While the rapidly growing presence of hedge funds in major segments of the credit markets promotes liquidity and diffuses credit risk, there are concerns that the loosely regulated investment vehicles could also exacerbate risk, according to a warning issued yesterday by Fitch Ratings.

The dilemma lies in the fact that hedge funds tend to "move in lock-step" in response to certain market developments, which may cause risk to concentrate. As a result, there may be potential, Fitch said, "for a single event to create wider spread distortions to multiple segments of the credit markets, rather than being contained to one or a few sectors."

Hedge funds currently manage about $1 trillion in unleveraged assets. If leveraged assets were taken into consideration, that number would go much higher, Fitch said. And while fixed-income strategies remain a relatively small investment approach among hedge funds, their growth has outpaced all other strategies managers employ.

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