The Bank of Japan (BOJ) has purchased a large number of exchange-traded funds (ETFs) linked to TOPIX, Nikkei 225, and other broad Japanese equity indexes. By the end of 2018, BOJ’s total ETF purchases reached ¥23 trillion, an estimated 4% of all Japanese stocks. Market have shown increasing concern at the prospect of BOJ’s ending its ETF purchasing.
Jesper Koll, CEO of WisdomTree Japan K.K. and a well-known analyst who has lived in Japan since the mid-1980s, has a proposal for BOJ that he says will stimulate the retail stock market.

Investment
Japan (IJ):

In 2018 BOJ exceeded its annual purchase ceiling of ¥6 trillion in ETFs.Market participants and watchers have expressed concern over the coming sale of BOJ's ETFs as a major downside risk to the stock market, though some bear market players have hoped for a continuation of the buying policy. What are your thoughts?

Koll:

BOJ's ETF buying program has turned into a structural problem for global asset managers. Here, we are not talking about short-term investors such as hedge funds, but about global asset allocators, such as sovereign wealth funds and pension funds. Their time horizon for investment is 3 to 5 years. Every time I've met with them, they've said equity overhang by the BOJ is a big structural risk because the moment the BOJ stops its buying program, it will have a huge negative impact on the Japanese market.

Looking back to 6 years ago when Kuroda became the Governor of BOJ, they announced an aggressive 2% inflation target, and ¥6 trillion in ETF purchases was quite necessary as a crisis management policy to help get Japan out of deflation. Now in 2018 and 2019, Japan is not in crisis. The economy is fine, we're seeing wage gains and record corporate profits, and banks are healthy. So why does BOJ continue to buy? This is a very big problem.

IJ:

Then, do you think BOJ should end the ETF purchases as soon as possible?

Koll:

I think the more important question is not when, but how. At present, the only consistent buyer of Japanese equities is BOJ. If the sole buyer were to unwind its holdings in Japanese equities, there would be a big problem. If BOJ were to announce at it's next policy meeting that it will stop purchasing ETFs, the Nikkei 225 could easily face a 3 or 4 thousand point loss.

In the 1990s Mochiai, or cross-shareholding among major Japanese companies, was a big negative issue. Similarly, we now have the BOJ overhang issue and it poses the same fear to the Japanese market.

IJ:

Do you have any ideas about an exit policy for the BOJ's ETF holdings?

Koll:

It is very clear that BOJ alone cannot solve it. What is needed is a 'kokka senryaku' or a national strategic policy.

My proposal is this: we need to find buyers who will hold equities and ETFs for a long time. I think the only one answer is Japanese retail investors. Most of them are older people and that is where Japan's surplus is. About 70% of financial assets belong to people 65 and older.

How can we get them to buy ETFs from the BOJ? BOJ should coordinate with the Ministry of Finance and the Tax Agency to create an incentive policy granting an exemption from inheritance tax for ETFs that senior investors buy from BOJ.

For Japan's senior generation, generational transfer is a big concern. They fear a very high inheritance tax. With an inheritance tax exemption policy, those ETFs can be used to transfer wealth to their children and grandchildren. It would be the smartest way to clean up the BOJ's balance sheet and the smartest way to raise the risk profile of household balance sheets.

Remember, revenue from the inheritance tax accounts for only 2.3% of total tax revenue in Japan, so the actual amount is small. Of course, the bigger the BOJ's ETF portfolio is, the more difficult it will be to implement an exit strategy.

IJ:

How certain are you that those who inherit will become long-term holders of ETFs?

Koll:

Of course some people will decide to hold the ETFs inherited from their parents and others will sell them. The key point is that it will not be a selling tsunami.

For the last twenty years, Japanese tax policy has mostly wrestled with direct tax versus indirect tax, or income tax versus consumption tax. That's no longer the case. For Japanese households today, the inheritance tax is the biggest issue. Recall that 1 in 4 Japanese is already over the age of 65 and may they live long time! But everybody wants to ensure a generational transfer of assets.

If this strategy is announced in the Olympic year, it will be a big boon. The impact on supply and demand in the stock market would be zero. Global asset allocators and everybody would like it.

In my opinion, this must happen while Mr. Kuroda is the Governor of BOJ. He came from MOF, after all, and presumably could help persuade his former colleagues to go along with the new policy.

IJ:

Thank you very much.

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Jesper Koll

Jesper Koll has been researching and investing in Japan since becoming a resident in 1986. On July 1, 2015 he was appointed Chief Executive Officer of WisdomTree Japan K.K. For the previous two decades Jesper served as the Managing Director of Research and Chief Strategist for major U.S. Investment banks - J.P. Morgan and Merrill Lynch. His analysis and insights have earned him a position on several Japanese government- and corporate advisory committees. Jesper is one of the few non-Japanese members of the Keizai Doyukai, the Japan Association of Corporate Executives. He has written three books in Japanese, “Japan’s Economy – The Envy of the World (2017)”, “The End of Heisei Deflation (2001)”and “Towards a New Japanese Golden Age (1999)”.

After arriving in Japan in 1986 Jesper initially worked as an aide to a Member of Parliament. Jesper has a Masters degree from the School of Advanced and International Studies at Johns Hopkins University and was a research fellow at both Tokyo University and Kyoto University. He is a graduate of the United World College Lester B. Pearson of the Pacific.