* Fund returns 0.1 pct in Q3
* U.S. stocks gains offset by European stocks losses
* Fund to apply soon to invest more in China -CEO
* Fund may soon be able to invest directly in infrastructure (Adds fund chief's comments on Tesco, investments in China and infrastructure investments)
OSLO, Oct 29 (Reuters) - Norway's $860-billion sovereign wealth fund, the world's largest, booked a flat return in the third quarter as it was dragged down by weak European stocks, foremost among them embattled retailer Tesco.
The fund, one of the world's biggest investors, is the top shareholder in the British supermarket group, which has lost 53 percent of its market value over the past year after an accounting scandal and a number of profit warnings.
"It is clear that our investment in the British company Tesco has performed particularly poorly in the course of the year," Chief Executive Yngve Slyngstad told a news conference to present the fund's third-quarter results.
The wealth fund owns 6.98 percent of Tesco after raising its stake by 44 percent in less than two years, according to Thomson Reuters Eikon data. Other top investors such as U.S. billionaire Warren Buffett have cut their shares and Buffett called investing in Tesco a "huge mistake".
Slyngstad declined to comment on what he thought the retailer should do to solve its problems but told Reuters the fund was in "a dialogue with the board and the leadership of Tesco".
Tesco's new chief executive, Dave Lewis, told investors last week there were no easy answers and they should not expect a single new over-arching strategy but rather a series of incremental improvements that would be felt over time.
Norway's wealth fund is used to invest the country's earnings from oil and is invested in more than 8,000 companies worldwide averaging a 1.3 percent stake in each.
It has a target to achieve a 4 percent annual return but has undershot that target since it was set up in its present form in 1998.
It returned 0.1 percent in the third quarter.
"The companies that made the most negative contributions were retailer Tesco, chemical producer BASF and carmaker Daimler," Slyngstad said.
The value of the fund's European equity holdings fell 4.3 percent in the quarter, offsetting a 3.4 percent gain on its U.S. equities and 0.9 percent fixed-income investment gains.
The fund trimmed its bond holdings to 37.3 percent of its portfolio from 37.6 percent three months earlier, while equity holdings rose to 61.4 percent of the fund from 61.3 percent.
The return on equity and fixed-income investments was 0.5 percentage point lower than the return on the benchmark indices the fund uses to measure its performance.
The fund is heavily exposed to developed economies but is slowly building up its positions in emerging markets to capture the growth in the global economy.
In China it can only invest a maximum of $1.5 billion but Slyngstad said on Wednesday the fund would soon apply to Chinese authorities for permission to invest more.
"We will renew our application (for an investment quota) in the nearest future ... We would like to have a higher limit than we currently have," Slyngstad said.
He declined to say when the application would be submitted or how much the fund would apply for.
The share of European investments should be gradually reduced to 41 percent, Norway's finance ministry, which sets the fund's mandate, said in 2012.
Slyngstad is also keen to invest beyond stocks, bonds and real estate into assets such as infrastructure to boost the fund's return.
The fund can invest in infrastructure projects by buying stocks or bonds of the governments or companies that run them but cannot become a joint owner in an unlisted company, unless the firm plans to float.
However, Norway's Labour opposition party has proposed allowing the fund to directly invest in infrastructure projects, starting with renewables such as solar farms and wind parks, and its plan is gaining support among other parties.
"We think it is natural for the fund over time to have a large portion of so-called real assets, we include real estate but also infrastructure and other similar investments," Slyngstad said, declining to comment directly on Labour's plan.
The fund made a 3.3 percent return in the second quarter, after a 1.7 percent return in the first quarter. (Reporting by Gwladys Fouche, editing by Susan Fenton)