(Reuters) - Investors pulled back sharply from Japan-focused equity mutual funds in May, cashing out as a long rally in the market lost momentum and the prospect of interest rate hikes loom.

According to LSEG Lipper, domestic and global equity mutual funds which primarily invest in Japanese stock markets sold assets worth $7.2 billion, the highest in 8 years.

The outflows show investors are taking money off the table after a sparkling run that carried the benchmark Nikkei to record heights and up some 30% in 17 months.

The cashing out is also large enough to suggest enthusiasm for further buying may be waning as markets also expect interest rates to rise in Japan, perhaps as soon as next month.

"Our view is that the Japanese market will likely tread water in the short- to medium-term after the run up in stock prices," said Martin Schulz, senior portfolio manager at Federated Hermes.

He also attributed the outflows to profit-taking and concerns over the domestic political climate. Recent surveys show support for Prime Minister Fumio Kishida at its lowest since he took office in 2021.

The Nomura NF Nikkei 225 ETF led the sell-off with outflows of $2.07 billion, while the Nomura NF TOPIX ETF and iShares MSCI Japan ETF withdrew $1.28 billion and $699 million, respectively.

Japan's Nikkei hit record high levels in March, but has since slipped into a months-long range below those peaks. The long rally also left valuations less attractive than before.

The MSCI Japan index trades at 15.4 times forward price-to-earnings, a common metric for assessing value, higher than the 10-year average of 14.1, and above the MSCI Asia Pacific's P/E of 14.03.

Kenneth Kim, senior investment analyst at Polaris Capital Management, said he is witnessing some repositioning of balances across Asia and said strong inflows to Japan seen in 2023 have slowed.

According to Lipper, Indian equity funds recorded inflows of $2.41 billion in May, totalling $24.65 billion for the year, while Chinese equity funds received $1.1 billion in the same month, bringing their year-to-date inflow to $46.88 billion.

(Reporting By Patturaja Murugaboopathy and Gaurav Dogra in Bengaluru; Editing by Tom Westbrook and Varun H K)

By Patturaja Murugaboopathy