Hindsight is often 20-20, but some mistakes look too obvious to brush off. Take, for instance, the romance many mutual fund managers began with Japan this year and continued as late as the third quarter despite earlier signs of trouble.

Bargain-oriented fund managers only months ago were talking up the prospects of the world's second-largest economy and home to major corporations such as Toyota Motor (TM) and Canon (CAJ) . In Japan they saw cheap stocks and thrifty consumers with more cash than debt.

But on Monday, Japan made official what many already surmised: It's in a recession. Unfortunately for investors betting on the long-awaited Japanese comeback, economists expect Japan's slowdown to be a protracted one as it joins Europe and likely the U.S. in a global downturn.

In turn, Japan-focused stock funds are now down 42% this year, about on par with U.S. stocks but better than Asian stock funds excluding Japan, which are down 58%. (Asian stock funds have been especially hard hit by the brutal selloffs in China and other emerging markets.)

Unfortunately, the growing allure of Japan this year meant that even investors in more diversified international stock funds had hefty exposure to the country. The average international stock fund has 10.5% of assets in Japan, according to Morningstar, excluding Japan-focused funds but including Asia-focused funds. Some funds have more than that, with 30%-plus of their portfolios invested in Japan. Longleaf Partners International (LLINX), for example, which had a third of its capital invested in Japan, has lost nearly half its value this year. Top holdings as of the fund's latest disclosure included Olympus, Tokio Marine and Japan Petroleum.

So why the refusal to say sayonara to a long-sluggish country that's been in need of major economic reforms for years? Longleaf's international fund managers, in their semi-annual report, put their reasoning succinctly: "Two words: price matters."

"At the beginning of the year, Japan traded near record lows on every valuation measure despite solid progress in both corporate governance and increasing returns on equity -- progress overlooked or misreported by the media," the managers wrote in their report. They also said that their "biggest contributors for the half were all Japanese: Millea, Daiwa, and Kyocera, despite the fact that business conditions arguably worsened for all three.

"We submit that something resembling the Japanese 'buyer's strike' grips today's global equity markets. Everyone knows that the economy has slowed and that the next few years will be tougher than the recent past. The relevant question for investors (rather than speculators) is: what's in the price?"

Granted, there's a danger in putting too much emphasis on short-term performance. A several-years-long recession in Japan may prove a blip on the screen for long-term investors trying to buy quality stocks on the cheap. But Japan's long-term value has to depend a good deal on whether it can really get out of its economic funk for a sustained run.

Unfortunately, Japan has a history of disappointing. "Even going back more than a decade, Japan's performance is among the worst compared with any foreign or the U.S. market," notes Morningstar's Arijit Dutta.

While it's easy to blame Japan's latest troubles on the world-wide financial crisis, many of its problems are home-grown. Japan's government, in a scenario unfortunately all too familiar to those in the U.S., is trying to stimulate its economy with one-time cash handouts and more government spending, despite its already massive public debt of an estimated 170% of GDP. In contrast, the U.S. public debt is 61% of GDP.

Meanwhile, Japan has the highest corporate tax rates of major countries at 39.5% when combining federal and state taxes, according to the Tax Foundation. Japan's individual income taxes are also near the top. Even the nation's famous work ethic has fallen on hard times. Japan's slacker generation turns down job promotions and refuses to put in extra hours at the office, earning it the cultural moniker "hodo-hodo zoku," or the "so-so folks," according to The Wall Street Journal.

"Japan has had economic stagnation for the last 20 years and now they have stagflation. They have negative population growth [and] they don t earn anything on their savings, because interest rates are so low, says Keith McCullough, chief executive and chief investment officer of Research Edge. "These are not things an investor looks for. A bargain isn t a bargain if it remains a bargain." For Japan to turn around, McCullough says the country needs political leadership willing to raise interest rates amid economic slowdown.

Below, we list international stock funds with the largest share of their assets in Japan as of the most recent data from Morningstar. (We exclude Asia-focused funds, funds with less than $100 million in assets and institutional funds.) As you can see, having above-average exposure to Japan isn't a winning strategy this year. It's possible some of these funds have since scaled back their Japan exposure since last reporting their holdings. Either way, it's a good lesson for investors: Even some "diversified" funds aren't always as diversified as you might think, particularly when they get enamored with an idea.

Funds With Hefty Japan Exposure

Fund	Ticker	% Assets Japan*	YTD Return %	5-Yr Return %
* As of 9/30/08, ex Longleaf 6/30/08 and Nuveen 8/31/08 Returns through 11/14/08, 5-Yr annualized Source: Morningstar
Dreyfus Premier Intl Stock A	DISAX	37.10	-38.03	N/A
Longleaf Partners Intl	LLINX	36.65	-47.08	-1.47
Nuveen Tradewinds Intl Value A	NAIGX	32.43	-39.99	3.91
Columbia Intl Value A	NIVLX	31.80	-40.49	3.74
ING Intl Value A	NIVAX	29.95	-43.45	2.89