Lily Chung
Ian Chen
- The FTSE Blossom Japan Index demonstrated significant improvements to the ESG metrics while maintaining minimal tracking error, ensuring reliable performance tracking.
- Strategic exclusion of low ESG sectors led to better risk/return profiles and positive impact investing.
- The index offers a comprehensive multi-asset sustainable solution, harmonizing seamlessly with the methodology of the FTSE Blossom Japan Equity Index.
Increase in sustainable investment in Japan
In October 2023, during a keynote speech at the annual conference of the Principles for Responsible Investment[1] (PRI), Japanese Prime Minister Fumio Kishida made a commitment to increase the levels of sustainable investment in Japan.
Kishida announced that seven Japanese public pension funds, collectively managing JPY 90trn in assets, would sign up to the PRI. This move aims to reinforce the country’s efforts in sustainable finance and to spread the interest to the whole financial market. The new commitment follows in the footsteps of Japan’s Government Pension Investment Fund (GPIF), the largest asset owner globally, with JPY 200trn in assets under management. The GPIF became a PRI signatory in 2015, setting a precedent for responsible investment practices in Japan.
Launched in 2006 and supported by the United Nations, the PRI is a global initiative for responsible investment. By signing up to the PRI, organisations demonstrate their commitment to integrating environmental, social, and governance (ESG) considerations into their investment and ownership practices, and to reporting annually on their progress. Between 2010 and 2023, the number of PRI signatories in Japan has grown from 9 to 128 (see Figure 1) and currently comprises 87 investment managers, 29 asset owners and 12 service providers. This remarkable increase highlights the momentum in Japan towards sustainable finance.
Figure 1. Number of PRI Signatories in Japan
Source: Signatory directory | PRI (unpri.org). Please see the disclaimers for important legal disclosures.
Over the years, GPIF has played a pivotal role in advancing sustainable investment in Japan. Recognising the impact of ESG factors on long-term investment performance, GPIF has integrated ESG considerations across various asset classes. In equity, GPIF has adopted nine domestic and foreign equity ESG indices as passive benchmarks, including the FTSE Blossom Japan Index in 2017, and the FTSE Blossom Japan Sector Relative Index in 2022 (see Figure 2 for a summary of the methodology of these two sustainable equity indices). In fixed income, GPIF collaborates with multilateral development banks and governmental financial to invest in green, social, and sustainability bonds. In addition, in alternative investments, GPIF has integrated ESG into its asset manager selection and post-selection monitoring processes.
Figure 2. FTSE Blossom Japan index and FTSE Blossom Japan Sector Relative index methodology
| FTSE Blossom Japan Index | FTSE Blossom Japan Sector Relative Index |
|---|---|
| Approximately 200 Japanese securities | Approximately 500 Japanese securities |
| Industry-neutral approach to minimise industry bias by matching weights with those of the underlying index | Sector-neutral approach to minimise sector bias by matching weights with those of the underlying Index |
| Selects Japanese companies with an ESG Score 3.3 and above | Selects Japanese companies in the top 50% of each sector and with an ESG Score 2.0 and above |
| Since 2017, demonstrates a clear ESG standard for market participants and companies to utilise in their stewardship and engagement efforts | Supports climate transition to a low carbon economy by evaluating companies’ climate governance and climate change efforts with the TPI Management Quality Score |
Source: FTSE Russell. Please see the disclaimers for important legal disclosures.
With rising institutional and retail demand for sustainable investment options, Japan has witnessed a sharp increase in the availability of sustainable mutual funds and exchange-traded funds (ETFs). Between 2019 and 2023, the number of sustainable funds in Japan has grown from around 90 to more than 260, with the total net assets of these funds expanding nearly eightfold from JPY 516bn to 4,000bn (see Figure 3).
While domestic and international asset managers have responded to this demand by introducing a variety of multi-asset sustainable investment products, equities remain the focus of sustainable funds. Among the 267 sustainable funds domiciled in Japan, 218 are equity funds, accounting for over 90% of the funds’ total net assets as of the end of January 2024 (see Figure 3). Even so, the number of sustainable bond funds and multi-asset funds has risen in recent years, indicating a positive trajectory towards the expansion of sustainable investment choices in Japan.
Figure 3. Sustainable funds market in Japan
Source: LSEG Data & Analytics; TNA: Total Net Assets. Please see the disclaimers for important legal disclosures.
Introducing the FTSE Blossom Japan Fixed Income Index
To meet the rising demand for sustainable fixed income investments, FTSE Russell will be extending the FTSE Blossom approach to the bond markets, launching the FTSE Blossom Japan Fixed Income Index Series for Japanese investors in 2024. The index series will measure the performance of Japanese yen-denominated bonds issued by companies demonstrating specific ESG practices. At launch, the series will include two benchmarks:
- FTSE Blossom Japan corporate bond index: This index will focus on Japanese public corporations, aiming to encourage stewardship and engagement from a governance perspective, thereby fostering transparency and accountability in corporate practices.
It will serve as a pioneering benchmark tracking investment-grade and high-yield JPY corporate bonds issued by the Japanese public companies and their domestic, majority-owned subsidiaries. These companies will be selected based on their membership in the FTSE Blossom Japan sector relative equity index, which selects companies in the top 50% of each sector (ranked by ESG score) and with a minimum score of 2.0. The FTSE Blossom Japan Sector Relative equity index also evaluates companies’ climate governance and their efforts towards climate change mitigation through Transition Pathway Initiative[2] (TPI) Management Quality Scores.
- FTSE Blossom Japan broad bond index: This index will extend coverage to private corporations and the government-related sector including government agency, government-sponsored and local government bonds, providing a more comprehensive view of the Japanese yen bond market for passive tracking purposes.
While the private debt and government debt sectors typically lack ESG ratings coverage, it’s important to note that the absence of data does not necessarily imply poor ESG performance, nor should it automatically lead to exclusion from an ESG index. By adopting a neutral stance and including the private sector and government-related sectors, FTSE is addressing not only the potential liquidity concerns that go with a narrow focus on corporate bonds but also broaden the index’s market representation by enhancing the practicality for a wider investor base.
On request, FTSE Russell can offer tailored versions of these indices, for example including foreign issuers or mortgage-backed securities, ensuring that investors can match their investment portfolios to their preferences and objectives.
Figure 4. Index structure (by market weight)
1 FTSE Japan corporate bond Index is a subset of FTSE Japanese Broad Bond Index (JPBBI). The index includes Japanese yen-denominated corporate bonds issued in the Japanese market.
2 FTSE Japan All Cap Fixed Income Index selects the JPY corporate bonds issued in the Japanese bond market by the Japanese public companies that are in FTSE Japan All Cap Index and their subsidiaries
One of the key objectives of the FTSE Blossom Japan fixed income index series will be to support ESG integration by focusing on bonds issued by Japanese public companies with higher ESG performance. By comparison with its parent index (the Japan All Cap Fixed Income index, which does not have an ESG focus—see Figure 4), the FTSE Blossom Japan index excluded 123 bonds from 16 issuers that do not meet the eligibility criteria for the FTSE Blossom Japan Sector Relative equity index (i.e., an ESG ranking in the top 50% of each sector and an ESG Score of 2.0 and above).
These exclusions are typically due to high greenhouse gas emissions, poor TPI management quality scores or involvement in controversial business activities, while the excluded companies were primarily in the transportation and electricity sectors and with longer-duration bonds. Following the exclusions, the FTSE Blossom Japan Corporate Bond index exhibited a slightly shorter duration and lower coupon rate, while maintaining a similar yield to that of the parent index. The market value weight of the index remained 91% of the parent index, ensuring a similar overall risk profile and characteristics, as shown in Table 1. Similarly, the FTSE Blossom Japan broad bond index encompassed 96% of its parent index. While the effective duration and average life were slightly higher than the base index, the coupon rate and yield remained the same (all data as at March 2024).
Table 1. Index profile
| Index | # of Issues | # of Issuers | Market Weight | Average Coupon (%) | Average Life (Years) | Yield to Maturity (%) | Effective Duration | OAS (bps) |
|---|---|---|---|---|---|---|---|---|
| Blossom Japan Corporate Bond Index | 888 | 127 | 91%* | 0.7 | 5.04 | 0.99 | 4.74 | 64 |
| Parent Index – Japan All Cap Corporate Bond Index | 1,011 | 143 | 100% | 0.74 | 5.52 | 1 | 5.02 | 64 |
| Blossom Japan Broad Bond Index | 2,373 | 183 | 96%* | 0.98 | 13.29 | 0.92 | 11.68 | 5 |
| Parent Index – Japan Broad Bond Index | 2,738 | 220 | 100% | 0.98 | 13.07 | 0.92 | 11.5 | 6 |
Source: FTSE Russell. Data as of March 2024. Please see the disclaimers for important legal disclosures.
*The market weight percentage of the Blossom Japan index refers to its weight compared to its respective parent index.
Given the similar characteristics, the FTSE Blossom Japan fixed income indices are poised to deliver low tracking error compared to their parent indices.
Between June 2018 and March 2024 the maximum monthly return difference was 0.06% for the FTSE Blossom Japan corporate bond index, and 0.05% for the FTSE Blossom Japan broad bond index (See Figure 5). While ESG scores do not necessarily imply better performance, the FTSE Blossom Japan corporate bond index had a positive excess return when the overall corporate bond market experienced downturns.
Figure 5. Index performance in JPY
Source: FTSE Russell. Data from June 2018 to March 2024. Past performance is no guarantee of future results. Please see the end for important legal disclosures. Please see the disclaimers for important legal disclosures.
Source: FTSE Russell. Data from June 2018 to March 2024. Past performance is no guarantee of future results. Please see the end for important legal disclosures. Please see the disclaimers for important legal disclosures.
Over the same period, the FTSE Blossom Japan corporate bond index demonstrated overall outperformance compared to its parent index, with an improving annualised return of 5 bps, a reduction in volatility by 7 bps, and an enhanced Sharpe ratio (+0.05), accompanied by a lower maximum drawdown (see Table 2). Through the exclusion of sectors with low ESG scores or controversial involvement, the index facilitated positive impact investing, while mitigating risks and enhancing the overall risk/return profile.
The FTSE Blossom broad bond index slightly underperformed its parent index over the same period, a fact that can be explained by its omission of foreign issuers, which were the best-performing sector in the Japanese bond market (the FTSE Blossom broad bond index’s focus is on Japanese public corporations). However, the FTSE Blossom Japan broad bond index still maintained a very low tracking error at 0.06%.
Table 2. Performance Statistics
| Performance Statistic | Blossom Japan Corporate Bond Index | Parent Index – Japan All Cap Corporate Bond Index | Blossom Japan Broad Bond Index | Parent Index –Japan Broad Bond Index |
|---|---|---|---|---|
| Annualised Return | 0.07% | 0.02% | -1.02% | -1.00% |
| Annualised Volatility | 1.13% | 1.20% | 3.01% | 2.94% |
| Sharpe Ratio | 0 | 0.01 | -34% | -0.34 |
| Sortino Ratio | 0 | 0.02 | -0.53 | -0.53 |
| Calmar Ratio | 0 | 0.01 | -8% | -0.08 |
| % Positive Months | 50.72% | 53.62% | 44.93% | 44.93% |
| Higherst Monthly Return | 0.96% | 1.00% | 2.61% | 2.56% |
| Lowest Monthly Return | -1.19% | -1.23% | -2.08% | -2.04% |
| Max Drawdown | -2.96% | -3.34% | -12.47% | -12.19% |
| Tracking error (vs parent index) | 0.09% | - | 0.06% | - |
Source: FTSE Russell. Data from June 2018 to October 2023. Past performance is no guarantee of future results. Please see the disclaimers for important legal disclosures.
This strategic exclusion has led to significant improvements in ESG scores (3.76 vs. 3.59) and environmental, social and governance pillar scores, as indicated in Table 3. Additionally, there was an uplift in the TPI management quality score from 3.32 to 3.38.
Table 3. ESG excess score
| ESG Excess Score | Blossom Japan Corporate Bond Index | Base Index - Japan All Cap Corporate Bond Index | Blossom Japan Broad Bond Index | Base Index - Japan Broad Bond Index |
|---|---|---|---|---|
| ESG Score | 3.76 | 3.59 | 3.76 | 3.59 |
| E Score | 3.66 | 3.52 | 3.66 | 3.52 |
| S Score | 3.72 | 3.49 | 3.72 | 3.49 |
| G Score | 3.93 | 3.79 | 3.93 | 3.79 |
| TPI MQ | 3.38 | 3.32 | 3.38 | 3.32 |
| Data Coverage | 100.0% | 100.0% | 6.5% | 6.9% |
Note that Blossom Japan Broad Bond Index included both private and government-related sector which typically lack ESG data coverage, resulting in lower data coverage. The absence of data does not necessarily imply poor ESG performance, nor should it automatically lead to exclusion from an ESG index. FTSE is adopting a neutral stance by including the private sector and government-related sectors while addressing the potential liquidity concerns that go with a narrow focus on corporate bonds.
Source: FTSE Russell. Data as of March 2024. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
Conclusion
ESG integration lies at the heart of the FTSE Blossom Japan fixed income index, has driven improved corporate sustainability performance and practice without compromising returns. Based on past performance, the FTSE Blossom index methodology has demonstrated significant improvements to the ESG metrics while maintaining minimal tracking error to the respective parent indices. Moreover, its alignment with the methodology of the FTSE Blossom Japan equity index enables investors to adopt a joined-up approach to multi-asset sustainable investment strategies.
As Japan embarks on its journey towards a sustainable future, innovative indices like the FTSE Japan Blossom fixed income index will aim to drive positive change within the financial markets. By harnessing the power of finance to drive positive environmental, social and governance outcomes, we pave the way for a more sustainable and resilient future.
As investors embrace the principles of sustainable finance, FTSE Russell provides robust, transparent investment solutions to shape a world that grows with sustainability. The FTSE Blossom Japan fixed income index promises to be an attractive new option for investors in conventional Japanese corporate bonds.
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