Thread by @bauhiniacapital

JPX Nikkei 400 has always been a RIDICULOUS Index but because it purports to have governance factors, it gets mindshare.

The fine print? In rebals, 40% of the ranking is ROE, 60% is size-related.

Result: big companies go in. Then they get the boot if they lose money.

Then when they make money again, they go back in.

Practical result? Stocks go up. They go in. They go down? They get sold. Buy high sell low.

The governance bit? IFRS, Independent Directors, English Docs, etc are meant to provide a swing of 10 names out of 400.

This year the rebal is 32 names in and 27 out (5 had been merged and they re-up to 400 only once a year). That's of 400 names.

And 60% of the flow in the trade is actually funded by bringing a half dozen names down to the 1.5% cap.

How important is the index?

~3% of major index passive AUM among TOPIX, N225, JPNK400, MSCI, FTSE.

How differentiated vs TOPIX?

7yr beta to TOPIX? 1.003
7yr R^2? 0.997
7yr Perf vs TPX? -17bp (-0.0243%p.a.)

So today, first day after the rebal, ADDs underperformed DELETEs on average by 2.77%.

This is the biggest one-day move I can remember in a rebal period for the ADDs vs DELETEs basket since the index was created.

It is not clear this is rebal-related given the huge moves in biases today in the market. But because the Add vs Delete function is fundamentally long vs short momentum, the risk is clear.