By Chikafumi Hodo TOKYO, Nov 18 (Reuters) - Japanese retail investors looking for higher returns are taking on more exposure to foreign currency-linked mutual funds, mainly in Brazil -- this year's hit destination for Japan's $665 billion retail fund market. Japan's retail investors, who hold $15 trillion in personal assets, are keen to buy into emerging markets thanks partly to rapid recoveries in countries such as China and India, while prospects at home and in other advanced economies remain unclear. "It's very easy to picture a (rosy) scenario for the Brazilian real. Investors know the Brazilian economy is driven by both domestic and external demand," said Akihiro Watanabe, a senior executive marketing executive at Nomura Asset Management. Asset managers are queueing up to offer yield-hungry retail investors investment trust funds, similar to mutual funds known as "toushin", that allow holders to select a currency, including the high-yielding Brazilian real (BRBY: Quote, Profile, Research, Stock Buzz). "The trend will continue as long as interest rates of countries with natural resources are well above industrialised countries. I don't think it will end soon," said Ryosuke Okazaki, chief investment manager at ITC Investment Partners. Retail investors favour the Brazilian currency because the country exports resources and has a liberalised currency system, unlike China's highly controlled exchange regime, analysts said. A currency-selective fund gives investors an opportunity to acquire interest income and foreign exchange gains on top of conventional returns, but they could face foreign exchange losses should the currency they choose depreciate. BLAME IT ON RIO Brazil's benchmark Bovespa stock index .BVSP has surged 80 percent since the start of the year, while Japan's key Nikkei stock average .N255 has risen only 9 percent. The Brazilian real BRLJPY=R was trading at 52.15 yen on Wednesday, up about 33 percent from the start of the year. Japanese retail investors fled toushins during the global financial crisis, with the asset value of the market slumping below 50 trillion yen in January for the first time since 2005. But their appetite for riskier assets returned quickly after the launch of Nomura Asset Management's currency selection-type U.S. junk bond funds in January, which drew solid demand as investors saw it as a great bargain-hunting opportunity. Fund managers have launched 18 other currency-linked funds since then, tapping assets from junk bonds to oil, property and gold. More are set to be launched in November and December. Investors can choose the currency they want to hold in a fund, which usually includes high-yielding currencies such as the Australian dollar AUD= and the South African rand ZAR=. Funds using the Australian dollar have attracted more interest recently following two interest rate hikes since October by the Reserve Bank of Australia, but those offering the Brazilian real are still enjoying the strongest demand. Nomura Asset alone has launched seven series of such currency-selective type mutual funds, attracting 404.1 billion yen ($4.52 billion) at the time of the subscription. The outstanding value of Nomura Asset's currency-selective type has tripled since the subscription, boosted by gains in market value and additional inflows into the mutual funds. The overall asset value of the retail toushin market has risen more than 21 percent since February, with the market also seeing consistent net inflows. [ID:nT111088] For a graphic on the trend, click: here INVESTORS CAN'T RESIST Japanese retail investors are keen to diversify their portfolios by investing in emerging markets, aiming for higher returns as domestic share prices struggle and as the country's interest rates look set to remain near zero for some time. "Investors understand the risk, but they simply can't resist buying them (currency-selective funds) after seeing the astonishing performance of Nomura's first series of funds," said a senior fund manager at a Japanese asset company. "Retail investors' exposure to emerging markets is still relatively small relative to others in Asian markets such as in Hong Kong or Singapore ..." Analysts say retail investors are looking to reallocate their portfolios by shifting out of global sovereign funds, which invest in government bonds with high credit ratings and are largely denominated in the low-yielding dollar and the euro. Japan's Global Sovereign fund, with an asset value of about $48 billion, is the world's second-largest bond fund after PIMCO Total Return Fund of the United States. The fund has been a symbol of Japanese households' appetite for foreign assets in recent years, but its popularity has sagged as the yen surged and interest rates of industrial countries dropped. It has seen net withdrawals since October last year. (Additional reporting by Michiko Iwasaki; Editing by Kim Coghill) ($1=89.33 yen)

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