The Bank of Japan's purchases of the country's exchange-traded funds (ETFs) has been distorting the market, offering traders a leg up on picking stock winners.
Japan's central bank has been scooping up ETFs and the numbers are large enough to sway markets. At its late July meeting, it said it would increase its ETF purchases so that their amount outstanding will rise at an annual pace of 6 trillion yen ($56.7 billion), from 3.3 trillion yen previously.
The book value of the BOJ's ETF holdings was 8.7 trillion yen at the end of July, Citigroup said, citing BOJ data, with the investment bank estimating the market value of 9.7 trillion yen at that time.
That's introducing distortions into Japan's stock market, not just from the amount, but also due to the makeup, with more than 50 percent of the purchases in ETFs tied to the Nikkei 225 index, analysts said.
That's because the Nikkei 225 index is weighted by the price of individual stocks, compared with other indexes, such as the broader Topix, which are weighted by market capitalization. Indeed, in a note dated Sunday, CLSA analyst Nicholas Smith called the Nikkei 225 a "Flintstones index from an abacus age."
But the BOJ's focus on Nikkei 225-tied ETFs can open up opportunities for traders.
For one, analysts have advised focusing on sectors strongly represented in the Nikkei index, rather than the Topix.
"If the BOJ were to continue to purchase mainly ETFs linked to the Nikkei average, we would recommend overweighting sectors with high weightings in the Nikkei, namely retail, electricals, information and communications, pharmaceuticals, and chemicals," Citigroup said in a note dated Tuesday.
"At the individual stock level, we would overweight names with high ratios of BOJ purchases to trading value and stocks that are overweight in the Nikkei average and underweight those which are underweight in the Nikkei average," it added.