By David Randall
NEW YORK May 23 (Reuters) - Japan's white-hot stock market has investors crowding in, but there are a few reasons why you shouldn't follow the pack.
It's a temptation, of course. The benchmark Nikkei 225 index is up 50 percent for the year, more than any other developed market, and nearly triple the approximate 17 percent gain for the Standard & Poor's 500 stock index through May 21.
This streak prompted investors to put a net $9.1 billion into Japan equity funds and exchange-traded funds in April. In fact, that's the bulk of the $9.9 billion investors added to all sector funds during the same month, according to Lipper data.
Yet investors might already hold more of Japan in their portfolio than they think. The average international mutual fund has 17.1 percent of its assets invested in the country, or nearly a fifth of the fund's portfolio, according to Lipper, a unit of Thomson Reuters Corp.
Adding a Japan-only stock fund or ETF on top of that at a time when the market has already seen big gains might set the stage for larger losses once the market cools, analysts said.
The Japanese economy grew at an annualized 3.5 percent in the first quarter.
"People are clearly thinking that the monetary policy Japan has put into place has at least the likelihood of turning the economy around," said Kate Warne, market strategist at Edward Jones. "But expectations have run a bit ahead of reality."
Nevertheless, there are ways to benefit from Japan's rising stock market without taking on concentrated risk. Here are two:
MUTUAL FUND STAKES
One big reason why investors in diversified mutual funds shouldn't increase their stake in Japan is that their managers might have already done it for them.
The $33.6 million TCW International Small Cap Fund , for instance, has about 31.6 percent of its portfolio in Japanese equities, according to Morningstar data, nearly double its 16.4 percent stake in March of last year.
The $1.1 billion Wasatch International Growth fund , meanwhile, more than doubled its stake in Japan over the last 11 months. The fund now has about 15.5 percent of its assets in the country, according to Morningstar, up from 7.1 percent as recently as June of 2012.
(These figures reflect both new purchases on the part of fund managers and the rising value of assets they held prior to the market surge.)
Funds such as the $212 million Wells Fargo Advantage Asia Pacific Fund, the $992 million Oppenheimer International Value Fund, and the $4.1 billion William Blair International Growth Fund have all increased their Japanese weighting by seven percentage points or more during the last year as well.
Add it together and "it's another reason to be skeptical of flavor-of-the-month or flavor-of-the-quarter funds," said Bill Rocco, a senior fund analyst at Morningstar. "Ideally, you want a broad foreign fund with a manager who said last October: 'Wow, I think there's some real opportunity in Japan.' And now they're reaping the rewards."
Investors might want to consider multi-cap core international funds such as the $17.3 billion Oakmark International Fund and the $8.8 billion Artisan International Value Fund. Both funds have 10 percent or more of their assets in Japanese stocks and have category-leading returns of an annualized eight percent or more during the last five years, according to Lipper data.
BROADER ASIAN PLAY
Any pickup in Japan's economy will likely benefit Singapore, South Korea and China as well, so funds that invest broadly in Asia offer another way for investors to reap the rewards.
Kenneth Lowe, a co-manager of the $4.9 billion Matthews Asian Growth and Income Fund, said the fund hasn't been adding to its overall allocation of Japanese stocks. Instead, the fund, which is up an annualized 14.4 percent during the last three years, is keeping about 10 percent in Japan, with the largest stake of the portfolio invested in China.
The fund's largest positions are in companies such as Malaysian financial firm AMMB Holdings Bhd and Singapore based Ascendas Real Estate Investment Trust, which should benefit from the powerful combination of the region's rising middle class and continued economic growth.
Lowe, who stresses his fund invests on individual merits rather than macro trends, said Japan's rally could be sidelined if proposed reforms to the labor market and trade policies fail.
"We're still not sure of what reforms will look like," he added.