Mini-Stocks for the Mini-Investor in Japan

Mini-stocks are Japanese stocks traded in lot sizes one-tenth the minimum trading units (tanni). Japanese stocks have traditionally maintained a minimum trading unit (or minimum lot size) of 1,000 shares, although some have minimums of 100, 10, or even one share. With few stocks trading in less than four-digit yen prices, taking a position in a Japanese stock can be a very expensive proposition for the small investor. As an example, purchasing shares of Fujitsu Limited (6702) with a minimum trading unit of 1,000 shares at a recent price of ¥3,350 would require a hefty investment of ¥3,350,000. With mini-stocks, an investor could buy 100 shares with only ¥335,000. Because fractional shares cannot be traded, however, stocks with a minimum trading unit of one share, such as Yahoo Japan (4689) or NTT DoCoMo (9437), are not eligible to be miniaturized.

Mini-stocks are provided by a handful of Japanese brokerages (see inset). Some brokers offer a wider selection of mini-stocks than others. Mini-stocks are treated the same as regular stocks for tax purposes and typically do not incur any additional fees to the normal brokerage commissions.

While policies differ slightly from broker to broker, mini-stocks generally work the following way. Ten mini-stock orders are pooled together by the broker and executed as a regular stock order at the following business day's opening price. The disadvantages of mini-stocks are that the client cannot specify a limit price or limit period and cannot have a trade executed on the day of the order. Mini-stocks are not a good tool for day-traders, but are an affordable way for the small investor not concerned with daily price fluctuations to invest in individual Japanese stocks.

Although public companies in Japan have catered primarily to institutional investors, some are beginning to conduct stock splits and to lower their minimum trading units in order to both boost liquidity and attract smaller investors. Hopefully, this trend will eventually eliminate the need for mini-stocks all together.

ADRs
Mini-stocks are a service offered by certain Japanese brokerages, but currently only residents of Japan are eligible to open Japanese brokerage accounts. Depositary receipts, on the other hand, represent a convenient means for small investors everywhere to invest in Japanese stocks.

American Depositary Receipts (ADRs) are US dollar-denominated securities designating equity ownership in a non-US company. They represent shares of a non-US company held by the American bank that issues the ADRs. It is not always a one-to-one relationship, and ADRs and their prices may represent several of the underlying shares or a fraction of one share. ADRs trade on US markets and must conform to the reporting requirements of US securities regulations. They are a simple way for American investors to invest internationally as well as a vehicle for non-US companies to tap into US capital markets. And not limited to the US, the concept of the ADR finds itself realized on other markets in the form of global depositary receipts (GDRs), international depositary receipts (IDRs), and European depositary receipts (EDRs).

Not all non-US equities are available as ADRs. There are a few dozen Japanese companies listed in the US as ADRs, and they tend to be the internationally well-known ones. For the Japan investor, ADRs may prove in many cases even more attractive than trading Japanese stocks directly, because ADRs are not subject to the minimum trading units that spawned mini-stocks. To use our example above again, a minimum investment in Fujitsu not utilizing mini-stocks would require ¥3,350,000 for 1,000 shares. Fujitsu's ADR (FJTSY) trades at around US$163, with one ADR representing five underlying shares. A round lot of 100 ADRs would require US$16,300, although even smaller odd lots can usually be had.

In the case of very expensive stocks, ADRs that represent a fraction of the underlying share may be the only alternative for the small investor to own equity in those individual stocks. For example, a single share of NTT DoCoMo trades on the Tokyo Stock Exchange at ¥3,090,000, whereas its ADR (NTDMY) trades over-the-counter at around US$148 3/4 , representing 1/200th of the underlying share.

However, because ADRs are denominated in and pay dividends in US dollars, they are exposed to the risk of currency fluctuations, which may affect the price of the ADR regardless of the price of the underlying stock. Another risk is that some ADRs are thinly traded and subject to price volatility.

Covered Warrants
Earlier this year, several foreign securities houses in Japan, including Citicorp, Credit Lyonnais, Goldman Sachs, and Societe Generale, began offering covered warrants on individual Japanese stocks and marketing them toward retail investors.

A warrant is an option to buy (call) or sell (put) underlying assets, such as shares of a company, at a certain strike price by a certain maturity date. Unlike a company (or equity) warrant, which is issued by the company of the underlying share, a covered warrant is issued by a third-party financial institution who "covers" the warrant with underlying shares or derivatives.

Unless exercised, warrants do not represent ownership of the underlying shares but only the contractual right to buy or sell the shares. Covered warrants are listed securities traded on exchanges. Most investors will simply trade warrants with no intention of converting them to ordinary shares.

The main advantage that warrants offer is their leveraging effect. Warrants provide the opportunity to enhance returns (including negative ones) with relatively smaller outlays than direct investment in the underlying shares. With prices in the ¥20,000 to ¥30,000 range, covered warrants cost less than a tenth of options traded on the Tokyo and Osaka stock exchanges and may thus appeal to retail investors.

Evaluation of warrants is beyond the scope of this article, but the following hypothetical example can illustrate the leveraging effect. Kaisha XYZ has a share price of ¥1,000. Kaisha XYZ call warrants have a warrant price of ¥200. Let us say for simplicity's sake that one warrant entitles the holder to buy one share. This warrant, therefore, has a "gearing factor" of 5X, because the investor can gain exposure to one share of Kaisha XYZ through a warrant at one-fifth the price of a share. The issuer reports that this warrant has a "delta" of 60%, meaning that a ¥100 movement in share price leads to an expected ¥60 movement in the warrant price. If the share price rises from ¥1,000 to ¥1,100, a 10% gain is posted. The warrant price should then rise from ¥200 to ¥260, a 30% gain. The warrant holder thus posts a 30% gain from a ¥200 outlay, while the stock holder posts a 10% gain from a ¥1,000 outlay. Of course, if the share price moves in the opposite direction, then losses rather than gains will be amplified.

An investor who anticipated the stock price of Kaisha XYZ to fall would have purchased a put warrant rather than a call warrant, as the value of the put warrant increases with a decrease in the price of the underlying share. Put warrants can also be used to hedge holdings in a portfolio. By purchasing puts, an investor holding Kaisha XYZ shares can protect the value of these shares during bearish times. No matter how much Kaisha XYZ's share price fell during the period of the put warrant, the investor could be assured of being able to sell those shares at the higher strike price.

Whereas buy-and-hold investors of ordinary shares can forget about the stocks they own, this is not true with warrants, which become worthless paper after they expire.

All share prices are June 8 closing prices. ¥/$=105.71