* GPIF portfolio of $1.26 trln, nearly matches Spanish GDP
* GPIF says will investment in infrastructure for first time
* Plans to invest $2.7 bln in 5 yrs in infrastructure
* Will invest jointly with Canada's OMERS, Japan's DBJ
By Chikafumi Hodo
TOKYO, Feb 28 (Reuters) - Japan's public pension fund, the world's largest, reported a 4.73 percent return on investments in the October-December quarter, thanks to gains in Japanese stocks and an increase in the value of its foreign assets due to a weaker yen.
The Government Pension Investment Fund (GPIF) has posted an increase in returns for a record six consecutive quarters, having shown a 2.71 percent increase in the previous quarter.
The public fund announced it has reached an agreement with Canada's Ontario Municipal Employees Retirement System (OMERS) and Development Bank of Japan (DBJ) to invest in infrastructure projects through an investment trust fund.
GPIF plans to invest as much as $2.7 billion over five years, mainly in developed countries infrastructure investments selected by OMERS.
The value of its total portfolio - which almost matches the Spanish economy, the world's 13th largest in size - rose 4 percent over the quarter to stand at a record 128.6 trillion yen ($1.26 trillion).
GPIF's portfolio has increased by 19 percent since Prime Minister Shinzo Abe's aggressive reflationary and monetary policy triggered a sharp fall in the yen and gains in Tokyo stocks in late 2012.
The overall investment gain during the October-December quarter was 5.77 trillion yen, compared with a gain of 3.24 trillion yen in the previous quarter.
The return in October-December was the fourth best quarterly gain in percentage terms since 2008, when all of the money from the previous fund management system was transferred to GPIF, and the second biggest gain in value terms.
Global investors will be closely watching the fund's review of its asset allocation strategy after receiving a new pension actuarial revaluation from the government scheduled in March.
Japanese government bonds (JGBs), which make up the lion's share of the portfolio, generated a meagre return of 0.18 percent in the October-December quarter.
By comparison, foreign equities produced the biggest investment return of 16.23 percent, followed by Japanese stocks with 9.19 percent and foreign bonds with 8.16 percent.
During the latest quarter, the GPIF's holdings of JGBs fell near their asset allocation floor of 52 percent, while holdings of Japanese equities rose close to their ceiling of 18 percent of total assets.
As of the end of December, GPIF had 53.4 percent of its total assets held in domestic bonds, 16.66 percent in Japanese equities, 10.26 percent in foreign bonds, 14.68 percent in foreign equities and 5 percent in short-term assets.
Japanese share prices have fallen from recent highs since the start of the year, but GPIF could come under pressure to rebalance its assets in line with the portfolio targets should share prices start to recover.
Founded in 2001, the fund conducted the most significant shake-up of its investment strategy last June when it revised its allocation targets, setting a core weighting of 12 percent for Japanese stocks, with a fluctuation of 6 percentage points allowed either way.
The core weighting for domestic bonds was set at 60 percent, foreign stocks at 12 percent, and foreign bonds at 11 percent. GPIF also has 5 percent invested in short-term assets.
GPIF is under pressure to overhaul its JGB-heavy portfolio after a government-appointed advisory panel recommended fundamental changes to its governance and investment strategy in a report issued in November.
For instance, GPIF began investing in emerging markets equities in 2012.
GPIF said earlier on Friday it will start investment in infrastructure for the first time. Infrastructure investment will be categorised in GPIF's foreign bond portfolio.
GPIF plans to invest about $2.7 billion, or 280 billion yen, in infrastructure investments which Canada's $60 billion OMERS selects. Another partner, Japan's DBJ, plans to invest about $100 million in the fund.
Japan's Nissay Asset Management and New York-based investment consultant Mercer Investments will supervise the fund on behalf of GPIF.
GPIF hopes diversifying into infrastructure will improve the efficiency of its portfolio.
Tokihiko Shimizu, director-general of GPIF's research department, said the public fund will continue to seek opportunities to partner with other public entities to invest in other infrastructure projects.
"We've set this amount for this particular deal between three entities, while we'll continue to consider other possibilities," Shimizu said.
The fund needs to generate healthy investment returns. Since the 2009/10 financial year, it has been paying out more in benefits than it has received in contributions due to the rising number of retirees among Japan's ageing workforce.
Reserves managed by GPIF represent one of three sources of revenue to support Japan's pension scheme, the others being contributions from the working population and a state subsidy from the national treasury.