A pedestrian holding an umbrella walks past an electronic board showing the graph of the recent fluctuations of Japan's Nikkei average outside a brokerage in Tokyo

Rise and fall of Japan defensive stocks highlights new class of indexes

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By Tomo Uetake

TOKYO (Reuters) – Japanese defensive shares, a star performer early this year, suddenly lost steam over the past month as buying fueled by a new class of stock indexes had run its course and higher bond yields undercut their attraction.

Their valuations remain high, suggesting they are unlikely to be leading a market rally again soon, although some market players think attention to the new benchmarks based on “smart beta” strategies will underpin defensive stocks in the long run.

In the short run, a reversal for drugmakers, food companies and railway operators has caused the Topix Growth Index <.TOPXG>, which includes many defensive shares, to shed all of its outperformance versus the Topix Value index <.TOPXV> over the past 1-1/2 years.

Early this year, defensive shares shot up because yield-hungry investors bought them as an alternative to bonds, said Shun Maruyama, chief Japan equity strategist at BNP Paribas.

“There are investors globally who seek dividend yield when there’s low growth, low inflation and low interest rates,” he said, adding that bubbles in defensive shares that yield-hunting creates will end when interest rates rise.  

Indeed, that’s what happened to bond yields in developed markets in late April.

Earlier, the chase for defensives was fueled by investors such as pension funds using smart beta indexes, which are a hybrid of passive and active investments.

Many defensive shares became too expensive as shorter-term players, such as hedge funds and retail traders, bought in. Even some active fund managers, many of whom had underweighted defensive shares, jumped on the bandwagon.

One share that bubbled was drugmaker Eisai <4523.T>, the biggest component in the MSCI Japan Minimum Volatility Index, one of the most popular smart beta indexes with heavy exposure to defensive stocks.

Eisai rose 82 percent in the first quarter and once was trading at more than 100 times earnings. In general, price-earnings multiples above 20 are considered in expensive, and possibly overvalued, territory.


But buying of defensives started to subside just before the new financial year started on April 1. From a lifetime high on March 24, Eisai’s share price has fallen nearly 20 percent.

Investors kept buying Eisai and others “until they realized they had climbed a tree too high – to the point where they didn’t know how to climb down,” said Yasuo Sakuma, portfolio manager at Bayview Asset Management.

“On the whole, the market is not in a bubble,” he said. “But the tide may be changing from ‘search for yield’ to ‘search for real growth’.”

Seiichiro Uchi, managing director of MSCI in Tokyo, estimated that at the end of 2014, about $10 billion was invested in Japan in funds benchmarked to MSCI’s seven smart beta offerings.

He said that the semi-public Pension Fund Association for Local Government Officials, with 19 trillion yen ($153.2 billion) in assets under management, is among major pension funds that used its minimum volatility index.

Pension funds are expected to do fresh allocations around June, and smart beta funds could draw new attention.

“In the long run, a shift to smart beta will continue,” said Shingo Ide, chief equity strategist at NLI Research Institute.

(Editing by Richard Borsuk)


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