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Hedge funds investing in Japan increased their short-selling of companies sensitive to the yen’s fluctuations as the currency surged amid the U.S. credit downgrade and concerns that Europe can’t contain its debt crisis, Deutsche Bank AG said.

“What we have seen is selective shorting of foreign-exchange-sensitive companies increase,” said Christopher Donald, managing director and the head of global prime finance trading in Japan at Deutsche Securities Inc. in Tokyo. “If things were to worsen, some people may be looking to put on some shorts.”

The yen has climbed 5 percent over the past three months and was trading at about 76.70 to the dollar in Tokyo on Friday afternoon, near its postwar record of 76.25 touched March 17. A stronger yen reduces the value of overseas profits when Japanese exporters convert it back into their home currency.

The Eurekahedge Japan Hedge Fund index has gained 1.4 percent this year through July, compared with a 1 percent advance by the global benchmark. Shorting involves selling borrowed securities with the view that their prices will fall and they can be bought back cheaper to make a profit.

Signs of earnings growth may prompt some funds to buy stocks following the selloff, Donald said. Deutsche Securities has seen inflows from Japan-focused hedge funds increase 10 to 15 percent since April 1, he said.

“Some long-short funds are thinking there could be some opportunities,” Donald said. “This is very much a time for selective stock-picking, where people can go in and take a look at the underlying companies that have good solid earnings that might have been unfairly punished or sold out of.”

The Nikkei 225 average has fallen 9 percent this month.

Funds betting on volatility and high-frequency or quant funds may have benefited from the recent increase in market swings, while funds that had long- or short-bias bets may have been affected, he said.

The VIX, as the Chicago Board Options Exchange Volatility Index is known, had the second-largest percent drop ever Tuesday, reversing the biggest surge in four years the day before, after Fed Chairman Ben Bernanke vowed to keep interest rates at record lows to revive economic growth.

“We’re not seeing a hedge-fund fallout and we’re not seeing any redemptions, which could have a cascading effect where managers have to sell out of their portfolios,” said Donald. “The question is what is going to be the long term and do people have the stomach to withstand the volatility.”

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