The Nikkei 225 and the TOPIX are the two most important stock market indexes in Japan. We discuss their differences and similarities. Furthermore, we address the question of which one makes more sense if we are looking for an ETF to invest in.
The Japanese stock market is the third largest in the world in terms of market capitalization, only behind those of the United States and China. According to data from the World Bank, the value of the Japanese stock market was over $6 trillion at the end of 2019.
Within the famous MSCI World Index, which includes all developed countries, Japan is the second most represented. There is no doubt that Japan is one of the major players in the global economy.
As a result of all that, and the diversification opportunities available, investing in Japanese stocks is a topic of great interest. We all know some of its big corporations: Toyota, Sony, Honda, Panasonic, Softbank, Nintendo, or Mitsubishi.
If we want to invest in Japan through an ETF, we must choose which index we want to track. The two main stock indexes in Japan are the Nikkei 225 and the TOPIX. Let us discuss some of their features so you can determine which one is the best for you.
The Nikkei 225 is the most famous Japanese stock index. This is because it receives the most coverage from the financial press.
It was introduced in 1950 by Nihon Keizai Shimbun, a conglomerate better known as Nikkei. Nikkei is the company that publishes the newspaper with the same name. It is the financial newspaper with the largest circulation in the world. The company Nikkei also owns the British company Financial Times.
The index is made up of 225 of the largest and most liquid companies on the Tokyo Stock Exchange (TSE). The members of the index are from all possible sectors and updated once a year.
The Nikkei 225 reached its all-time high on December 29th, 1989, at 38,957 points. Over the next two decades, it lost 82% of its value, touching 7,055 points in March of 2009. While the index has recovered a lot since then, it remains well below the levels seen during the Japanese housing and real estate bubble.
A very distinctive characteristic of this index is that, unlike most other stock indices, it weights companies according to their nominal stock price, and not their market capitalization.
This has important consequences for how the index looks like, since a company with a high nominal stock price but low market capitalization will have a greater weight than a company with a very large market capitalization but lower nominal stock price.
Because of this, the Nikkei 225 index is not really the best indicator of the Japanese stock market. While this does not have major consequences for the financial press, it is something to be aware of when it comes to passive investing in Japan. At the end of the day, we must remember that our investment in each of the companies in the index is determined by something as random as their nominal share price.
Outside of Japan, the other most famous stock index that weights its companies according to their share price is the Dow Jones Industrial Average.
The TOPIX (Tokyo Stock Price Index) is the other major Japanese stock index. It has been calculated by the Tokyo Stock Exchange since 1969.
Unlike the Nikkei 225 index, the TOPIX contains around 1,700 companies. We are talking about all companies listed on the First Section of the Tokyo Stock Exchange. The First Section is where the companies with the most market capitalization and liquidity are traded.
At the same time, those 1,700 companies are weighted according to their market capitalization (their size) adjusted for free float. The adjustment for free float means that those shares in hands of insiders, such as founders, or public authorities, are not taken into account.
This adjustment is very important in Japan due to the structure of its corporate world. There are many large conglomerates, active in multiple industries and with cross-business participations. Thanks to the fact that the market capitalization of each company is adjusted for the free float, the same participation is never double counted.
For all these reasons, the TOPIX is a more representative index of the Japanese stock market and the country’s economy. Its international equivalents would be the majority of stock indices in the world, including the S&P 500, the DAX and the Footsie 100.
It should be noted that, although the methodology of the TOPIX is diametrically opposed to that of the Nikkei 225, the correlation between both indices is very high. Nevertheless, the movements of the TOPIX are more influenced by the largest companies in the country, while the movements of the Nikkei 225 are more heavily influenced by those companies whose shares have higher nominal prices.
Other Japanese Stock Market Indexes
While the Nikkei 225 and TOPIX are the most important stock market indices in Japan, they are not the only ones.
Both Nikkei and the Tokyo Stock Exchange publish alternative indices with more and fewer stocks. Some examples would be the Nikkei 100 or the TOPIX 500. These reduce the number of stocks within the indexes to 100 and 500, respectively.
At the same time, there are foreign companies that also calculate indices for the Japanese stock market. The other famous Japanese stock indices are the MSCI Japan and the FTSE Japan. Both of them weight their companies according to their market capitalization adjusted for free float. In that sense, they more closely resemble the TOPIX.
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