Emerging market concern over rising inflation and interest rates is increasingly making portfolio managers shift money in favour of Japanese equities. For the year till date, foreign institutional investors (FIIs) pumped in a record $42 billion into Japanese market, which was 99.5% higher than that of same period of last year.

In contrast, Indian equities received a negative $ 52 million from foreign investors, as against positive inflows seen in the previous year. Among asian markets, FIIs have reduced exposure to South korea while increasing exposure to Taiwan, Indonesia and Phillipines. For Japanese market, inflows received till mid-may is the highest since November 2007. About a quarter of this fund flow arrived since the second week of March when Japanese economy was recovering from the earthquake and Tsunami that struck the Asian giant in March 2011.

Many of the fund managers are taking tactical calls to reduce emerging-market exposure till the inflation threat wanes and shifting to safer havens of developed markets, said experts. ?The two main concerns for emerging market investors are inflation and hard-landing of the Chinese economy? said Adam Matthews, MD and head of Asia CPM team, JP Morgan Asset Management. As per RBI data released on Tuesday, inflation in the Indian context is yet to be tamed.

While Japanese equity market technically comes under the developed market ambit and therefore isn?t competing directly with Indian equities of emerging markets, tactical allocation as well as relative lucrativeness of Japanese markets has precipitated flows to Japan. ?Japanese equities were already attractively valued before the earthquake, and have become even more so since then. Many of the Chinese and US investors were also mildly bullish or neutral on Japanese equities? said Hasan Tevfik, global equity strategist of Citigroup. He added that downside appears limited in Japanese markets at these levels.

For the year till date, Nikkei 225 index was down 6.7% as against appreciation of 4.2% seen in MSCI Emerging market index.

Unlike some other developed markets, Japanese equity market has seen a sustained rise in the fund flows since late 2010. However, the pace of this fund flow gained a striking momentum since the third week of March, a week after Japan was hit by the biggest earthquake in more than 100 years.

?Allocation to Japanese markets is more of a tactical move given the uncertainty with respect to inflation in emerging markets. I see allocation coming back to emerging markets as the inflation stabilises? said Gopal Agrawal, CIO at Mirae Asset management. He added that at this juncture Japanese equity is undervalued.

The iShare MSCI Japan Fund, the largest ETF linked to the Japanese stock market has experienced a total inflow of $2.2 billion in 2011, almost half of which has come in since March.

A large chunk of this fund flow that arrived in the the initial days following the natural disaster was a reaction to the close-to-16% fall in the Nikkei 225 index values. In the first week after the earthquake itself, the Japanese equity market received $11 billion of funds.

Experts, expect this trend of inflows to continue in the coming quarters as investors believe that the economic recovery in Japan may turn out to be faster than expected.

In its recent report titled ?Global Profits Outlook?, a Citi report mentioned that it was ?Overweight? on Japan as it expected the prospect of reconstruction and a weaker yen to support Japanese equities.