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Mutual funds increasingly driving short-term volatility in credit markets, says Fitch

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European mutual funds are increasingly driving short-term volatility in credit markets, as they have increased their investments in credit assets to approximately EUR1trn at the end of 2010, according to a new report from Fitch Ratings.

Although European insurance companies hold around double the amount of private debt assets, mutual funds have become a driving force in credit markets, as they represent a much greater proportion of daily market activity. However, insurers’ decisions will continue to influence structural changes in demand for and the pricing of credit, according to Fitch.

"Credit has become more "retail" in nature, in Fitch’s view, although mutual fund investors’ focus has changed in the past months with a gradual switch from fixed income to equity," says Aymeric Poizot (pictured), Senior Director and head of Fitch’s EMEA Fund and Asset Manager team. "Specialised credit funds have become more popular, with EUR120bn of net sales in 2009 and 2010 and 30% of funds launched in the past three years, according to Lipper data. The EUR7bn mutual fund segment is a sizable capital pool for the European credit market".

The European mutual fund industry’s EUR1trn of credit investments is held in bond funds and the bond portion of balanced funds and compares with total European mutual fund assets of over EUR7trn.Within bond funds, about 800 funds dedicated to investment grade and high yield credit represent approximately EUR300bn, according to Lipper FMI. Fitch estimates that another EUR700bn is invested in generalist bond funds and balanced funds. Credit funds mainly track indices (such as IBoxx, BoA Merrill Lynch or Barclays) but benchmark-free products are gaining momentum, reflecting investors’ appetite for absolute return and a questioning of the relevance of outstanding based indexes.

European insurers hold about EUR2trn of private debt, while pension funds hold EUR500 bn. Insurance companies are the most prominent European investors in private debt, given the sheer size of their portfolios (EUR5.5trn excluding unit-linked investments), of which approximately 75% is invested in bonds, compared with. 45% at pension funds.

"Whether it is driven by tactical decisions or regulation such as Solvency 2, any reallocation to or within credit portfolios by European insurers is likely to weigh on the demand and pricing of private debt," says Monica Insoll, Managing Director in Fitch’s Credit Market Research group.

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