UPDATE 1-Japan Post Bank to increase risk assets but cautious on FX impact-CIO

* Japan Post Bank almost fully hedging FX risk on new foreign bonds

* Japan Post Bank likely to increase stocks

* Preparing to start alternative investments

* Domestic bond holdings likely to fall further (Adds CIO’s comments, background)

By Tomo Uetake

TOKYO, Jan 20 (Reuters) - Japan Post Bank is increasing risk assets, but is cautious about currency exposure and will mostly hedge its new foreign bond investments, its chief investment officer said on Wednesday.

How the newly listed Japan Post Bank allocates its massive assets of 205 trillion yen ($1.74 trillion) is closely watched by market players, especially after the bank accelerated its foray into risk assets in recent years.

In an interview to Reuters, chief investment officer Katsunori Sago also said that the bank will soon start investing in alternative assets, a category that includes hedge funds, private equity and properties.

One major disadvantage of alternative investments is that they are much harder to cash out than more liquid assets such as government bonds. But Sago said the bank’s huge asset size allows it to have some illiquid assets.

“It is natural to have some portion of our 200 trillion yen assets in such investments. For we can expect much higher return by taking liquidity risk there than taking additional risk in market products,” said Sago, a former Goldman Sachs executive.

He said the bank could have a few percentage points of its total assets in alternative products.

That would be a big leap for Japan Post Bank. Before privatisation of Japan’s postal system, it channelled most of its funds to government bonds.

Sago said the bank has been changing its allocation faster than its medium-term plan to increase what it defines as risk assets to 60 trillion yen by March 2018 from 46 trillion yen at March last year.

Such a shift accelerated after Prime Minister Shinzo Abe took office in late 2012, pledging to adopt massive fiscal and monetary stimulus and calling for the country’s investors to take more risk.

Sago said the bank has not changed its investment stance even after sharp falls in the world’s stock markets this month.

Hit by plunging oil prices and subsequent pains in the energy sector, concerns on slowdown in the Chinese economy and the spectre of U.S. rate hikes, Japanese share prices have fallen to a near 15-month low.

“In a way, when we are trying to start new investment, market correction is welcome,” he said.

Sago said its holding of Japanese stocks, currently at around 2 trillion yen, is likely to increase in the future but added the size of the increase will depend on market conditions.

The bank has been stepping up investment in foreign bonds as an alternative to rock-bottom yields on Japanese bonds.

But Sago said the bank is keen to avoid currency risks, unlike the Government Pension Investment Fund, the world’s largest pension fund with its 135 trillion yen ($1.15 trillion) of coffers, which has been buying foreign bonds mostly without such currency hedging.

“At the current yen levels, we basically hedge our currency exposure. Our new investment in foreign securities are mostly fully hedged,” he said. (Reporting by Tomo Uetake; Writing by Hideyuki Sano; Editing by Muralikumar Anantharaman)