Credit bubble looms as investors rush in

LONDON (Reuters) - A bubble could be building up in the credit markets, fueled by investor demand for an asset class with low prices and attractive yields, the head of hedge fund Polar Capital (POLR.L) said.

"Some people are looking at credit to the exclusion of everything else," Chief Executive Mark Kary said at the Reuters Hedge Funds and Private Equity Summit in London.

"There is a pretty scary consensus around ... a lot of people are chasing the same idea."

Kary said investors were attracted to credit because it looked incredibly cheap. This is because the market is building in historical default rates, he said, but these could turn out to be even worse than the market was pricing in.

"The global economy is in some sort of free fall. I don't know if there is anybody living that has seen anything like it." Polar Capital (POLR.L), a UK-listed firm running long/short equity hedge funds and traditional fund, does not invest in credit, but Kary said a lot of hedge funds were focusing in on this area.

"In January last year, the three things people were looking at were commodities, real estate and emerging markets," Kary said. "Arguably they were the three disaster trades of last year."

"This year everyone is looking at credit, distressed (debt) and CTA's," Kary said. "Every man and his dog is raising money for distressed."

CTAs -- Commodity Trading Advisers, or managed futures, follow trends in futures markets.

Last year, the worst year on record for the $1.4 trillion hedge fund industry, managed futures returned 18.33 percent, making them the best-performing strategy and one of only two to make money, according to Credit Suisse/Tremont.

In the first two months of 2009, however, they are down 0.72 percent.

Investors have turned to credit for its attractive yields relative to cash and weak equity markets, where companies are cutting or scrapping dividends.

Investors' insatiable appetite for corporate bonds has helped companies issue more than a billion euros of bonds so far this year partly to refinance short-term debt and boost reserves of cash to help them through the recession.

But there is a risk of the market getting overheated and of returns getting eroded because so many investors are piling in.

The credit markets are cheap because companies' bonds have fallen sharply to reflect the grim economic climate, which could bring a wave of defaults on corporate bonds and other debt.

(Additional reporting by Laurence Fletcher; Editing by Rupert Winchester)