Japanese equities, long regarded by global investors as a value market, are beginning to attract growth funds, as artificial intelligence-linked firms power to the top of market-cap rankings, beating out the manufacturers and telecoms giants that dominated for decades.

¡°We have been raising our exposure to Japan based on the growth prospects of Japanese companies¡± under a strategy of investing in innovative firms globally, said Kei Takizawa, senior investment strategist at AllianceBernstein Japan. The nation¡¯s firms are playing an increasingly critical role in building AI infrastructure, he added.

Investors had historically classified Japan¡¯s equities as low-growth value stocks?due to the country¡¯s sluggish economic growth and declining population. Global interest reemerged after 2023, driven by Warren Buffett expanding holdings of trading house shares as well as by corporate governance reforms. Yet the market¡¯s appeal was still largely rooted in its cheapness.

Now, the rising prominence of high-growth firms suggests a meaningful shift in the investment narrative.

While that could mean more investors worldwide funneling capital into the country¡¯s stock market in the coming years, it also underscores the risk of a significant correction if the AI-driven trend reverses.

¡°We¡¯re seeing a growing number of foreign investors who are interested in the growth potential of Japanese firms, something that was relatively rare in the past,¡± said Richard Kaye, co-head of Japan equity strategy at Comgest Asset Management. Such clients include overseas pension funds, he added.

The change is already obvious in Japan¡¯s market-cap rankings. Memory-chip maker Kioxia Holdings overtook Toyota to become the largest company by market value for the first time this month. SoftBank Group?also briefly surpassed Toyota, while other AI-related names are emerging among the market¡¯s leaders. This marks a dramatic transformation from a decade ago, when automakers and telecommunications giants occupied the top positions.

¡°The perception of Japan could shift from that of a market dominated by manufacturing-driven, cyclical stocks to one increasingly defined by growth stocks, led by AI-driven semiconductors,¡± said Jumpei Tanaka, head of investment strategy at Pictet Asset Management Japan. ¡°That could prompt global investors to view Japan as a market that deserves a larger weighting in the AI trade, potentially attracting further capital inflows.¡±

Price-to-earnings ratios (PERs), which offer insight into investors¡¯ growth expectations, also reflect the changing dynamics. The forward 12-month PER of the ¡°Core 30¡± mega-cap stocks in the Topix-firms with the largest market value and deepest liquidity-had long traded below those of other large-cap and small- to mid-cap shares.

In recent years, the mega-caps have been trading at a higher ratio and are continuing to pull ahead of their smaller rivals, indicating increasing investor confidence in the growth prospects of Japan¡¯s leading firms.

The re-rating of Japanese equities has...