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Will Japanese stocks captivate foreign investors again?

NEW YORK -- Hedge funds and other overseas investors that helped drive Japanese share prices higher last year still have the momentum for a repeat performance.

     But in a bad sign for the market, such investors' reasons to stay invested or to raise Japanese holdings further seem less compelling.

     U.S. hedge fund Joho Capital, which specializes in Japanese and other Asian shares, notified investors earlier this year that it will close. Dwango, a Japanese online entertainment content company in which Joho Capital is a major shareholder, briefly fell prey to heavy selling pressure in late January as a result.

     Joho Capital founder Robert Karr launched the fund in 1996 after leaving Tiger Management, a major shareholder in Apple and Google. Joho Capital employs a long-short strategy with an estimated $5 billion in assets under its belt.

     Karr will likely focus on wealth management services for a limited number of investors after he closes the hedge fund, say industry insiders. This has set off a race among hedge funds and others that focus on Japanese and Asian investment to woo Joho Capital's clients after it disbands.

Believing in Abenomics

Joho Capital was a big proponent of Japanese shares during the Abenomics-fueled rally. The fund, however, is not scaling back investment because of slumping investment returns. Rather, industry insiders believe tougher financial regulations may have played a role in Karr's decision to close up shop.

     The Dodd-Frank Act in the U.S., borne amid a public backlash against the financial industry after the 2008 Lehman shock, imposes tougher registration and reporting requirements on hedge funds. Such rules can be a burden, says a hedge fund manager, who asserts Karr probably wants to manage a smaller amount of money at a more leisurely pace.

     The impact of Joho Capital's closure on supply-demand conditions in Japanese shares is uncertain. But the fact that such news about a single fund can become such a major topic for Japanese shares illustrates the market's lack of strength. The domestic stock market thus remains reliant on overseas investors for direction.

Selling pressure returns?

Foreigners were net sellers of Japanese shares to the tune of nearly 1 trillion yen ($9.7 billion) between March 10 and March 14. The selling was attributed to European funds, which apparently unloaded Japanese financial and real estate shares brimming with Abenomics-driven paper profits, as they moved to minimize risk in response to the Ukraine crisis.

     Meanwhile, market participants pointed to a U.S. pension fund's move to entrust short-term trades to a Japanese hedge fund as the main reason for sharp gains in the trading value of small- and midcapitalization shares associated with energy conservation on the Tokyo Stock Exchange.

     Hedge funds triggered the flood of foreign money that poured into Japanese shares last year, buoyed by Abenomics hopes. But since the beginning of this year, Japanese shares have failed to find a catalyst for further gains. This is because most hedge funds have already completed most of their position adjustments, according to a U.S. fund manager.

Eye on longer-haul investors

Overseas investors with a medium- to long-term focus, such as pension funds with long-only strategies, are currently weighing whether to plow fresh funds into Japanese shares. Many are monitoring whether the third arrow of Abenomics, growth strategies, will pan out. A certain foreign pension fund manager who visited Japan last year to gauge growth prospects says the outlook for 20 years ahead remains uncertain, citing a lack of confidence in the nation's direction.

     But long-term investors who did not own any Japanese shares during last year's rally are likely waiting for an opportunity to buy. Japanese pension funds are said to be slow to act, but U.S. pension funds also follow certain procedures, so it can take time for them to decide how to allocate new weightings, says a stock marketing official at an American brokerage.

     The U.S. stock market is chock full of items of interest, including the unrest in Ukraine, concern about a slowing Chinese economy, and the Federal Reserve Board's policy direction under new Chair Janet Yellen. The U.S. midterm elections will also become a focus. "As time passes, (foreign) interest in Japanese shares may wane again," warns a Japanese stock specialist at a foreign brokerage in Japan.

     The Japanese stock market's sizable gains last year got the attention of foreign investors. But if the market fails to retain that interest, global investors may end up skipping the Japanese market.



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