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Don't look now, but Japan is back in favour.

The latest Bank of America Merrill Lynch survey of fund managers shows a surprising – some might say, masochistic – surge in affection for the Land of the Rising Sun (AKA, Land of the Falling Sum).

As those of us who have held Japanese equities for a few years – and, yes, I'm one of them – can tell you, this is a trade that requires a certain insensitivity to pain.

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Over the past two decades, it's often been possible to make a case that the Tokyo stock market is an attractive, bargain-priced buy. Unfortunately, results have not always reflected those happy sentiments. For most of that period, Japanese stocks have badly lagged their Northern American counterparts.

Despite that sad history, the new BofA survey shows that 30 per cent of more than 200 fund managers were "overweight" Japanese stocks in early August – in other words, they held proportionately more of them than the benchmark index. That is up sharply from the 26 per cent of fund managers who were overweight Japan in July.

What's behind this latest upswelling in Japanophilia? One possibility is that investors are beginning to shed their fear of the Japanese economy.

When GDP numbers are released Wednesday, they're likely to show the country endured a miserable second quarter. However, Japan has, until recently, enjoyed current account surpluses – something you can't say for the United States. Its pace of economic growth, when adjusted for the shrinking size of its working age population, doesn't look greatly different than the rate in Germany or the U.S. over the past decade.

But, as we veterans of Japanese investing will tell you, those positives tend to be offset by a huge negative – the country's enormous government debt. Japan recently raised its consumption tax to help bring finances back into some semblance of sanity and it's hoping that stronger economic growth in years to come will help reduce the real burden of its debt.

For the moment, though, those hopes for more rapid growth remain nothing more than hopes – which is what makes fund managers' new affection for the country that much more surprising. They could be betting that "Abenomics" – the reform program unleashed 18 months ago by Prime Minister Shinzo Abe – will succeed.

Abenomics includes strong monetary and fiscal stimulus, as well as structural overhauls to the economy. But even fans such as Adam Posen, president of the Peterson Institute for International Economics, caution that its effects will be bumpy and slow.

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In an interview with the Wall Street Journal, Mr. Posen said that Japan has to balance its plans to grow more rapidly with a realistic plan to tame its debt addiction. That is easier said than done.

If it's not Abenomics that is drawing fund managers, perhaps it's the perception of cheapness. On some measures, such as price-to-book ratios, equities look relatively inexpensive in Tokyo. But such yardsticks have to be viewed cautiously. The main reason that Japanese stocks can look like bargains now is that they were so absurdly overpriced 20 years ago.

So why are fund managers choosing to load up on Japan right now? Perhaps the best reason is that its stock market is just a tiny bit less risky than the alternatives.

It's not quite as frothy, for instance, as its counterparts in the United States, while it's more stable than markets in Europe, where Ukraine and a generally gloomy economic outlook are dragging down prospective returns.

At a time when fund managers are trying to avoid risk, Japan has become one of the last places to look for refuge. That is remarkable, but, given the country's track record, it may not be enough reason for most investors to jump in.

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About the Author

Ian McGugan is a reporter with The Globe and Mail's Report on Business and has been writing about investing, economics and business for more than 20 years. He joined the Globe and Mail in 2010. He has been executive editor of Canadian Business magazine and founding editor of MoneySense magazine. More

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