This is the first installment of a series on what the BOJ should do with its equity ETF holdings. The BOJ began purchasing ETFs more than a decade ago. While it has now nearly halted new purchases after revising its asset purchasing policies several times, it has amassed ETF holdings with a book value of ¥36trn as of April 30, 2022. It is time for serious thought about the BOJ’s ETF holdings going forward.

I previously wrote about this issue in BOJ exit discussions missing the forest for the trees (lakyara vol. 336, March 2021), in which I noted that ideas were being bandied about but discussions seemed to be going nowhere. A number of commentators have since proposed comprehensive, realistic exit strategies. In this series, I will offer my take on these proposals.

The first commentator whose ideas I want to discuss is Kenichi Hirayama. While an executive officer of Tokio Marine Asset Management, Hirayama wrote an entire book¹ on the BOJ’s ETF purchases. His book presented many cogent arguments from the perspective of a market participant with a wealth of hands-on expertise in fund management, but I want to focus solely on its content pertaining to the BOJ’s ETF exit strategy.

Hirayama’s core proposal is that the BOJ should declare a freeze on ETF purchases. Because ETFs, unlike JGBs, have no maturity date, most of the ETF exit strategies proposed so far involve selling. Hirayama, however, rules out this option from the outset. He argues that the BOJ should publicly pledge to not sell its ETF holdings.

Many people may be taken aback by the argument that the BOJ should retain its ETF holdings in perpetuity. This argument is open to criticism on various grounds, including the problematic implications of a central bank indirectly becoming a major corporate shareholder through ETF ownership and the inappropriateness of holding ETFs as an asset to back a currency given their risk of price volatility. That said, I think declaring a freeze on ETF purchases makes sense as a first step. Conversely, the BOJ should not unwind its ETF holdings if doing so would exert too much selling pressure on the equity market.

Hirayama goes on to propose that once the BOJ has frozen its ETF purchases, it should redeem its ETF holdings, converting them from a collective investment scheme to cash equities. He recommends holding the equities in an index-tracking portfolio under a discretionary investment contract. Such an approach would enable the BOJ to reduce its cost of ownership by 80-90% and strengthen its commitment to corporate stewardship, most notably by directly voting the shares it owns. I find Hirayama’s proposal to be very sensible.

Hirayama proposes that the index-tracking portfolio of cash equities ultimately be named the Long-Term Growth Fund and that dividends generated by the portfolio (~¥600bn per year) be earmarked largely for funding R&D expenses. In other words, profits generated by Japanese companies would be used to seed Japan’s future.

I wholeheartedly endorse the idea of putting the income from the BOJ’s ETF holdings to good use. I personally believe the government, not the BOJ, should decide how to utilize the ETFs because spending decisions are within the realm of fiscal policy. I think the government should buy the BOJ’s ETF holdings and pledge not to sell them for at least a while. The government would then formulate policies on how to best utilize the ETFs without selling them.

Even if the government were to commit to buying the BOJ’s ETF holdings, much of the public would likely be skeptical of its ability to actually do so, given the ETF holdings’ enormous market value in excess of ¥50trn. Having discussed this issue with many people, I am under the impression that quite a few people doubt the government has the fiscal wherewithal to purchase the BOJ’s ETF holdings. However, there is a realistic solution to this funding problem, as I will discuss in my next installment. (To be continued)

• ¹  

  Nichigin ETF Mondai (Chuokeizai-sha)

• Katsutoshi Takehana

  Group Manager

  Financial Market & Digital Business Research Department