* Asian investors behind rally on Polish debt
* Foreign holdings of Poland's debt hit all-time highs
* Buyers see Poland as safe alternative to euro bonds
By Dagmara Leszkowicz
WARSAW, Dec 21 (Reuters) - Where does a major bond investor take their cash if they want to steer clear of the euro zone's troubles but don't have the stomach for emerging markets? The answer, for a growing number of Japanese funds, is Poland.
Heavy demand from Japanese investors has helped drive foreign holdings of Polish sovereign bonds to an all-time high of nearly 190 billion zlotys ($62 billion) by the end of October, pushing down the yields - which are inversely proportional to the level of demand - to record lows.
"Poland looks very attractive. The yield on the country's 10-year bonds is now below 4 percent, but you can't find such a yield anywhere around the world," said Genzo Kimura, bond fund manager at Japan's Sumitomo Mitsui Trust Asset Management.
"Many are around 2 percent. That's the reason why investors want to direct their money to Poland," said Kimura.
The reason for the upsurge in interest is that Asian investors have identified Poland's bond market as a kind of halfway house; a fairly solid European economy, but without the low growth and risk of a crash that come with the euro zone.
In terms of volumes, Poland is still a side show compared with the big global bond markets where Japanese funds invest their money. But it is on the rise.
"Japanese investors have wanted to diversify away from the euro zone whilst still maintaining European exposure," said a London-based source who has been close to negotiations with Japanese investors.
"In this regard, when factoring in the importance of liquidity and ratings to the Japanese, Poland is the obvious choice," said the source, who did not want to be identified.
Poland's finance ministry does not disclose who holds its sovereign bonds, making it difficult to establish who is driving the demand, but traders and government officials say the buyers include major financial institutions in Japan.
In October, Japan's biggest mutual fund manager, Kokusai Asset Management, said it added Poland to the portfolio of its Global Sovereign Open Fund.
That seems to have started a trend.
"More fund managers considered allocating funds into Poland after seeing Global Sovereign Open Fund stepping in," said a portfolio manager at a Japanese company who declined to be identified.
Where Japanese funds invest is followed closely because they are such big and stable players. Japan has a huge pool of domestic savings to invest, negative yields at home, and needs strong returns to keep paying out pensions for an ageing population.
In a measure of the growing links between Japan and Poland's bond market, the Deputy Finance Minister, Wojciech Kowalczyk, led a delegation of officials on a week-long visit to Japan in October to drum up more demand.
A conference room at the Polish foreign ministry also underlines the importance of the trade; one wall is decorated with Japanese paintings, miniature Samurai swords and porcelain dolls.
"Big Asian entities have our bonds in their portfolios already ... Now this group is expanding, and those who already have our bonds are increasing their investment limits," Piotr Marczak, the head of the ministry's debt department, told Reuters.
"It seems that, for Asian investors, Poland is no more an emerging market, but neither is it a developed one. It is somewhere in between," he said.
In many ways, the Polish bond market mirrors the niche occupied by the country's economy as a whole.
While the euro zone lurched from crisis to crisis over the past four years, Poland avoided recession, the only European Union country to manage that feat. It grew 4.3 percent in 2011, though that has slowed significantly this year.
At the same time, Poland's stable political scene, prudent fiscal management and close economic and diplomatic ties to its neighbour Germany have, for foreign investors, set it apart from some of the more volatile emerging markets.
Polish bonds are also attractive relative to its Eastern European peers. It pays 3.30 percent on five-year bonds, while the Czech Republic pays 0.7 percent.
Hungary's 5-year yield is nearly twice as high as Poland's, but comes with less political stability and a weaker economy.
It also has advantages over emerging markets further afield, such as Mexico or Turkey, which are also seeing an upturn in investor interest. Chief among these is stability; while insulated from the worst of the euro zone's risk, it is close enough to the EU mainstream to look solid and robust.
"The Polish economy, and recently political situation, is amazingly stable," Yoshizane Ishii, First Secretary at the Japanese Embassy in Warsaw, told Reuters.
"This stability is usually not so expected with typical 'emerging markets'."