The rebound of the yen has prompted global investors to reduce their hedging of exchange rates, as they no longer expect the yen to depreciate rapidly.

Expectations of further strengthening of the yen have prompted strategists from JPMorgan, UBS Group, and BNP Paribas Asset Management to recommend lifting the forex hedge on Japanese stocks, as this will increase the return calculated in US dollars. The performance of Japanese stocks has outperformed many Asian peers.

Wei Li, portfolio manager of the multi-asset quant solution at BNP Paribas Asset Management, said: "The current recommendation is to invest in Japanese stocks without hedging currency risk in order to benefit from the higher US dollar-denominated returns potentially brought by the appreciation of the yen."

The shift in hedging strategies reflects a broader change in perception of the yen since the Bank of Japan raised interest rates in July. This is a double-edged sword for the stock market, as the stronger yen reflects the improvement of Japan's economic conditions, but it also leads to higher stock prices, which undermines the profit outlook for exporters.

UBS strategist Nozomi Moriya is inclined to invest in the Japanese stock market without hedging against a weak yen. Previously, UBS raised its year-end yen to USD exchange rate forecast from 160 to 145. However, UBS has downgraded its rating on Japanese stocks to reduce shareholding, citing the risk that a stronger yen could pose to earnings expectations.

The TOPIX index, measured in USD, has rebounded from the plunge on August 5th and reached a three-year high last week. Since then, it has erased the gains due to concerns about slowing global economic growth. The index has risen 7.1% year-to-date, outperforming the regional benchmark MSCI Asia Pacific ex-Japan index's gain of 5.4%. The TOPIX index has also outperformed the Hang Seng index and Korea Composite index.

Many long-only investors bet on rising stock prices rather than downside and do not use currency hedges in their overseas stock investments. However, the sustained weakness of the yen in recent years has encouraged investors to buy Japanese stocks with such protection. The size of the WisdomTree Japan Hedged Equity ETF listed in New York doubled in 2023, reflecting the popularity of this strategy.

But WisdomTree's ETF has experienced outflows of $0.897 billion since August this year, mainly due to changes in the yen's trend and reaching a seven-month high under the guidance of the Bank of Japan's hawkish policy. JPMorgan's Betbuilders Japan ETF is a popular unhedged Japanese stock fund, with inflows of $0.687 billion during the same period.

However, not all analysts believe that the yen's trend is the main driving factor for profits. Masashi Akutsu, Chief Japanese Equity Strategist at Bank of America Securities, said that a large part of Japanese corporate profit growth now depends on the ability of companies to raise prices in an inflationary environment, rather than the depreciation of the yen. However, strategists indicate that the risk of a rapid strengthening of the yen could still impact corporate profits, leading some analysts to be more cautious in their stock selection.

"I will selectively invest in Japanese stocks, focusing on interesting long-term themes such as beneficiaries of corporate governance reform and geopolitical themes," said Charu Chanana, Market Strategist at Shengbao in Singapore. "It's a very different world now, with short-term risk-return tilting towards a stronger yen and a weaker Japanese stock market."

Editor/Rocky