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Nomura analyses new Tokyo index and finds 7% excess return on ESG exclusions

Brokerage giant back-tests new ‘investor friendly’ JPX-Nikkei 400 index

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Japan’s Nomura Equity Research has back-tested the new JPX-Nikkei 400 index and found more than 7% excess return when companies with downgraded environmental, social and governance (ESG) factors are excluded.

The new 400-component index, a joint project of exchange operator Japan Exchange Group, the Tokyo Stock Exchange and Nikkei, went live at the start of this year.

They say it comprises companies with a “high appeal for investors” which meet global investment standards, such as efficient use of capital and investor-focused criteria such as independent external directors and English-language earnings disclosure. It has a relatively large number of relatively small cap stocks that don’t have ESG ratings, Nomura says. It used ESG data from Italy-based ECPI for its analysis.

Nomura’s ESG Research team has looked at historical data for the new index going back to 2006 and found that applying specific exclusion rules “boosts cumulative excess returns versus the original index by around 7.3%”.“As we have demonstrated, screening the JPX-Nikkei 400 by excluding stocks with ESG rating downgrades results not only in better performance but also higher ESG scores for stocks in the investment portfolio,” writes analyst Masako Yamamoto.

“As such, ESG screening may be an effective investment methodology for investors looking to use the new index while also factoring in ESG.”

In January last year the Nomura team demonstrated a link between changes in companies’ environmental, social and governance (ESG) ratings and market outperformance.

In December last year, the first ever domestic Japanese survey of the country’s pension funds and their approach to responsible investment found that more than two thirds of 46 respondents (81%) believe ESG issues are or will be important to their investment decisions.

It came as a draft of Japan’s version of the UK’s Stewardship Code was published by an expert panel.

RI Asia 2014 will be held at the Tokyo Stock Exchange on March 5-6.