Japan: Passive foreign interest limits upside – BNY

BNY's Geoff Yu points out that foreign interest in Japanese equities remains low in comparison to demand for the Japanese Yen (JPY) and Japanese government bonds (JGBs). While the MSCI Japan Index delivered a 22% return in JPY terms for 2025, international investors' holdings trailed benchmarks, limited by allocation rules and Japan's reduced presence in the semiconductor sector.

He suggests that rebalancing is more likely to favor JGBs. Our recent report on Japan's intervention reveals growing interest in JPY and JGBs. However, equities continue to be the weak link. Despite Japan's industrial strength, it has not been as influential in the semiconductor/memory chip trend as Taiwan and South Korea. The recent market downturn may provide an opportunity for Japan, provided a long-term growth and earnings story can be articulated.

The initial reaction to a stronger JPY could further weaken Japanese equities due to translation effects on earnings. Moreover, cross-border portfolio investments in Japan are predominantly equities (63% as of year-end 2025), so any rebalancing would probably favor the JGB market. Japanese survey data from the end of 2025 do not indicate a surge in inflows.

In JPY terms, the MSCI Japan Index yielded a median gain of 17% for key international investors, slightly below the benchmarks. The United States and Europe hold nearly 90% of all international equity holdings in Japan, amounting to approximately ¥320tn as of the end of 2025. Instead of reacting to earnings outlooks, structural changes in hedge ratios will likely have the most significant impact, particularly if front-end rates show a closer alignment. However, currency markets must remain realistic about the figures.