Understanding the Japanese stock market – the Tokyo Stock Exchange restructure

Josef Licsauer | 2 June 2023

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Understanding the Japanese stock market – the Tokyo Stock Exchange restructure

As the third largest economy, Japan is home to one of the biggest stock markets in the world. The Tokyo Stock Exchange (TSE) was set up in 1878 and is run by the Japan Exchange Group. Made up of almost 4,000 listed companies the TSE is in the heart of Japan’s capital city, Tokyo.

Though big, it’s a complex exchange. It can be overlooked or misunderstood. Investors tend to be more familiar with the likes of the London Stock Exchange (LSE) or the New York Stock Exchange (NYSE).

To help address its complexities, the TSE was restructured on 4 April 2022 and the old market divisions changed into three new segments.

Let’s look at each in more detail.

This isn’t personal advice. If you’re not sure what’s right for your circumstances, ask for financial advice. Remember all investments can fall as well as rise in value, so you might get back less than you invest. Past performance isn’t a guide to the future.

The TSE market restructure

Before the restructure there were five main divisions within the TSE – the First Section, Second Section, Mothers, JASDAQ (standard and growth) and Tokyo Pro Market.

While these divisions served a purpose, the number of different sections made it hard to understand why companies fell into one section over another. It also made comparison of standards, comparing to other parts of the world around company disclosures and levels of governance, difficult. On top of this, historically Japanese companies haven’t had a great deal of accountability to shareholders.

The late Shinzo Abe, one of Japan’s most loved Prime Ministers, tried to address some of these issues in 2012. He did this through more structured political and economic reforms known as Abenomics. While some good progress was made, there are still plenty more opportunities for improvement.

What’s changed?

On 4 April 2022, four out of the five market divisions changed into three new market segments:

Prime Market – highest requirements for levels of liquidity, corporate governance, and commitment to sustainable growth. Companies also need to show constructive dialogue with investors
Standard Market – lower requirements compared to the Prime market, but still requires companies to place an emphasis on liquidity, corporate governance, and sustainable growth
Growth Market – the smallest out of the three segments, it focuses on smaller and emerging companies with a market cap of less than 500 million yen (roughly £3 million)
The Tokyo Pro Market hasn’t been changed for now

The purpose is to raise the overall standards of listed Japanese companies, as well as the requirements to be added to and stay part of a particular market.

Off the back of these changes, improvements are likely to mean a clearer environmental, social and governance (ESG) focus, diversity within companies, and better disclosure. This might mean companies are viewed more positively and potentially fuelling greater interest from foreign investors.

Since the restructure was completed in April 2022, there’s been a lot of criticism about markets still being too complex and the new rules being too lax. Overall, there hasn’t been enough change (nearly 85% of companies that were in the earlier ‘Top Section’ are now in the new ‘Prime’ market for example), and companies are still not meeting the disclosure and governance requirements.

At the end of December 2022, 10 to 20% of companies in each market didn’t meet the standards set out by the TSE. Roughly 269 companies in the Prime section, 200 companies in the Standard section and 41 companies in the Growth section, failed to meet the new criteria in full.

So, what’s happening to these companies?

In January 2023, the TSE said it would ramp up the pressure on the businesses failing to comply. If companies listed on the Prime market haven’t met the new rules and requirements by March 2025, they’ll be given a one-year “improvement period” to become compliant.

If companies still fall short, they’ll be designated as shares under supervision for three to six months before delisting. Both the Standard and Growth markets are expected to be held to this as well.

A couple of months later, the TSE announced more specific requests for companies listed on the Prime and Standard sections. One example is they want companies to become more strongly aware of raising their corporate values in the medium-to-long term, and give a draft of their specific plans. At time of writing, no timeframe has been specified.

Despite this ultimatum and request for plans showing their efforts, many think it’s not harsh enough or being enforced quick enough. Others think there are still far too many companies in the Prime market. While improvements are being made, it’s clear the restructuring will take time to perfect, and we’d expect more changes to come.

But that doesn’t mean there aren’t opportunities in Japan.

Investment ideas

While Japan is still off the radar for lots of investors, we think the Japanese stock market is attractively valued. There are lots of parts of Japan that are misunderstood and under researched, so there might be some hidden gems for investors.

For those without the time or knowledge to navigate the complexities of investing in Japanese companies for themselves, a fund might be an option.

Investing in funds isn't right for everyone. Investors should only invest if the fund's objectives are aligned with their own, and there's a specific need for the type of investment being made. Investors should understand the specific risks of a fund before they invest, and make sure any new investment forms part of a diversified portfolio.

iShares Japan Equity Index

Tracker funds can be a great way to get diverse and low-cost access to a certain market by tracking the performance of a stock market index.

This fund aims to match the performance of the FTSE Japan – a broad index of more than 500 companies. These are selected by FTSE as a representation of large and medium sized companies in Japan. The fund invests in every company in the FTSE Japan Index to track the index as closely as possible.

While it invests more in larger companies, it can invest in higher-risk smaller companies too. It also invests in a range of different sectors, including industrials, consumer discretionary, technology and healthcare. We think it’s a good option for low-cost, broad exposure to the Japanese stock market.

MORE ABOUT ISHARES JAPAN EQUITY INDEX, INCLUDING CHARGES

ISHARES JAPAN EQUITY INDEX KEY INVESTOR INFORMATION

Man GLG Japan CoreAlpha

Active funds are another way to invest. They're run by a professional investment manager who will try to beat a certain index, instead of just tracking it. While there’s potential for the fund to perform better than the index over the long run, the reverse can also be true.

Jeff Atherton and his team invest in companies they feel can be bought at a lower price than their true worth and sell them when they feel the company and the share price has recovered. It’s a style known as value investing. Remember though, not all these companies are guaranteed to make a recovery. Their discipline in this approach has set them apart from their peers.

The fund invests in a relatively small number of companies. That means each one can have a significant impact on how the fund performs, which adds risk. While this can increase the fund’s performance potential, it is a higher-risk approach.

MORE ABOUT MAN GLG JAPAN COREALPHA, INCLUDING CHARGES

MAN GLG JAPAN COREALPHA KEY INVESTOR INFORMATION

FSSA Japan Focus

This active fund invests in companies that are dominant in their industries. The managers believe the strength and quality of the companies they own is what drives returns over the long run.

They tend to invest in relatively few companies which adds risk. Over two thirds of the fund is invested in technology, industrials, and consumer staples companies. This can change over time, depending on where they find what they believe to be the best opportunities.

MORE ABOUT FSSA JAPAN FOCUS, INCLUDING CHARGES

FSSA JAPAN FOCUS KEY INVESTOR INFORMATION

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Our fund research is for investors who understand the risks of investing and that investing in funds isn't right for everyone. Investors should only invest if the fund's objectives are aligned with their own, and there's a specific need for the type of investment being made. Investors should understand the specific risks of a fund before they invest, and make sure any new investment forms part of a diversified portfolio.