Mitsubishi UFJ Trust and Banking Corporation

SMART BETA in Japan

SEPTEMBER 2015

A member of MUFG, a global financial group

Smart beta : the 360°view For Seminar Use Only

1. Smart Beta in Japan 2. Quality investing in Japan 3. Conclusion

1

Outline

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JAPA

N E

TF A

UM

MU

TB s

mar

t bet

a AU

M

MUTB smart beta AUM(left) JAPAN ETF AUM(right)

(Billion Yen) (Billion Yen)

2

Smart Beta in Japan

Source: MUTB, The Investment Trusts Association

• ETF AUM in Japan and smart beta AUM at MUTB are increasing rapidly

• 2013 Japanese pensions invest Smart Beta in earnest • 2014 JPX-Nikkei 400 GPIF allocates to Smart Beta • 2015 Stewardship code and Corporate Governance code

3

Smart Beta in Japan

Source: R&I, MUTB

Top AUM of smart beta in Japan • value（fundamental） • minimum variance and low volatility • quality（including JPX-Nikkei400）

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mvp

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divi

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AUM of smart beta in Japan

Mar-14 Mar-15

（Billion Yen)

-150%

-50%

50%

150%

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09

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09

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Quality HDY Value VOLA SIZE

Quality

Value

HDY

SIZE

VOLA

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Factor return in Japan

Source: MUTB

• Value factor has been effective in Japan for a long time. • Quality factor is not efficient in Japan

-150%

-100%

-50%

0%

50%

100%

150%

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Quality HDY Value VOLA SIZE

Quality

Value VOLA SIZE

HDY

Japan

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150%

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Quality HDY Value VOLA SIZE

HDY

SIZE

Value

Quality

VOLA

Europe

USA

<factor definition> • Quality（ROE, High-Low） • Value(P/B Ratio, Low-High) • SIZE(Market Cap, Small-Big) • VOLA(Historical Volatility, Low-High) • HDY(Dividend Yield, High-Low) data: from Sep 2006 to Jul 2015

5

Challenges to ROE investing in Japan

Source: MUTB

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PBR

ROE

Equity Valuation

ROE based

B/S based

Theoretical relation <ex> Finite RIM Valuation Assume

• const. ROE

• RI >0 for 10YR

• cost of equity 8%

• investors optimally stop

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Challenges to ROE investing in Japan

Source: MUTB

• ROE of many companies in Japan are low • Stock prices in Japan have been determined by

value rather than growth.

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ROE

P/B-ROE in Japan Number of Sec(Right)PBR(Left)

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P/B-ROE in USA Number of Sec(Right)PBR(Left)

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P/B-ROE in Europe Number of Sec(Right)PBR(Left)

・ROE used the realized net income and book-value at the latest fiscal period. ・P/B Ratio used the latest book-value and market cap of the data period. ・universe: STOXX global 1800 ・data : the end of March 2015

7

Change in attitudes towards ROE

Source: MUTB

• Action by companies on ROE investment environment company's reaction ROE

1994～1996 ・Emergence of a foreign investor ・Prefer to financial solvency by bad-loan problem of bank and fallof the property price

not increased

2005～2008 ・A foreign investor included in"Activist" rises more

・Midterm management plan and share buy-back・Prefer to financial solvency by the lehman shock

not increased

2012～・Abenomics・Japan's Stewardship Code・Japan's Corporate governance Code

・Strongly conscious of ROE management・Setting the target of ROE increase?

GPIF restructuring of investment policy

JPX-Nikkei400

Japanstewardship code

Corporategovernance

code

strengthingcorporate

governance / ROE

improvement

Policy to fulfill responsibility

adopting as benchmark

pressure through index review

ISS rejects proposals regarding the election of a director of low ROE company comunication

ROE target

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Change in attitudes towards ROE

Stewardship code and Corporate governance code

Source: MUTB

（Contents） Monitor investee companies Understand in common with investee companies

through the constructive engagement Have a clear policy on voting and disclosure of

voting activity

（Object）To promote sustainable growth of companies through investment and dialogue （Outline）Produced by the Financial Services Agency in accordance with Japan Revitalization Strategy. Principles of the Institutional Investor to appropriately discharge their stewardship responsibility.

Japan’s Stewardship Code Corporate Governance Code

finalized on Feb 2014

entered into force in June 2015

（Object）To promote transparent, fair, timely and decisive decision-making and to support sustainable corporate growth and increase corporate value over the mid- to long-term. （Outline）Produced by the Financial Services Agency and the Japan Exchange Group in accordance with Japan Revitalization Strategy (revised).

ROE improvement・sustainable growth of companies

Institutional Investor listed company

Voting

（Contents） responsibilities of the board dialogue with shareholders ensuring appropriate information disclosure and

transparency

Engagement

9

Change in attitudes towards ROE

• Changes in enterprise behavior Election of outside directors → ratio is rapidly increasing Setting a ROE target → Number of companies is increasing

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Setting a ROE target

source：MUTB, http://www.jacd.jp/, universe：TOPIX500

74%

92%

61%

85%

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100%

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

The outside director election company ratio (TSE1)

The independent outside director electioncompany ratio (TSE1)

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Key to ROE investing

Source: FactSet, MUTB

• Companies that sustain consistently high ROE: Companies that currently have a high ROE in the top 1/3 and remain in the top 1/3 for the next 2 fiscal years.

• Companies that fail to sustain high ROE: Companies that currently have a high ROE in the top 1/3 but are not in the top 1/3 in either or both of the next 2 fiscal years.

• The chart shows cumulative excess returns for each group assuming monthly rebalancing. • Universe: Top 500 companies by market capitalisation. • Period: from Mar 2006 to Jul 2013.

• Companies with consistently high ROE mark positive returns over the mid-to-long term, while those failing to sustain high ROE are likely to produce negative returns.

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200603 200703 200803 200903 201003 201103 201203 201303

Companies that sustain consistently high ROE

Companies that fail to sustain high ROE

Performance comparison

Excess return over TOPIX (%)

High ROE into the future

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1. Financial Health

Financial strength unlikely to be affected by economic fluctuations

2. Profitability Ability to generate cash-flow efficiently with high profitability

3. Business Stability Stable business model

Cash-Flow generation

ability

3 factors to sustain high ROE

Key to ROE investing

• Financial health, profitability and business stability are important factors to sustaining high ROE.

Low total debt to total capital

ratio

Low earnings variability

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Key to ROE investing

Source: MUTB

• At high ROE companies, companies with low D/C ratio, strong cash flow generation ability and low earnings variability are likely to be able to sustain high ROE.

• Companies with current high ROE are divided into 3 groups by each indicator. Relative change in average ROE of group to average ROE of total over next fiscal year and following fiscal year after.

• Universe: STOXX Japan 600. • Period: from Mar 2006 to Jul 2013.

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１year later 2 year laterrela

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ROE relative change by debt to capital

1(Low D/C ratio) 2 3(High D/C ratio)

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ROE relative change by earnings variability

1(low volatility) 2 3(high volatility)

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ROE relative change by cash flow generation ability

1(Strong CF Generation) 2 3(Weak CF Generation)

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Key to ROE investing

Source: STOXX, MUTB

Discriminant Analysis 𝑦𝑦 = 𝛼𝛼 + 𝑎𝑎1𝑥𝑥1 + 𝑎𝑎2𝑥𝑥2 + 𝑎𝑎3𝑥𝑥3

• 𝑌𝑌 𝑖𝑖𝑖𝑖 1 when companies that currently have a high ROE in the top 1/3 and remain in the top 1/3 for the next 2 fiscal years and y is 0 when companies that currently have a high ROE in the top 1/3 but are not in the top 1/3 in either or both of the next 2 fiscal years

• Combination of 3 indicators is average of debt to capital, CF generation and Earnings variability. • Universe: STOXX Japan 600 • Period: from Mar 2006 to Jul 2013.

A B C D E

Intercept 0.48 0.38 0.54 0.38 0.40

(t value) (50.99) (33.19) (57.22) (29.15) (31.93)

Debt to Capital 0.14 -0.02

(t value) (8.8) (-0.97)

Cashflow genaration ability 0.28 0.29

(t value) (17.06) (14.6)

Earnings variability 0.04 -0.01

(t value) (2.15) (-0.3)

Combination of 3 indicator 0.28 (t value) (12.7)

Rsquare 0.0069 0.0255 0.0004 0.0256 0.0143

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Efficacy of quality investing

• iSTOXX MUTB Japan Quality 150 has a tendency to achieve higher Sharpe Ratio than TOPIX.

Cumulative return and excess return over TOPIX (from Jan 2005 to Jun 2015)

Performance from Jan 2005 to Jun 2015 Source: STOXX, MUTB

Annualised Return

Standard Deviation

Sharpe Ratio

iSTOXX MUTB Japan Quality 150 7.5% 17.4% 0.43

TOPIX 5.3% 18.4% 0.29

▲ 40%

▲ 20%

0%

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100%

120%

2004.12 2005.12 2006.12 2007.12 2008.12 2009.12 2010.12 2011.12 2012.12 2013.12 2014.12

Excess Retun over TOPIX STOXX MUTB Japan Quality TOPIX

15

Efficacy of quality investing

Source: MUTB

• Representative examples of companies that have sustained high ROE

SUNDRUG KOBAYASHI PHARMACEUTICAL

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35.0%

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ROE Debt_to_Capital CF_Gen Earnings_Stdev

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Conclusion

• Smart beta AUM is increasing rapidly.

• Minimum variance is very popular.

• In Japan, value factor has been most efficient and quality has been not so efficient.

• After Abenomics, the company’ CEO has been strongly conscious of ROE management.

• To invest in the quality factor, we need to focus on the sustainability of high ROE.

• Financial health, profitability and business stability are important to sustain high ROE.

• By increasing the effective factors (smart beta), we will have many choices to invest and expect the expansion of the investor base and low cost passive funds (ETF).

The information contained in this document is for information purposes only and does not constitute an offer or a solicitation of an offer to buy or sell a security.

Past performance (including back test) is not necessarily a guide to future performance. Principal and income of the Investments are subject to risk and there is no guarantee that the investment objectives will be achieved. The value of the investments can fall as well as rise and investors may not get back the full amount originally invested.

Investing in securities including Japanese equities involves risk, and may result in the loss of the whole investment. Risks include: ・Market risk: the risk of price fluctuations of invested securities due to various market risk factors including movements in

equity markets, interest rates and exchange rates. ・Credit risk: the risk of price fluctuations of invested securities due to the business and financial state of the issuer.

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