Japanese investors held onto their cash instead of piling more into investment trusts in October, data showed on Thursday, a sign that the U.S. mortgage mess and ensuing market turmoil may be hurting their appetite for risk.

A new law obliging financial institutions to explain investment risks to Japanese customers in more detail also dampened demand for riskier assets such as investment trusts, a potential negative for already bleak stock market sentiment, some economists said.

With Japan emerging from deflation and the economy in good shape, investors are buying higher-risk assets and I don't think that big trend will change, said Naoki Iizuka, a senior economist at Mizuho Securities.

But after the subprime shock, people are becoming more aware of the risk of being exposed to market volatility.

The Bank of Japan's money supply data showed that cash in circulation rose 2.4 percent in October from a year earlier, a jump from September's 1.6 percent increase and the fastest pace of growth in about a year and a half.

That was partly behind the 2.0 percent expansion in M2 plus certificates of deposit (CDs) -- Japan's most widely watched measure of money supply -- in October, higher than a 1.7 percent rise in September.

Meanwhile, growth in investment trusts -- a component of broadest liquidity but not M2 plus CDs -- has been slowing after peaking in July at 34.4 percent and grew 30.0 percent in October.

A BOJ official said the subprime woes and the new financial law -- which took effect in late September to protect customers from fraud -- were partly behind the slower fund inflow to investment trusts, although the impact was uncertain.

Economists say the law has made it harder for banks and brokerage firms to sell investment trusts as aggressively as before, since it increased the burden of explaining to customers the potential risks of each investment decision they make.

While it is hard to predict whether inflows will continue to slow, Japanese investors have plenty of reasons to be jittery.

Asian equities -- their favourite fund destination -- have been on a declining trend so far this month on credit fears.

Tokyo's Nikkei average (.N225: Quote, Profile, Research) fell 2 percent to a two-month closing low on Thursday, tracing Wall Street declines on concerns that the subprime mortgage problems could spread to the wider economy and hurt U.S. growth.

Some economists argue that Japan's ultra-low interest rates -- now at 0.50 percent compared with 4.5 percent in the United States -- will keep investors from becoming too risk aversive.

I don't think households will stop buying investment trusts because the alternative would be to earn very little by placing money in bank accounts, said Takeshi Minami, chief economist at Norinchukin Research Institute.

But others warn that if market sentiment sours further, safety will again emerge as the priority for many Japanese.

The subprime problem was a wakeup call for retail investors who in the past bought risky assets without much thought, said Yasuhide Yajima, a senior economist at NLI Research Institute.

They are much more cautious now, so I expect the popularity of risk assets to keep declining as a trend. (Editing by Michael Watson)

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