Introducing the JPX Prime 150 Index: A New Japanese Stock Index

The JPX Prime 150 Index, a novel equity index developed by the Japan Exchange Group (JPX), was launched on July 3. It immediately drew considerable attention due to its unique concept diverging from the TOPIX and Nikkei Stock Average. Ahead of this launch, Naoya Takahashi, Executive Officer of JPX Market Innovation & Research, Inc., responsible for the development and promotion of the new index, offered some insights into its concept, comparisons with major domestic and international indexes, and a look ahead to its future prospects.
The following article is a translation of a piece originally published June 30th on 'Finasee,' a Japanese financial information website catering to individuals interested in managing their own assets.

Q.:	The JPX Prime 150 Index (referred to as 'the Prime 150' hereafter) has become the subject of much discussion since its outline was unveiled in March this year, particularly with regards to its constituent stocks. Can you please explain the concept and overview of the new index for us?
Takahashi:	The fundamental concept of the Prime 150 is that it includes representative Japanese companies projected to generate value. We’ve combined two groups from the top 500 companies based on market capitalization listed on the Tokyo Stock Exchange (TSE) Prime Market. The first group consists of the top 75 companies with the best financial performance. The second group consists of the next top 75 companies by market capitalization, excluding those from the first group, that possess a price-to-book ratio (PBR) exceeding 1x. We also measure financial performance using an indicator called the ‘equity spread,’ which represents the return on equity (ROE) minus the cost of shareholders’ equity (in case of borrowing, equivalent to the interest rate). If a company’s ROE exceeds its cost of shareholders’ equity (the return shareholders demand), it signifies that the company is creating value.

Q.:

The JPX Prime 150 Index (referred to as 'the Prime 150' hereafter) has become the subject of much discussion since its outline was unveiled in March this year, particularly with regards to its constituent stocks. Can you please explain the concept and overview of the new index for us?

Takahashi:

The fundamental concept of the Prime 150 is that it includes representative Japanese companies projected to generate value. We’ve combined two groups from the top 500 companies based on market capitalization listed on the Tokyo Stock Exchange (TSE) Prime Market. The first group consists of the top 75 companies with the best financial performance. The second group consists of the next top 75 companies by market capitalization, excluding those from the first group, that possess a price-to-book ratio (PBR) exceeding 1x.

We also measure financial performance using an indicator called the ‘equity spread,’ which represents the return on equity (ROE) minus the cost of shareholders’ equity (in case of borrowing, equivalent to the interest rate). If a company’s ROE exceeds its cost of shareholders’ equity (the return shareholders demand), it signifies that the company is creating value.

Stock Selection Method of the JPX Prime 150 Index

Source : JPX

Q.:	The index appears to highlight prosperous 'winning' companies. Tell us how it compares to the JPX Nikkei Index 400 (JPX Nikkei 400), launched in 2014, which also differs from other indexes such as TOPIX and the Nikkei Stock Average.
Takahashi:	The JPX Nikkei 400 index is based on a selection of the top 1,000 liquid companies in the TSE's Prime, Standard, and Growth markets, scored by ROE, operating profit, and market capitalization. It includes a wide range of stocks, from large to small and mid-cap, with an average market capitalization of JPY 1.5 trillion and a median of JPY 0.6 trillion. In contrast, the Prime 150 is dominated by large-cap stocks listed on the TSE Prime Market, with an average market capitalization of JPY 2.6 trillion and a median market capitalization of JPY 1.5 trillion. While the JPX Nikkei 400 aligns closely with the market average TOPIX, making the two indexes interchangeable, the Prime 150 exhibits characteristics of being both large and growing. This leads to different price movements than the market average. Therefore, we believe there is a demand for this index amongst active investment managers. Moreover, we anticipate that the Prime 150 can provide new investment value to pension funds and institutional investors as part of their asset management diversification.
Q.:	When did the discussions on developing this new index begin?
Takahashi:	We received substantial feedback since the TSE re-organized into the three new market segments - Prime, Standard, and Growth - in April 2022. Notably, that around half of the companies in the Prime Market have a PBR lower than 1x, and there is no set deadline for transitional measures for companies until they meet the listing criteria. Furthermore, it has been pointed out that the TOPIX includes too many components. To address this issue, we initiated a gradual exclusion of approximately 500 companies with a liquid market capitalization of less than JPY 10 billion over a two-and-a-half-year period. In addition, we also looked into whether there was anything we could do in terms of indexes to respond to the general criticism. We began discussions and deliberations of this around autumn last year. All this finally culminated in the development of a new index which emphasizes large-cap stocks.
Q.:	The constituent stocks of the Prime 150 differ significantly from those of TOPIX. The absence from the Prime 150 of Toyota Motor Corporation, which carries the largest weight in TOPIX, and the megabanks has already sparked substantial discussion. What is your take on this?
Takahashi:	The composition results from applying the selection criteria mentioned earlier, and taking into account the financial data from the immediately preceding two fiscal years. Sectors such as banking, transport equipment, and real estate are notably underweighted in the Prime 150 compared to TOPIX because the top companies by market capitalization have not been able to surpass a PBR of 1x. Conversely, sectors such as electrical equipment, information and communications, and pharmaceuticals are overweighted in the Prime 150. As a result, the tracking error (TE) against TOPIX, which represents the degree of divergence in returns, is at 0.66% for the TOPIX 500 index and 3.2% for the Prime 150, indicating a significant difference.

Distribution by Sector (weight base)

Component Stocks

Source: JPX

Tracking Error vs TOPIX

Q.:	Recently, there has been an increase in foreign investor fund inflows to Japanese equities, creating a favorable backdrop for the new index. How does the new index differ from typical overseas indexes?
Takahashi:	I believe the PBR, ROE, sales, earnings per share (EPS) growth rates, and market capitalization distribution of the JPX Prime 150's constituent stocks are globally comparable to major indexes such as the S&P 500 in the US and the STOXX 600 in Europe. Check out the below graphs to see the comparisons in detail.

Data regarding Index Constituents

Q.:	What will be the timing and frequency of future stock replacements for the Prime 150?
Takahashi:	Regular stock replacements occur once a year on the last business day of August. However, since the index was first calculated in July this year, there will be no stock replacements in 2023. The first regular replacement will occur in August 2024. According to simulations dating back to 2014, an average of around 15 stocks - or approximately 10% - are replaced annually. That makes for an average turnover rate, based on market capitalization and one-way, of around 7%. Notably, companies that recently listed in October 2022 have also been included in the Prime 150 under the current selection criteria. We believe the inclusion of these 'momentum' companies further enhances the attractiveness of the new index.
Q.:	With the new NISA* set to begin in January next year, the Prime 150 launch seems perfectly timed. What has been the response from managers and investors, so far? * Nippon Individual Savings Account (NISA) is a tax-free investment available to individual investors in Japan. From January 2024, its system becomes permanent and the quota is substantially expanded.
Takahashi:	During the process of finalizing the content of the Prime 150, we engaged in discussions with asset managers who were very supportive of the overall concept. We also observed significant interest from individual investors through our website and other media platforms. Once the index calculation and management are underway, I believe people will gain a concrete understanding of the advantages of the Prime 150, as elaborated earlier. We hope that asset management firms will proactively create and offer financial products based on this index. For our part, we will continue to listen to suggestions and requests from management firms and investors to further refine the index.
Q.:	Finally, what is the goal of the JPX Group or the new index beyond increasing awareness and utilization of the Prime 150? Additionally, could you provide a message for institutional and individual investors?
Takahashi:	This may be an extreme way of putting it, but if all major companies listed on the TSE Prime Market were to surpass a PBR of 1x, the new index and the TOPIX index would be extremely closely aligned. We can’t deny that this is part of the objectives of our market reforms. If such a thing would ever come to being, I believe the Prime 150 could be a viable alternative index to TOPIX. Therefore, based on those premises, I would like to see institutional investors consider the index as a new investment potential. For individual investors, I hope they recognize the significance of including the 'equity spread' indicator in the stock selection criteria of the Prime 150. This signifies a move beyond ROE by focusing on the cost of capital. In any case, our ultimate goal, which is in line with the objectives of the JPX Prime 150 Index, is to enhance Japan's national wealth through the stock market and redistribute it to market participants.