UPDATE 2-Norway oil fund ditches more euro zone assets

* Raises fixed income exposure compared with stocks

* Bought US, German, Japanese bonds; sold UK, Italy

* Says happy to hold bonds paying negative yields

* Further cuts exposure to euro zone periphery

* Will invest more in China shares when limits rise

By Vegard Botterli and Balazs Koranyi

OSLO, Aug 10 (Reuters) - Norway's $600 billion sovereign wealth fund cut its exposure to the struggling euro zone further in the second quarter and aims to pick up more emerging market assets, particularly bonds, in the months ahead, it said on Friday.

Seeking a balanced approach to risk in an uncertain economic environment, it also said it would continue to invest in top-rated sovereign debt yielding negative interest rates rather than hold excessive amounts of cash.

The fund, one of the world's biggest investors, has been gradually pulling out of euro zone assets, especially those on the bloc's periphery, and aims to cut Europe's weight in its portfolio permanently as the region's recovery continues to stall.

"A larger portion will be invested in emerging markets, particularly in fixed income," Yngve Slyngstad, the fund's chief executive, told a news conference. "This is not based on expectations for higher return but it's an attempt to spread risk."

The fund, which manages Norway's surplus oil revenues and invests the equivalent of $120,000 for each of the country's five million residents, increased its exposure to U.S. and Japanese bonds.

Reflecting western Europe's bleak economic prospects, it trimmed back on UK, French and Italian debt, though it raised its holdings of the region's benchmark German bonds, which currently yield around minus 0.06 percent on two-year paper.

In emerging debt markets, it boosted holdings of Chinese, Brazilian and Indian paper.

On the euro zone periphery, the fund got rid of its Portuguese and Irish government bonds in the first quarter while its Greek holdings are close to nil. It Italian and Spanish debt was cut sharply to 36.3 billion crowns ($6.13 billion).

The European Central Bank indicated last week it may again buy bonds to reduce crippling Spanish and Italian borrowing costs but a lack of specifics, tough conditions and Germany's dissenting voice mean markets remain dosed with scepticism.

NEGATIVE RETURNS

As the continent's crisis has deepened, the fund has invested in bonds paying with negative yields and it said this would continue.

"We've learned over the past five years that the notion we can't hold bonds with negative yields is wrong," Slyngstad said. "We have bonds with negative yields, such as Swiss bonds, as we can't have too much cash because then we will have exposure to the banks.

"We will invest in short papers and we will see negative interest rates."

The fund's portfolio breakdown showed that, as a class, that type of asset was not among its top ten fixed income investments. The tenth-ranked was valued at $3.5 billion.

Overall, it raised its exposure to bonds to 40.1 percent from 39 percent three months earlier after a stock buying spree over the previous three quarters.

Slyngstad declined to predict how quick the euro zone's recovery would be but said he "hoped" Europe was doing the right things and the fund would continue to have a vested interest in the bloc.

In China, the fund has reached its quota for investment fixed by the Chinese government but said it was keen to invest further in the country.

"We will increase our investment in Chinese A shares when this ceiling is raised," Slyngstad said.

The fund also reduced its equity holding in Europe, picking up shares in the Americas, Africa and the Middle East instead,

In the U.S. it picked up shares in Facebook and holds around 0.1 percent of the company. This figure is likely to increase closer to the firm's index weighting over time, he added.