Yen Rally Prompts An Unwind Of Hedges In Japanese Stocks But Investors Wary Of Earnings Hit

The yen’s rebound has spurred a roll-back of exchange rate hedges by global investors who are no longer anticipating a rapid slide in the Japanese currency.
Expectations that the yen may strengthen further have prompted strategists at JPMorgan Chase & Co. to UBS Group AG and BNP Paribas Asset Management to recommend unwinding currency hedges on Japanese shares that have outperformed many regional peers, as that would boost returns in dollar terms.
“At this moment, the recommendation is to invest in Japanese stocks without hedging the currency exposure, to benefit from higher dollar-denominated returns from potential yen appreciation,” said Wei Li, a multi asset quant solutions portfolio manager at BNP Paribas Asset Management. 
The shift in hedging reflects a wider change in views on the yen since the Bank of Japan raised interest rates in July. It’s been a double-edged sword for stocks, with the stronger currency reflecting Japan’s improved economic fortunes, but making equities more expensive for foreign buyers and hurting the earnings outlook for exporters. 
UBS strategist Nozomi Moriya prefers investing in Japan without hedging for currency weakness after her firm raised its year-end yen forecast to 145 against the dollar from 160. However, the Swiss bank has downgraded Japanese stocks to underweight in local-currency terms, citing risks the currency’s strength poses to earnings forecasts.
In dollar terms, the Topix has recovered from its Aug. 5 crash and hit a three-year high last week. Since then it’s given up gains on worries about slowing global economic growth. Its year-to date rise of 7.1% outperformed the regional benchmark MSCI AC Asia Pacific Excluding Japan Index’s advance of 5.4%. The Topix also beat the Hang Seng Index and South Korean Kospi. 
Many long-only investors, who bet on rises in share prices but not on declines, don’t apply currency hedges on their foreign stock investments. But the yen’s persistent weakness in recent years encouraged investors to purchase Japanese stocks with such protection. The strategy’s popularity was reflected in New York-listed WisdomTree Japan Hedged Equity ETF’s size trebling over 2023. 
But WisdomTree’s exchange-traded fund has seen an outflow of $897 million since August this year as the yen’s trajectory changed course and hit a seven-month high on the Bank of Japan’s hawkish policy guidance. JPMorgan BetaBuilders Japan ETF, a popular Japan stock fund that doesn’t hedge the yen, has had an inflow of $687 million during the same period.
Not every analyst considers the yen’s moves as the primary driver for earnings. Masashi Akutsu, chief Japan equity strategist at Bank of America Securities, says a bigger part of Japanese earning growth is now being determined by a company’s ability to hike prices in an inflationary environment, rather than by a weaker yen.
Still, strategists say the risk remains that a rapidly-strengthening yen could undermine corporate earnings, making some analysts extra-cautious in coming up with stock picks. 
“I would be looking to be selective in Japanese equities, focused on interesting long-term themes such as corporate governance reform beneficiaries and geopolitical plays,“ said Singapore-based Saxo Markets strategist Charu Chanana. “It’s a very different world right now with the short-term risk-reward tilted to a stronger yen and weaker Japanese equities.” 
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