U.S. investors should diversify more: State Street

NEW YORK (Reuters) - U.S. institutional investors should triple the amount of foreign assets in their portfolios and take advantage of solid economic growth in the rest of the world, Brian Garvey, senior currency strategist with State Street Global Markets, said on Tuesday.

For at least the next two months, financial markets should be amenable to investors seeking yield, particularly in Asia, he said at the Reuters Investment Outlook Summit in New York.

"We think U.S. investors are still very much under-diversified in their foreign exposure," said Garvey, citing data from State Street, whose $12.3 trillion of custody assets reflect 15 percent of the world's tradable securities.

Pension funds -- known for their long-term, macroeconomic-oriented trading strategies -- currently have 20 percent of their portfolios dedicated to foreign assets.

However, Garvey said they should have exposure of more like 65 percent to foreign securities and 35 percent domestic.

Last year U.S. investors purchased a record $246 billion of foreign stocks and bonds, according to the U.S. Treasury Department.

Low financial market volatility and stable economic growth have driven investors in search of higher returns, particularly in the last three months, Garvey said.

One particularly popular trading strategy has been the carry trade, in which investors borrow cheaply in low-yielding currencies like the yen to buy higher yielding assets in order to profit on the spread.

Indeed, State Street's own flows show that bets on further strength in the New Zealand dollar, which has the highest interest rates in the industrialized world, have been near record highs for the last month.

The Reserve Bank of New Zealand on Monday intervened in the market to weaken its currency for the first time since it was floated in 1985. However, carry trades do not appear to be deeply affected.

Garvey said that if the yen carry trade were to unwind -- which he estimated involves as much as $300 billion -- Japanese stocks would be an attractive place to park money.

Japan's benchmark interest rate is 0.5 percent, the lowest in the developed world.

"We would argue that in a rising rate environment maybe Japanese equities are less exposed to the global rate cycle, with the Bank of Japan still tightening but with moderate rate increases," he said.

He added that U.S. Treasury yields would likely to have rise to 5.50 percent or even 6 percent to draw back domestic investors. On Tuesday the benchmark 10-year Treasury yield climbed to a five-year high of 5.27 percent.

(For summit blog: summitnotebook.reuters.com/)