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HONG KONG (Reuters) -- China's $200 billion sovereign wealth fund, which suffered big paper losses on stakes in Morgan Stanley (MS, Fortune 500) and Blackstone (BX), is set to invest up to $2 billion in U.S. mortgages as it eyes a property market recovery, two people with direct knowledge of the matter said Monday.

China Investment Corp. (CIC) plans to invest soon in U.S. taxpayer subsidized investment funds of toxic mortgage-backed securities, which it sees as a safer bet than buying into the Federal Reserve's Term Asset-Backed Securities Loan Facility (TALF).

Under the Public-Private Investment Plan (PPIP) launched earlier this year, the U.S. government plans to seed a number of public-private investment funds that would combine taxpayer money with private capital to buy as much as $40 billion in toxic securities from banks.

Compared with TALF, the new and smaller PPIP program focuses on safer toxic securities, which must have triple-A ratings from at least two agencies, and are debts guaranteed by the Federal Deposit Insurance Corporation (FDIC), sources explained.

"In this case, CIC feels safer to invest and the safer it feels, the more confident it will naturally feel about its investments, as well as in the prospects for the U.S. economy," said one of the sources.

The move comes after the United States and China ended their first annual Strategic and Economic Dialogue late last month, agreeing to lead the global economy out of recession, with China seeking safer investments in the world's leading economy.

"The Chinese government is always trying to seek a more ideal way to invest in U.S. assets rather than purely buying U.S. government bonds all the time," said the source.

"Some might think $2 billion for a $200 billion sovereign fund is not big money, but it can be regarded as an innovative and positive option for Chinese investment."

CIC is in talks with nine designated PPIP managers, which include Alliance Bernstein LP, with sub-advisers Greenfield Partners LLC and Rialto Capital Management LLC; Angelo Gordon and Co. LP, with GE Capital Real Estate; BlackRock Inc.; Invesco Ltd.; Marathon Asset Management LP; Oaktree Capital Management LP; RLJ Western Asset Management LP; Trust Company of the West; and Wellington Management Co. LLP, said the sources.

Choices to be made: CIC is expected to decide this month which of the nine designated PPIP managers it will mandate for its investments in financial products such as mortgage-backed securities (MBS) under the PPIP scheme, said the sources.

The fund is likely to select several, though not all, of the firms, said the sources, who have direct knowledge of the matter but asked not to be identified as the talks are confidential. CIC cannot invest directly in the PPIP.

CIC declined to comment.

Early this year, some U.S. asset managers approached CIC to invest in their funds focused on the TALF, the sources said, but the Chinese declined given the uncertain outlook at the time for U.S. economic recovery.

They noted, however, that these TALF-focused funds performed well in the second quarter as global markets perked up following the long financial crisis triggered by the U.S. property market.

CIC, established by China's Communist government in late 2007, is keen to participate in the PPIP as it expects the U.S. property market to recover gradually late this year, said the sources.

The U.S. Treasury has been informed that the nine designated PPIP managers are in talks to receive CIC money, and supports bringing foreign investors like CIC into the PPIP program, said the sources.

In June, Reuters reported Asia-Pacific sovereign wealth funds, including CIC and Singapore's Temasek, which have been rocked by soured bets on western financial companies, are diversifying into the riskier arena of distressed asset investments.

CIC's $200 billion fund is part of China's roughly $2 trillion of foreign exchange reserves, and the majority of its reserves are in U.S. government bonds.