Our View on the TOPIX Revision Proposal

On June 10, 2024, the Japan Exchange Group announced a proposal to revise the TOPIX, Japan's benchmark stock index. There are three important points in the proposed revision: the number of stocks to be included in the index will be reduced, the index will be reviewed once a year, and there will be no significant impact on the price movements of the index. Let's look at the details of each of these points.

Regarding the first point, the number of stocks to be included in the index will be reduced from approximately 2,100 at present to 1,200 by October 2028. The number will be reduced based on criteria such as stock liquidity and free float ratio. Second, since there has been no regular replacement system in the past, once a company is selected, it will continue to be included in the index, but it will be replaced every October from now on. The third point, price fluctuation, is expected to have little impact on the market, as the transition to the new rules will take place over time, in eight quarterly installments from 2026 to 2028. According to SMBC Nikko Securities, the tracking error between the current TOPIX and the new rules will be only 0.24% based on the past five years of data, so the change is not expected to cause any confusion in the market.

Even if there is no major disruption to the market as a whole, from the perspective of individual companies, the impact on companies that may be excluded from the TOPIX will not be small. They will lose investment from funds linked to the TOPIX, which is expected to have a negative impact on their stock prices. Therefore, there is a strong incentive for companies (mainly small- and mid-cap stocks) that are on the fence about being included in the index to increase their stock price and stock liquidity as a measure to survive inclusion in the index. One immediate measure is to encourage stable shareholders, represented by strategic shareholders, to sell their shares. An increasing number of companies are already willing to sell their strategic holdings as part of corporate governance reforms, and the TOPIX review will be a force that encourages this trend. More fundamentally, listed companies are also expected to step up their efforts to enhance corporate value. The economy as a whole will be positively impacted if more companies make direct efforts to increase value creation, promote sustainability, and enhance dialogue with investors. In such a process, companies are expected to become more active in their investor relations activities, and investors are called upon to play a role in supporting corporate value creation.

Looking at stock price trends over the past few years, large-cap stocks have continued to dominate, while small-cap stocks have become more attractive in terms of valuation. Although the TOPIX has risen 80% over the past five years, there has been a wide variation in performance by company size. The TOPIX Core 30, which includes only 30 large-cap stocks, rose 106%, while the TOPIX Small, which includes small-cap stocks, rose only 58%. In addition, the TSE Growth Market 250 Index (formerly the TSE Mothers Index), which consists of small growth stocks, fell 27%.

Companies with undervalued stock prices and a sense of urgency in their efforts to increase their value will provide investment and engagement opportunities, making Japanese small and mid-cap stocks increasingly attractive as investment candidates.