Global hedge funds sharply reduced their holdings in Japanese stocks last week at the fastest pace of selling in nearly two and a half months, just ahead of Japan’s upper house election on Sunday, according to a report by Reuters.

The report cites a Goldman Sachs prime brokerage report as highlighting the sell-off ahead of the election which dealt a significant setback to Prime Minister Shigeru Ishiba and his ruling Liberal Democratic Party (LDP).

Japan’s benchmark indices, the Nikkei 225 and Topix, have declined 1.7% and 0.6% respectively so far in July, underperforming global markets which have generally rallied.

Hedge fund selling from 11-17 July was driven predominantly by increased short positions alongside a modest reduction in long holdings, Goldman Sachs noted. Although Japanese markets were closed on Monday, the yen gained strength and Nikkei futures edged higher, indicating much of the election impact was already priced in.

Despite the recent outflows, hedge funds remain modestly overweight Japan by 0.6% relative to its MSCI World Index weighting.

Analysts warn that the loss of a majority for the LDP in both parliamentary houses – the first since 1955 – raises the risk of political instability, and potential policy gridlock.