(Oct 7): Japan Exchange Group Inc unveiled the biggest-ever reshuffle of the Topix on Wednesday, a revamp that shrinks one of Asia’s broadest major equity benchmarks and intensifies pressure on Japanese companies to boost their market appeal.

There were 683 companies earmarked for removal under tougher inclusion rules, according to JPX’s announcement. Those slated for gradual removal include Medley Inc and Ichiyoshi Securities Co. Among the 35 stocks that will be added are McDonald’s Holdings Co Japan and Ferrotec Corp. The changes will begin to take effect on Oct 30.

The changes are the second stage of a multiyear effort by the group, which operates the Tokyo Stock Exchange, to make the Topix more investable. The benchmark has long stood out among major global indexes for its large number of constituents, including hundreds of relatively illiquid small-cap companies.

The overhaul has potentially significant implications for global investors. About ¥166 trillion (RM4.3 trillion) in passive assets track the Topix, according to a September estimate by Daiwa Securities chief quantitative analyst Junichi Hashimoto. Companies that are to be dropped face rules-driven selling by index funds while those pencilled for inclusion can generate steady demand from passive investors and will be on the radar of active managers seeking to beat the index.

The first phase of the revamp that ended in January 2025 reduced the number of members to about 1,700 from roughly 2,200. After the latest overhaul, the tally could fall further to just under 1,000 in two years. Cutting the number of constituents should make it easier for investors to run passive strategies tracking the index while encouraging competition among aspiring companies to secure a place in the benchmark.

Reducing Topix constituents is “basically positive", said Hiromi Ishihara, head of equity investment at Amundi Japan Ltd. As companies increasingly need to justify their inclusion in the index and “if steady reforms at individual companies add up, the Japanese equity market as a whole could gain a higher valuation,” she said.

Ishihara said there have been several cases in which small-cap companies stepped up shareholder returns in an effort to avoid removal from the Topix, helping to lift their share prices. For investors, she said, there are opportunities in determining “whether actions aimed at staying in the index end up being temporary measures to support the share price or lead to genuine increases in corporate value through stronger corporate governance and other reforms.”

Under the new rules, additions and deletions will be determined using criteria including annual traded-value turnover, a measure of how actively shares change hands and the market capitalisation of shares available to public investors.

Stocks selected for removal will not disappear from the index immediately. Their weightings will be reduced quarterly through July 2028. Companies that meet the requirements when they are reassessed in October 2027 can halt that process. From October 2028, the benchmark will be rebalanced annually.

Investors are expected to remain mindful of the risk that small-cap stocks could be removed from Topix going forward and “the trend toward large-cap stocks will likely strengthen”, said Shota Sando, an analyst at Tokai Tokyo Intelligence Lab.

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