on a daily basis (end-Dec. 2010 = 0). Sample period is 4 Jan. 2011 – 10 May.2013. We did not take transaction costs into account. Analysis is based on historical share prices and does not guarantee future performance.
Source: Nomura
Nonresident investor purchases likely to work more positively for profit-based factors than value factors
Comparison of risk characteristics: Stocks overweighted by domestic pension funds vs. Stocks overweighted by nonresident investors
0 000.10 0.20
Size
B/PSensitivity to dollar
0 30-0.20 -0.10 0.00
E/PHistorical volatility(60 months)
-0.40 -0.30
Forecast dividend yieldHistorical beta(60 months)
Sales growthDebt ratio
ROE
Past 3-month return
Past 1 year return
Domestic pension funds #5-#1 Non-resident #5-#1 TOPIX
10
Note: we calculated risk characteristics of each portfolio and plotted the historical average of each risk characteristic. We conducted a cross-sectional normalization of each set of data so that weighted average market cap was 0 and variance was 1 at the beginning of each month, adjusting standard deviation to ±3σ if it exceeded that level, and repeated this process three times. Sample period is June 1995 through March 2013.
Source: Nomura
Idea 1: Learning from non-resident investors’ stock selection skills
Performance of stocks overweighted by domestic pension funds and nonresident investors
(End-1995/6 = 0%) Cumulative return
80
100Active weight factorof Nonresident investors
40
60Active weight factorof Domestic Pension
20
40
‐20
0
ROE factor
‐40
1995
0619
9512
1996
0619
9612
1997
0619
9712
1998
0619
9812
1999
0619
9912
2000
0620
0012
2001
0620
0112
2002
0620
0212
2003
0620
0312
2004
0620
0412
2005
0620
0512
2006
0620
0612
2007
0620
0712
2008
0620
0812
2009
0620
0912
2010
0620
1012
2011
0620
1112
2012
0620
1212
11
1 1 1 1 1 1 1 1 1 1 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2
Note: We divided the universe of TSE-1 stocks into five groups based on their active weightings in the portfolios of nonresident investors at the start of each month. Figure shows cumulative monthly returns on a strategy combining long positions on stocks in the highest group (overweighted stocks) with short positions on stocks in the lowest group (underweighted stocks). We did not take transaction costs into account. Analysis is based on historical share prices and does not guarantee future performance. Sample period is June 1995 through April 2013.
Source: Nomura
Company valuation and profitability closely associated
∞ A simple residual income model gives the relationship between future ROE and P/B ratio.
, , 11
1
The ROE-P/B curve: the cross sectional relationship between ROE and valuation (P/B)p ( )
6 0
7.0 Jan 2009Apr 2013
P/B (x) Relationship between ROE and P/B
4.0
5.0
6.0 Fitted curve (Jan 2009)Fitted curve (Apr 2013)
2.0
3.0
4.0
0.0
1.0
15 0 10 0 5 0 0 0 5 0 10 0 15 0 20 0 25 0 30 0 35 0
12
Note: We plotted each stock's expected ROE (next-FY forecast where available, otherwise current-FY forecast) on the x-axis and its P/B on the y-axis, in a two-dimensional scatter plot. Universes were TSE-1 stocks as at the beginning of April 2013 and the beginning of January 2009, respectively. To remove outliers, we excluded stocks in the top 1% and bottom 1% of the universe in terms of ROE from our analysis.
Source: Nomura
-15.0 -10.0 -5.0 0.0 5.0 10.0 15.0 20.0 25.0 30.0 35.0
ROE (%)
The ROE-P/B curve fitted by converted model
Relationship between ROE and valuation (log P/B)
Th t d d l
3.0 Converted relationship between ROE and P/B (Apr 2013)ln (P/B)
,
,_ , , The converted model :
5.0
6.0
7.0
Apr 2013
Fitted curve (Apr 2013)
P/B (x) Relationship between ROE and P/B
1 0
2.0
2.0
3.0
4.0
y = 0.4556x + 0.0781 0
0.0
1.0
0.0
1.0
2.0
-15.0 -10.0 -5.0 0.0 5.0 10.0 15.0 20.0 25.0 30.0 35.0
ROE (%)
y
-2.0
-1.0
( )-3.0
-3.0 -2.0 -1.0 0.0 1.0 2.0 3.0
Standardized ROE (high)(low)
13
Note: We plotted each stock‘s standardized expected ROE on the x-axis and its log P/B on the y-axis, in a two-dimensional scatter plot. Universe was TSE-1 stocks at the beginning of April 2013. We estimated the best fit line using model , where ln(*) is the natural log of *, δt and βt are the intercept and regression coefficient, respectively, at time t, and εi,t is the residual. To estimate the regression coefficient, we standardized ROE, the explanatory variable, so that the average was 0 and the standard deviation was 1, and rounded any values beyond ±3σ to ±3σ. To remove outliers, we excluded stocks in the top 1% and bottom 1% of the universe in terms or ROE from our analysis.
Source: Nomura
,
,_ , ,
The ROE-P/B curve has recently steepened rapidly
Ti i β ffi i t f ROE P/B
The slope of the curve (β coefficient) has recovered to the level prior to Lehman collapse.
Time series β coefficient for ROE-P/B curve
0.7coefficient
0.5
0.6
Steep
The association between expected ROE and P/B is strong.
0.3
0.4
0.1
0.2 FlatThe association is weak.
0.0
1987
01
1988
01
1989
01
1990
01
1991
01
1992
01
1993
01
1994
01
1995
01
1996
01
1997
01
1998
01
1999
01
2000
01
2001
01
2002
01
2003
01
2004
01
2005
01
2006
01
2007
01
2008
01
2009
01
2010
01
2011
01
2012
01
2013
01
(yyy
ymm
)
14
Note: Universe was TSE-1 stocks. We carried out a cross-sectional regression analysis using expected ROE and P/B ratios at the beginning of each month, and the model ,where ln(*) is the natural log of *, δt and βt are the intercept and regression coefficient, respectively, at time t, and εi,t is the residual. Sample period was January 1987 through April 2013. To estimate the regression coefficient, we standardized ROE, the explanatory variable, so that the average was 0 and the standard deviation was 1, and rounded any values beyond ±3σ to ±3σ. To remove outliers, we excluded stocks in the top 1% and bottom 1% of the universe in terms or ROE from our analysis. We used a low-pass filter to determine phases of the coefficient.
Source: Nomura
,
, _ , ,
What does the steepening of the curve indicate?
S h ti f h h l f ROE P/B i hi h ( t ) d l (fl t)
We hypothesize that the slope of the curve indicates the effectiveness of revision strategy.
Schematic for phases when slope of ROE-P/B curve is high (steep) and low (flat)
3 0
Converted relationship between ROE and P/B (schematic)ln (P/B) (2) Steep(High)
2.0
3.0 (2) Steep(High)
A
A’
0 0
1.0 (1) Flat A
BB’
-1.0
0.0
Upward revisions
-3 0
-2.0
(Low)
15Source: Nomura
3.0 -3.0 -2.0 -1.0 0.0 1.0 2.0 3.0
Standardized ROE (High)(Low)
Revision factors are certainly effective when the curve becomes steep
Effectiveness of revision factor when the curve is steep / flat
0.80 Return/risk Performance of revision factor by phase
0.20
0.40
0.60
-0.20
0.00
-0.80
-0.60
-0.40
Note: Universe was TSE-1 stocks. We investigated the effectiveness of the earnings forecast revision factor in high, medium, and low phases of regression coefficient βt , estimated using model
0.80 Low Medium High
(flat) (steep)Slope of curve
16
. To calculate factor returns, we divided the universe into five groups based on the revision factor, then calculated statistical data for monthly returns on a strategy of going long on the top group and short on the bottom group. We did not take transaction costs into account. Analysis is based on historical share prices and does not guarantee future performance. We divided the entire sample period into three groups based on coefficient value. We defined periods with coefficient values above the level that divides the top third from the middle third as high phases and periods with coefficient values below the level that divides the top third from the middle third as low phases.
Source: Nomura
,
, _ , ,
In steep phase, profit-based factors perform well
Difference in factor performance between ”Steep” and ”Flat" phases
Difference in factor performance between “Steep” and “Flat” phases
P/E
P/B
Dividend yield
ROE
Profit margin
Sales turnover ratio
High financial leverage
High revision
Hi h l tilitHigh volatility
Large cap
High default probability
Historical 6-month return
Historical 3-month returnHistorical 3 month return
Herding
Equity finance
Earnings surprise (progress)
Earnings surprise (share price response)
-1.50 -1.00 -0.50 0.00 0.50 1.00 1.50 2.00
Earnings surprise (company earnings estimate)
High return in "Steep" phasesHigh return in "Flat" phases
Note: Universe was TSE-1 stocks. We investigated the effectiveness of a key factors in high, medium, and low phases of regression coefficient βt , model (*) ( ). , _ , ,
17
g y g , , p g βt , ( ) ( )To calculate factor returns, we divided the universe into five groups in terms of each factor, and calculated statistical data for monthly returns on a strategy of going long on the top group and short on the bottom group for each factor (but long on the bottom group and short on the top group in the case of P/E and P/B). Figure shows difference between time series average/standard deviation (annualized) in high and low phases. We did not take transaction costs into account. Analysis is based on historical share prices and does not guarantee future performance. We divided the entire sample period into three groups based on coefficient value. We defined periods with coefficient values above the level that divides the top third from the middle third as high phases and periods with coefficient values below the level that divides the top third from the middle third as low phases. Source: Nomura
,
The curve for high-ROE stocks has tended to steepen more than others
Relationship between ROE and valuation (log P/B) varies with level of ROE
β coefficient of ROE-P/B curve for different levels of expected ROE
y = 0.8278x - 0.22943.0
Converted relationship between ROE and P/B (April 2013)ln (P/B)
0.8
1.0 coefficient
High ROEMedium ROEL ROE
0.0
1.0
2.0
0.2
0.4
0.6 Low ROE
Steep
y = 0.1847x - 0.1768-2.0
-1.0
-0.4
-0.2
0.0
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 mm
)
Flat
N t W l tt d h t k' t d di d t d ROE th i d it l P/B
-3.0 -3.0 -2.0 -1.0 0.0 1.0 2.0 3.0
Standardized ROE (high)(low)19
8701
1988
01
1989
01
1990
01
1991
01
1992
01
1993
01
1994
01
1995
01
1996
01
1997
01
1998
01
1999
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2000
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2001
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2003
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2005
01
2006
01
2007
01
2008
01
2009
01
2010
01
2011
01
2012
01
2013
01
(yyy
ym
Note: We plotted each stock's standardized expected ROE on the x-axis and its log P/B on the y-axis, in a two-dimensional scatter plot. Universe was TSE-1 stocks at the beginning of April 2013. We divided the universe into three groups in terms of expected ROE at the beginning of each month and estimated the best fit line for each group using model , where ln(*) is the natural log of *, δt and βt are the intercept and regression coefficient, respectively, at time t, and εi,t is
,
, _ , ,
Note: Universe was TSE-1 stocks. We divided the universe into three groups based on
18
,
the residual. To estimate the regression coefficient, we standardized ROE, the explanatory variable, so that the average was 0 and the standard deviation was 1, and rounded any values beyond ±3σ to ±3σ. To remove outliers, we excluded stocks in the top 1% and bottom 1% of the universe in terms or ROE from our analysis.
Source: Nomura
expected ROE at the beginning of each month, and carried out a regression analysis for each group using model . Shows time series data for regression coefficient βt . Sample period was January 1987 through April 2013.
Source: Nomura
,
,_ , ,
Idea 2: revision factor is most effective for the high-ROE group
Revision factor performance by expected ROE
400
450
High ROE
(End-Dec 1986 = 0%) Cumulative return
250
300
350
400 g
Medium ROE
Low ROE
100
150
200
250
0
50
100
-50
1986
1219
8712
1988
1219
8912
1990
1219
9112
1992
1219
9312
1994
1219
9512
1996
1219
9712
1998
1219
9912
2000
1220
0112
2002
1220
0312
2004
1220
0512
2006
1220
0712
2008
1220
0912
2010
1220
1112
2012
12(y
yyym
m)
19
Note: Universe was TSE-1 stocks. Sample period was January 1987 through 12 April 2013. We divided the universe into three groups based on expected ROE at the beginning of each month, divided these three groups into a further five groups each based on our earnings forecast revision factor, and calculated monthly returns on a strategy of going long on the top group and short on the bottom group in terms of the earnings forecast revision factor, for each ROE group. Figure shows cumulative monthly returns. We did not take transaction costs into account. Analysis is based on historical share prices and does not guarantee future performance.
Source: Nomura
Earnings revisions were larger (smaller) for the (low) high-ROE group
The absolute value of revisions factor by expected ROE
8.0%
Revision factor by expected ROE (absolute value)(large)
5.0%
6.0%
7.0%
acto
r al
ue)
3.0%
4.0%
Rev
isio
n fa
abso
lute
va
0 0%
1.0%
2.0%
R (a
(small)0.0%
Low Medium High
Expected ROE
20
Note: Universe was TSE-1 stocks. Sample period was January 1987 through April 2013. We divided the universe into three groups based on expected ROE at the beginning of each month. Figure shows time series averages of the absolute value of the revision factor for each group.
Source: Nomura
Passive funds have shown growing presence in the Japanese equity market
AUM for passive Japanese equity ETFs has grown remarkably and became double in the last 3 years. The BOJ is expected to keep buying Japanese stocks.
AUM growth for passive Japanese equity ETFs
2.5
AUM growth for passive Japanese equity ETFs(end-Jan.2005 = 1.0)
AUM growth – TOPIX return
AUM growth : 67 044 mil USD
2.02
1.82 2
AUM growth : 67,044 mil USD
1.5
0.5
1
0
0501
0601
0701
0801
0901
1001
1101
1201
1301
21
200
200
200
200
200
201
201
201
201
Note: Shows growth in AUM (assets under management) for passive ETFs (excluding leveraged and inverse ETFs) that track Japanese equities and are listed on major markets in the US and Asia, including Japan. The red line shows cumulative monthly growth in AUM from the beginning of 2005 (AUM at beginning of 2005 = 1). The blue line shows the cumulative spread between monthly AUM growth and monthly TOPIX return. Sample period is February 2005 through March 2013.
Source: Nomura
Jan, Apr, Jul and Oct are periodical index rebalance season Anomalies might be seen around index events
Typical trading pattern of TOPIX-tracking fundAnnouncement Date Rebalance Date
5th business day in Jan / Apr / Jul /Oct
Day before last business day in Jan / Apr / Jul /Oct
(a) Stocks about to see a relative increase in FFW → Buy
(b) Stocks about to see a relative decrease in FFW → Sell
Trading by passive funds
Trading in typical event-driven strategy
( )
Announcement Date5th business day in October
in Jan / Apr / Jul /Oct
Rebalance DateDay before last business day
in Jan / Apr / Jul /Oct
Reverse trades to lock in profits(a) Stocks expected to see a relative increase in FFW → LongInvestments carried out in advance on basis of forecasts
22
(b) Stocks expected to see a relative decrease in FFW → Short
Typical event-driven strategy
Announcement Date5th business day
in Jan / Apr / Jul /Oct
Rebalance DateDay before last business day
in Jan / Apr / Jul /Oct
Investments carried out in advance on basis of forecasts Reverse trades to lock in profits
(a) Stocks expected to see a relative increase in FFW → Long
(b) Stocks expected to see a relative decrease in FFW → Short
p
2 0
3.0
Announcement date = 0% Cumulative return (vs TOPIX)
Top 10% in terms of weighting change
Announcement date
0 0
1.0
2.0
(b)
-2 0
-1.0
0.0
Bottom 10% in terms of weighting change(a)Note: In this event, all constituent stocks, including stocks unchanged in FFW,
see a change in their TOPIX weighting. We compare TOPIX weightings based on post FFW and new FFW. Covering periodic reviews of FFW in every October from 2006 through 2011. Sample size for each groups is around 400 stocks. Average cumulative excess return relative to TOPIX from 20 trading days before announcement/date to 20 days after
-3.0
2.0
-20 -15 -10 -5 0 5 10 15 20(days) 23
from 20 trading days before announcement/date to 20 days after announcement/rebalance date. We did not take transaction costs into account. Analysis is based on historical share prices and does not guarantee future performance.
Source: Nomura
After the rebalances of passive funds, return reversal is expected
Announcement Date5th business day
in Jan / Apr / Jul /Oct
Rebalance DateDay before last business day
in Jan / Apr / Jul /Oct
Trading by passive funds(a) Stocks about to see a relative increase in FFW → Buy
(b) Stocks about to see a relative decrease in FFW → Sell
2.0
3.0
Rebalance date = 0% Cumulative return (vs TOPIX)
Bottom 10% in terms of weighting change
Rebalance date
0.0
1.0 (b)
-2.0
-1.0 Top 10% in terms of weighting change
(a)
Note: In this event, all constituent stocks, including stocks unchanged in FFW, see a change in their TOPIX weighting. We compare TOPIX weightings based on post FFW and new FFW. Covering periodic reviews of FFW in every October from 2006 through 2011. Sample size for each groups is around 400 stocks. Average cumulative excess return relative to TOPIX from 20 trading days before effective date to 20 days after
-3.0 -20 -15 -10 -5 0 5 10 15 20
(days)24
(a)from 20 trading days before effective date to 20 days after announcement/rebalance date. We did not take transaction costs into account. Analysis is based on historical share prices and does not guarantee future performance.
Source: Nomura
Effect of FFW change on valuations
B/P value spread of the stocks for which FFWs are increased and decreased is expanded more than 3%. Then, the spread is eliminated gradually.
2.00%Value spred of stocks with incresing/ decreasing FFWs
Effect of FFW change on valuations
1.00%
1.50%(a) Stocks for which FFWs are to be increased (Buy) → relatively overvalued
0.00%
0.50%
‐1.50%
‐1.00%
‐0.50%
Expanded value spread more than 3%
‐2.00%
1.50%
Sep Oct Beginning of Nov Dec Jan Feb
(b) Stocks for which FFWs are to be decreased (Sell) → relatively undervalued
Trading period by passive fundsAnnouncement
25
Note: Taking TSE-1 stocks as our universe, we calculated the average P/B of stocks for which the FFW (free-float weight) was increased or decreased, respectively, in the periodic FFW review for the TOPIX carried out in October each year from 2006 through 2011. We then calculated the spread between these two averages, respectively, and the average P/B for the universe (the value spread). We rebased the data so that the value spread in the month preceding the announcement of the October FFW review each year = 0%.
Source: Nomura
Idea 3: investment strategy based on change in FFW
Start investment at the beginning of the next month when passive funds are rebalanced. Short the stocks for which FFWs increased (overvalued), and long the stocks
f ( )for which FFWs decreased (undervalued).
Strategy utilizing FFW change
Jan 2002 = 0% Cumulative return
60
70
80
Jan. 2002 0% Cumulative return
Composite:TOPIX + R/N + Passive Fund Buy/Sell
30
40
50
TOPIX FFW revision (3M)
0
10
20
( )
‐10
2002
01
2003
01
2004
01
2005
01
2006
01
2007
01
2008
01
2009
01
2010
01
2011
01
2012
01
2013
01
26
Note: We divided our universe of TSE-1 stocks into five groups on the basis of composite factor (TOPIX, R/N and Passive Fund Buy/Sell) at the beginning of each month. We then calculated the monthly return on a strategy combining long positions on the group of stocks with the lowest factor values (#1) and short positions on the group of stocks with the highest factor values (#5). Chart shows cumulative monthly return. We did not take transaction costs into account. Analysis is based on historical share prices and does not guarantee future performance. Sample period is January 2002 through April 2013.
Source: Nomura
Conclusion
We have seen more favorable investment environment in the Japanese equity market for profit-based factors to perform wellmarket for profit-based factors to perform well.
We propose the following three investment ideasWe propose the following three investment ideas (1) Strategy utilizing non-resident investors’ stock selection skills(2) Revision strategy in the phase when the ROE-P/B curve becomes steep( ) gy p p(3) Contrarian strategies based on passive fund trading
27
Appendix (1): definitions of factors
Definitions of factorsFactor Factor definition
1 P/E #1 (undervalued) - #5 (overvalued) Market cap / earnings forecast( f / / /S f f )
/ # (u de a ued) #5 (o e a ued)(next-FY forecast w here available; I/B/E/S consensus forecast > Toyo Keizai forecast)
2 P/B #1 (undervalued) - #5 (overvalued) Market cap / actual shareholders’ equity
3 Dividend yield #5 (high) - #1 (low ) Calculated from Nikkei estimated dividends
4 ROE #5 (high) - #1 (low ) Earnings forecast / actual shareholders’ equity(next-FY forecast w here available; IFIS consensus forecast > Toyo Keizai forecast)(next FY forecast w here available; IFIS consensus forecast Toyo Keizai forecast)
5 Profit margin #5 (high) - #1 (low ) Earnings forecast / sales forecast(next-FY forecast w here available; IFIS consensus forecast > Toyo Keizai forecast)
6 Sales turnover ratio #5 (high) - #1 (low ) Sales forecast / total assets(next-FY forecast w here available; IFIS consensus forecast > Toyo Keizai forecast)
7 High f inancial leverage #5 (high) - #1 (low ) Total assets / Net Equity
8 High revision #5 (high) - #1 (low ) Recurring profit forecast / past 3-month average recurring profit forecast – 1(IFIS consensus forecast w here available, otherw ise Toyo Keizai forecast)
9 High volatility #5 (high) - #1 (low ) Standard deviation of daily share price return (past 60 days)
10 Large cap #5 (large cap) - #1 (small cap) Log market cap
11 High default probability #5 (high) - #1 (low ) Estimated using Merton options theory
12 Historical 6-month return #5 (high) - #1 (low )
13 Historical 3-month return #5 (high) - #1 (low )
Active fund ow nership as % of total shares out14 Herding #5 (high) - #1 (low ) * Active funds defined as all the active (long-only) funds in the Japanese equities category, as
categorized by The Investment Trusts Association, Japan
15 Equity f inance #5 (high) - #1 (low ) Change in no. of shares out compared to 24 months previously
16 Earnings surprise (progress) #5 (high) - #1 (low ) Calculated from cumulative recurring profits (from Q1 through most recent quarter) as % of consensusrecurring profit forecast (FY1)
28Source: Nomura
17 Earnings surprise (share price response) #5 (high) - #1 (low ) Cumulative return versus TOPIX from most recent results announcement date to tw o trading days after
18 Earnings surprise (company earnings estimate) #5 (high) - #1 (low ) Company estimate versus consensus recurring profit forecast (FYU1) (IFIS consensus forecast > ToyoKeizai forecast)
Appendix (2) performance of Japanese fundamental-based active funds
Average performance of Japanese fundamental-based active funds
End-2010/12 = 0% Cumulative return
5
10 End-2010/12 = 0% Cumulative return
Fundamental Based Active Fund
0
5 Fundamental Based Active Fund
-5
Mimic Active Fund Portfolio (E/P + Revision)
-10
Mimic Active Fund Portfolio (E/P + Revision)
2011 Q1 Q2 Q3 Q4 Q22012 Q1 Q3
Great East JapanE th k
Europeanfi i l i i
Resurgence of European
Q4 2013 Q1 Q2Change of Government
&
-15
2010
/12
2011
/3
2011
/6
2011
/9
2011
/12
2012
/3
2012
/6
2012
/9
2012
/12
2013
/3
(yyyy/m)
Earthquake financial crisis European financial crisis
&Abenomics-driven rally
29Note: Shows average daily return (Jensen‘s alpha), on an indexed basis, for all long-only active domestic publicly offered investment trusts (based on Investment Trusts Association, Japan categories).
Sample period is January 2011 through 10.May.2013 . Source: Nomura
2 2 2
Appendix (3): transition in shareholding at market value by investor category
700 Shareholding at Market Value(trillion yen) Shareholding at Market Value(trillion yen) Shareholding at Market Value(trillion yen) Shareholding at Market Value(trillion yen)
Transition in shareholding at market value by investor category
500
600
00
I di id l 63 Business corporations, 67
200
300
400 Survey year 2011 ( as of Mar. 2012)
Financial Institutions, 90
Foreign corporations, 81
Individuals, 63
0
100
200
0 5 0 5 0 5 0 5 0
1970
1975
1980
1985
1990
1995
2000
2005
2010
(Survey year)(Survey year)(Survey year)(Survey year)Note: All domestic stock exchanges(Tokyo, Osaka, Nagoya, Fukuoka and Sapporo)in Japan. The market value of public pension funds is not included in that of Annuity Trusts.
- Business corporations: All companies incorporated in Japan (ex “Financial institutions” and “Securities companies”).- Individuals and others: Individuals and non-incorporated groups with Japanese nationality, regardless of their place of residence.- Foreign corporations: Corporations that were established based on foreign laws; foreign and municipal governments, and entities that are not incorporated; and individuals whose nationalities are other than Japanese, regardless of their place of residence.p , g p- Financial institutions> City, regional banks, etc.: Regular Japanese banks licensed under the Banking Act and the Long-Term Credit Bank Act (There have been no regular Japanese banks licensed under the Long-
Term Credit Bank Act since the 2006 Shareownership Survey)> Trust banks: Trust banks that are members of the Trust Companies Association of Japan> Investment trusts: Trust assets of trustors that are stipulated in the Investment Trust Act (Act on Investment Trusts and Investment Corporations), and whose nominees (trustees) are banks that
conduct trust business> Annuity trusts: Employees’ pension funds that are stipulated in the Employees’ Pension Insurance Act, and corporate pensions stipulated in the Defined-Benefit Corporate Pension Act or the
30
y p y p p p y , p p p pDefined Contribution Pension Act, whose nominees (trustees) are banks that conduct trust business. (excluding public pensions under management)> Life insurance companies: Life insurance companies that are stipulated in the Insurance Business Act> Non-life insurance companies: Non-life insurance companies that are stipulated in the Insurance Business Act> Other financial institutions: Financial institutions other than those stipulated above, including credit unions (shinkin banks), credit associations, agriculture-related financial institutions, mutual aid
associations, and government-related financial institutions, etc.Source: Shareownership Survey (TSE), Nomura
Appendix (4): outline regarding periodic review of FFW
Outline of calculating FFW Definitions of free-float shares and non-free-float shares
Outline Estimation of non-free-float shares
(1) Estimate the amount of non-free-float shares using publicly available documents released by listed companies.
(2) Calculate non-FFW. (Non-free-float shares / listed shares)
Shares held by the top 10 major shareholders, treasury stocks, shares held by the board of directors, and other shares TSE seems not available for trading in the market.
TSE t t h h ld b th t 10 j h h ld(3) Obtain the FFW by removing the non-free-float factor from
1. (1 – Non-FFW)※TSE multiply the FFW by 0.75x for stocks recognized as having low liquidity and newly listed stocks
TSE may treat shares held by the top 10 major shareholders as free-float shares in the following case.
Condition Major shareholder
As a general rule, shares considered as Securities finance
Periodic Review
Settlement Term
Announcement Date
EffectiveDate
Source: Nomura based on Tokyo Stock Exchange Index Guidebook published 9 February 2012g
free-float. companies, securitiesdepositories, nominees for depositoryTerm Date Date
January –March
Fifth business day of October
Last business day of October
April – June Fifth business day of J
Last business day of J
depositoryReceipts
Shares likely to be seemed as free-float.Cases where any of the following conditions are met and the TSE deems it appropriate to
Trust banks, master trusts, global
January January
July –September
Fifth business day of April
Last business day of April
October - Fifth business day of Last business day of
consider such shares as free-float.- There are descriptions in the Securities Report on the type of trust, the purpose of purchase of shares, etc.- It is clear that shares are held by several
gcustodians,insurance companies, securitiescompanies etc
31
Decembery
Julyy
July beneficiaries and managed centrally- It is clear that shares are held for margin Transaction
companies, etc.
Source: Nomura based on Tokyo Stock Exchange Index Guidebook published 9 February 2012 Source: Nomura based on Tokyo Stock Exchange Index Guidebook published 9 February 2012
※The TSE may review FFW in the cases (allocation of new shares to a third party, etc) where it seems that the existing FFW is expected to be significantly affected.
Appendix A-1
Any Authors named on this report are Research Analysts unless otherwise indicated
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