Foreign investment holdings reached a historical high of 34.7%, and the yen's continuous decline may reverse the flow of funds into Japanese stocks.

The yen has been falling recently, causing widespread concern among investors. If the depreciation trend continues, it may ultimately weaken the key driver of Japan's stock market reaching historical highs - the inflow of overseas funds. On the surface, exchange-traded open-ended index funds (ETFs) listed overseas still show strong demand from international investors for Japanese stocks. Compiled data shows that in recent years, ETFs investing in the Japanese stock market without hedging have continued to attract investors, with cumulative net inflows reaching $47 billion. Conversely, similar products using currency hedging have seen outflows. However, strategists warn that this situation could quickly change. Pension funds and asset management institutions that are long only typically do not hedge against currency risks. As the yen weakens further, their investment returns become more vulnerable. The market is starting to question: how much further will the yen fall before currency losses outweigh the attractiveness of Japanese stocks themselves? Chad Kay, Co-Head of Japanese Equities Strategy at the French asset management company Comgest, stated, "Currency risk is one of the core concerns facing Japanese stocks at the moment." While Japan remains an important destination for global investors seeking exposure to themes outside the US, the continuous depreciation of the yen has become increasingly difficult to ignore for those funds that do not hedge currency risk. So far this year, the TOPIX index has risen by 19%, setting a new record. However, when priced in US dollars, the increase has narrowed to about 14%, due to the yen falling below the 163 level against the US dollar, reaching its lowest level since 1986. The widening interest rate differential and market concerns about Japan's fiscal outlook are the main factors suppressing the yen. The increasing influence of overseas investors makes the currency effect even more important. Exchange data shows that by the end of March, overseas funds held 34.7% of the Japanese stock market, a new high, compared to 30.2% five years ago. Since Prime Minister Suga won the Liberal Democratic Party leadership election and became Prime Minister in October last year, overseas funds have accumulated a net purchase of Japanese cash equities exceeding 12 trillion yen (approximately $74 billion). The composition of foreign funds this time is significantly different from before. Yoshiyuki Sudatani, Senior Cross-Asset Strategist at Nomura Singapore, pointed out that during the early days of Prime Minister Abe's administration, foreign inflows were predominantly short-term funds, which typically hedge against currency risk. The driving force behind the current rise is long-term investors such as pension funds, which often do not hedge against currency risk. "From the perspective of fund flows, the positive impact of yen depreciation on Japanese stocks is no longer as clear as it used to be." Of course, yen depreciation still supports the profits of export companies. Estimates by professionals indicate that if the yen remains at its current low level, major Japanese car manufacturers could increase their combined profits by over 900 billion yen. However, Hideyuki Kamimbu, Chief Strategist at Daiwa Asset Management, stated, "As the yen falls to historic lows, the market generally believes that the depreciation trend shows no signs of stopping, which may cause investors who do not hedge against currency risk to hold off on buying until the exchange rate stabilizes." Overall, yen depreciation has changed from being a "clear positive" to a "double-edged sword" for Japanese stocks - while boosting export profits, it is gradually weakening the actual returns of overseas funds without hedging, potentially shaking the important foundation of this bull market.