One of Britain’s leading fund managers said yesterday that the $1 trillion (£500 billion) institutional packaged-loans market was flawed and posed significant risks to investors.

Anthony Bolton, the founder of the fund manager Fidelity International, likened the so-called Collateralised Debt Obligation (CDO) market to the UK’s split-capital investment trust sector, which collapsed in 2001 and 2002.

The warning came as souring sentiment in the credit market spilt over into the financing of private equity-backed buyouts. Private equity bosses such as Jon Moulton, of Alchemy Partners, told MPs that “overenthusiastic” lending could lead to casualties.

In recent weeks some deals have been scaled back or pulled altogether as sub-prime jitters seeped into the buyout market. New Look, the British high street fashion chain, cancelled its sale; Kohlberg Kravis Roberts and Clayton Dubilier & Rice broke off a $1.55 billion (£800 million) debt offering to help to fund their acquisition of US Foodservice; Thomson Learning, a former division of the media giant Thomson, reduced from $2.14 billion to $1.6 billion the bond offering that its new owners, Apax and the Ontario employees’ pension fund, had planned to use to help to finance its takeover. All eyes are now on the Alliance/ Boots debt syndication, which many observers say could hit choppy waters.

Mr Bolton, speaking at a conference in Monaco, said: “CDOs remind me of the split-capital trusts and the problems there. They prolong the party and put off the day of reckoning. I still think there are major risks with these.”

CDOs and collateralised loan obligations (CLOs) are bundled-up packages of bank loans and mortgages routinely bought and sold in the international capital markets. The underlying loans are packaged up to appeal to investors with differing risk appetites. The industry has mushroomed in recent years, but there are growing concerns among regulators that CDOs can be difficult to value accurately because the markets in them are illiquid and there is no quoted price.

Last week a big hedge fund managed by Bear Stearns, which specialised in sub-prime mortgage CDOs, narrowly averted collapse.

Mr Bolton told investors that the model and assumptions on which CDOs were valued might be flawed. “[Split-level investment trusts] were based on models and assumptions and it turned out the models were wrong and that led to the collapses,” he said.

Tens of thousands of institutional and private investors lost hundreds of millions of pounds in split trusts, which were often marketed as ultra-safe, but sometimes turned out to be highly leveraged vehicles invested in technology stocks. Trust managers compounded the problems by investing in one another’s trusts, prolonging the boom but ultimately leading to a vicious circle of collapses.

Richard Wohanka, chief executive of Fortis Investments, said that the media had overreacted. “I think the press has gone berserk on CDOs and the sub-prime debacle. CDOs are nothing but a bond, but highly illiquid . . . If you buy a CDO, you need to understand it has a good yield but be clear to hold it to maturity.”

The Financial Services Authority will say in a report today that it is concerned that sub-prime mortgages are being inappropriately sold to homeowners in Britain.

Its investigation, which preceded the meltdown in the US sub-prime market, found that some mortgage brokers had not kept proper records and could not show that loans they had sold were suitable for customers.

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