Private equity

Might private equity managers just voluntarily give the money back? No way. They often earn a fee on committed capital even if it is unspent. Forcing them to return funds would typically require a super-majority of investors to agree. So managers are looking at four areas of opportunity. None looks too appealing.

The first is taking minority stakes in public companies. Blackstone invested in Deutsche Telekom (NYSE:DT) last year while French group Wendel has been building a stake in Saint-Gobain. But it is unclear why behaving like a fund manager should be a core competence of a private equity firm. Second, firms can look to Asia, where credit markets are functioning better. But there are nowhere near enough politically plausible buy-out targets to expend that dry powder. A third option is the previously forbidden territory of financial services, where large amounts of equity can be put to work in already-geared businesses. Northern Rock has attracted interest but the stance of regulators towards buy-outs of healthy banks is untested. Finally, private equity could try to vacuum up leveraged buy-out loans that others no longer want. KKR and Citigroup (NYSE:C) are rumoured to be discussing such a project. This could soak up cash but, aside from the whiff of cannibalism, may depend on getting debt funding.

The absence of alternatives suggests that private equity firms, in order to deploy their dry powder, will attempt mega buy-outs once credit markets vaguely reopen. But debt costs have risen while the price of public equities has not fallen. That suggests that returns will take a dive.