* Institutional EMEA liquidity on Liquidnet up 42 pct

* Spain, Portugal, Greece see some of strongest pick-up

* Fund holdings of euro zone stocks at 20-month high

By Toni Vorobyova

LONDON, Nov 1 (Reuters) - Institutional investors have come back in force to European equities this year, gaining the confidence to do bigger trades and prompting a fresh focus on company fundamentals.

The return of pension funds and top asset managers to European equities bodes well for a market that had been dominated by speculative, high frequency traders through the years of the financial crisis, leading to high volatility and a disconnect between companies' health and share performance.

Average daily liquidity in EMEA in Liquidnet - a platform which allows some 700 institutional investors globally to trade anonymously - jumped 42 percent to $19.7 billion in January-September compared to last year. That marks the biggest rise in principal traded since 2009 for EMEA, contrasting with a drop in overall market volumes reported by banks.

The trend has continued into October, as the STOXX Europe 600 index set five-year highs, up 16 percent this year and rewarding investors for their confidence in the region.

"Europe has outperformed for Liquidnet globally. We have seen an increase in inflows from the U.S. into Europe, and an overall increase in investor confidence which has resulted in a strong desire to trade blocks in Europe," Mark Pumfrey, CEO of Liquidnet Europe, told Reuters.

"The biggest liquidity increases we've seen are in the markets that were most damaged by the financial crisis. If you're an institution that thinks the euro will survive, then companies that were priced low 18 months ago are going to look very cheap (today)."

Liquidity in Spain more than doubled, Portugal rose 166 percent and Greece jumped 281 percent, albeit from low levels.

"For us, Europe is definitely one of the areas to be overweight into next year," said Veronica Peculate, head of global equities at Ashburn.

"We have been historically very underweight the periphery, but now we are much more broadly spread."

That chimes with the Reuters global asset allocation poll, released on Thursday, showing holdings of euro zone equities rising for the fourth month in a row to a 20-month high.

GOOD NEWS FOR MARKETS

Backing the trend seen on Liquidnet, the percentage of STOXX Europe 600 shares held in lending programmes of institutional investors has risen to nearly 18.5 percent from less than 17.5 percent in January, according to Markit.

"It's not a huge increase, but could be taken as supporting evidence that international institutional investors are increasing exposure to Europe," said Alex Borg, director at Markit, adding that the data suggests investor overweights in economically sensitive software, real estate and tech hardware.