What the BOJ unwinding its ETF holdings means for Japan

THE Bank of Japan (BOJ) plans to start unwinding its exchange-traded fund (ETF) holdings, in a process that could take more than a century to complete.

As at mid-September, the BOJ held about 79.5 trillion yen (S$690.5 billion) of ETFs by market value, and had around 43.8 trillion yen of unrealised gains, according to calculations by Morgan Stanley MUFG strategists. 

Reducing its stockpile of ETFs – funds that aim to match the performance of a basket of assets or a specific index – would help the BOJ to start to look more like a normal central bank. It is entering a new era after decades of unconventional monetary policy to combat deflation, which included buying ETFs to stimulate the economy.

However, the sell-off risks undermining confidence in Japan’s stock market, which has been hitting record highs this year. The BOJ holds the equivalent of about 7 per cent of the Japanese stock market via ETFs, according to data compiled by Bloomberg.

What is the BOJ’s plan to sell its ETF holdings?

The BOJ announced in September that it will start selling its ETF holdings at a pace of around 620 billion yen per year by market value, or 330 billion yen by book value. This marks the first time the central bank has laid out a plan for offloading the assets it accumulated over years of ultra-easy monetary policy.

BOJ governor Kazuo Ueda said the decision to sell the ETFs is not related to the level of the stock market, and that offloading all the bank’s holdings may take more than 100 years to finish under the current plan. He also said that it is appropriate to offload the ETFs slowly, and that he hoped future BOJ boards would continue with the process. 

What are the market implications?

They could be immense. The BOJ initially invested heavily in the Nikkei 225, which comprises Japan’s heavyweight companies, before changing its guidelines in 2021 to only buy ETFs that track the broader Topix index.

The shares of Fast Retailing – the owner of clothing brand Uniqlo and the most heavily weighted stock in the Nikkei – closed 4.5 per cent lower on Friday (Sep 19), the day the BOJ announced its ETF-unwinding plan. 

Large-cap technology shares, to which the BOJ has more exposure, could come under selling pressure. A weaker stock market risks eroding investor enthusiasm for efforts to normalise Japan’s monetary policy.

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Why did the BOJ start buying ETFs in the first place? 

The BOJ began purchasing ETFs in 2010 to revitalise Japan’s corporate sector, lowering the cost of capital by making more funds available and encouraging more risk-taking activity in the economy.

It was the only major central bank to use ETF buying as a way to pump cash into the economy. These funds are usually held by institutional and retail investors.

The asset purchases grew rapidly after Haruhiko Kuroda took the helm of the BOJ in 2013, and this helped prop up Japan’s stock market, as the Nikkei advanced by 57 per cent in that year. However, the effect waned over time.

The buying activity peaked in 2020 as part of measures to support the market amid volatility caused by the Covid-19 pandemic, before slowing to just three purchases in 2023. The central bank said in March 2024 that it would stop buying ETFs, alongside an announcement that it would end the world’s last negative interest rate.

Why have the BOJ’s ETF holdings been criticised?

The central bank’s initial purchases of Nikkei 225 ETFs were controversial as it is a price-weighted gauge, meaning that a company’s weighting in the index is largely decided by how much an individual share is worth. Critics argued that the BOJ’s buying programme favoured the few stocks heavily weighted in the Nikkei.

Another major criticism has been that the central bank’s huge ETF purchases and holdings distort the market. Changes to its policy have sparked outsized moves, such as in 2021, when it shifted from buying Nikkei ETFs to exclusively those tracking the Topix. The change led to a 6 per cent drop in the Nikkei in the next four sessions. 

The BOJ’s holdings also reduce shares available for investors to buy, and make it harder for shareholders to influence corporate governance.