The Japanese market may not have incited a spell of crazed buying on the part of Europe's pension fund investors so far this year, but neither has it proved too much of a deterrent. Europe's institutional investors are showing a degree of optimism by holding safely on to their positions and some are even now in the process of adjusting their weightings upwards, according to investment managers.

One specialist manager is seeing particular interest from pension funds and other institutional clients in the UK, Netherlands, Switzerland and Belgium and is expecting serious revaluation of portfolios and allocations to Japan," this year.

In the UK alone, according to a WM Company survey of 1,600 UK funds with a total asset value of £450bn ($740bn), while asset allocations to Japan dropped from 3.8% at end-1996 to 3% at the end of last year, the net cash flow into Japanese equities during 1997 was £1.6bn bringing to the total £13bn currently held in the Japanese market.

The UK's £12bn Post Office scheme has just awarded a mandate to its existing Japanese manager, Schroders, for an extra $200m to be invested into Japanese equities as a sign of its faith in the imminent recovery of the market. The scheme's chief executive officer, Michael Duncombe is confident that he will see the money back. "We are very confident that the Japanese market will bounce back, and we are prepared to put our money where our mouth is," he affirms, admitting that he is in the minority but adding that with careful stock selection there is no reason to sit back and wait until the market recovers completely.

"It's not the whole of the Japanese economy that's gone downwards, and if you're selective, as in you hold nothing in banks and financial, you've not taken anywhere near the hit that the average manager has done."

Germany has come out as a surprisingly big investor, according to Bundesbank figures covering large institutional investors, banks and private investors. In 1997 alone, $2.5bn was ploughed into the Japanese equity and bond market, the majority of which was invested in the third quarter - a time when many investors were pulling out. This figure was also a significant jump from the $800m invested the year before.

Sean Roache of the ING Barings research team in London puts this down to an increasing pressure on German investors to widentheir portfolios' reach. "They need to increase their diversification," he says, adding that by nature German institutional investors take a long-term strategic view - unlike their UK and US counterparts who tend towards the cyclical. "The structured forces are pushing this rather than the cyclical forces."

Throughout Europe as a whole, pension fund allocations to Japanese equities are estimated at around the 5% mark, says Mark Petheram, marketing director at Nomura in London, which he points out may only be half of what would be in the MSCI World Index, but investors have nevertheless continued to reap the benefits of their conservative investments. "The beauty of the thing is that they've all made money by being underweight in Japan and that's a very good start," he says.

As a result Nomura has seen its clients slowly return to higher weightings in the Japanese sector, though he warns that 1998 will "not be a year of excessive mandate awards". However, with Wall Street topping 9,000 and the domestic markets continuing to outperform, investors are likely in the coming months to view such markets, the US in particular, as areas where they prepare for the bubble to burst. And in direct contrast, they are beginning to view the Japanese index in terms of "Can it go any lower?", says Petheram.

"Clearly, the economic woes will slow this process down," he says, "but it is very interesting from our perspective to see real demand in terms of both equity and firm mandate business in Japanese equities throughout the major markets in Europe."

In the past six months, he says, Nomura has seen more mandate offers and renewed interest in Japan than it has done in the past 18 months. "We have had firm interest in terms of RFPs or serious discussion, not only from existing clients to increase their current allocation to Japan and Asia which they are, but also from prospective customers. I would say that this year alone that if we add the increase from existing customers to those asset classes and serious enquiries on RFPs, we've probably seen more than 20."

Nikko Global Asset Management has not seen such an aggressive upturn, but existing clients are maintaining their current holdings, says Tony Thomson, chief executive officer, though one of its clients has recently informed the manager of its intentions to increase its weighting in Japan.

"By and large my impression is that people in the US, UK and Western Europe are not ready to recommit and you can see that foreigners have been net sellers of Japanese assets and I think it has been the Japanese themselves putting their toe back in the water."

Japanese pension funds are growing very rapidly and are viewed by the investment management industry as becoming one of the most substantial net buyers of Japanese equity in the future. And this new flow of money into the region is likely to push the stock markets up, making them more even more attractive to foreign investors, though Thomson sees that process as being slow.

Despite poor performance and all the disappointments about the Japanese economy, a handful of appointments of Japanese specialist fund managers, continue to be awarded year after year signalling a moderate degree of faith placed in the region by Europe's investors.

In the long term the outlook looks positive for European funds to realise their previous weightings in Japan. But as Thomson points out, Japan is not going to remain the investor's underdog for long. "Japan has remained the second largest economy in the world and yet briefly the UK market is bigger that the Japanese market," he says. "With respect to the UK which is doing very well economically, I don't think that's a natural state of affairs.""