“Carlyle, Fortress, KKR, Apollo or Blackstone - which will be the next private equity (PE) giant to go under?”

For US and European PE fund managers this has become one of the most popular topics of conversation around the water-cooler these days. Recently, the US-based Fortress Investment Group sacked 11% of its employees and up to 25% of some of its overseas teams. The share price of this first listed PE and hedge fund group has plunged by 95%. The market value of Blackstone, another listed PE group, has also evaporated by 86%. Coincidentally, the share price of 3i, the largest UK-based PE, was also down 86% falling below its 1994 IPO price, down from the GBP17.7 (US$25.1) per share it was worth at its peak. 3i also closed its Shanghai representative office recently.

Today most PE groups, including those just mentioned, find themselves facing depreciating investment portfolios and high liabilities caused by the financial chaos emanating from Wall Street. To survive these difficult times, they have no choice but to call a halt to investment in new projects, sell their assets at a faster pace and resort to other sources to raise funds.

What really concerns investors is that PE’s investment channels are unlikely to revive anytime soon. According to the latest statistics from the National Venture Capital Association, the channels whereby PEs could withdraw their investments have been blocked for the most part. Over the past year, the share price of most listed companies has fallen below their IPO price and these companies raised no more than 5% of the funds they did in 2007. More than 1,300 M&A deals, totaling USD911 billion in value, were cancelled. Only 6 start-up businesses went public with the support of venture capitals (VCs), far below the figure of 86 in 2007. The number of companies sold by VCs also decreased to 325, a record low since 2003. Investments by PEs around the world also plummeted by 72% to USD188.7 billion. In addition to all this, leveraged buy-outs have almost completely ground to a halt.

Now a series of follow-on effects resulting from the blockage of PE withdrawal channels are making the coming year even tougher for US-based PEs.

Firstly, it is becoming more and more difficult to raise funds. “The funds invested in PE groups should not exceed 10% of the total assets, and one should never have any one manager managing more than 10% of the investments,” says a pension and endowment fund investor. Investors are also demanding more decision-making powers in terms of PE service charges, fund sizes and other issues. This is because PEs failed to withdraw their investments over the past year - leading to dramatic losses for investors due to the stock market crisis - yet service charges remained unchanged. A report by financial services firm UBS indicates that last year 136 pension funds in the US lost over USD100 billion between them, and half of these pension funds now need urgent injections of capital because of a lack of sufficient funds.

What is in no doubt is that, impacted badly by the global financial storm, investors are more cautious when selecting fund managers, and therefore a major reshuffle of the PE industry is inevitable. David Rubenstein, Co-founder of Carlyle Group, has this prediction: “Very few new firms will be able to raise money. Those that can will receive an enormous amount of attention from investors.” Industry insiders estimate that the funds investors commit to VCs are likely to be more than halved in 2009, and within five years the number of PEs in the US will reduce by more than 50%.

However, compared with stocks and various financial derivatives, PEs bring a much smaller systematic risk and can more easily shake off troubles when the market finally turns the corner. If PEs can find any solace this year it would be in the highly attractive estimated valuations in the current climate, and any investments made in companies could bring in a considerable return on investment (ROI) in the future.

Fortunately, China still remains a heaven where investors and PEs have continued to expand. The Guidelines on the Risk Management of M&A Loans of Commercial Banks announced by the China Banking Regulatory Commission and the Measures for the Administration of Registration of Equity Investment issued by the State Administration for Industry and Commerce - along with other policies adopted by the competent authorities and the venture capital funds established by local governments - are all good news for PEs investing in China. It is also reported that the new Growth Enterprise Board, which is likely to be launched this year, will provide a new withdrawal channel for PE investments.

Unlike US-based PEs, local institutional investors in China are more likely to be eliminated because they are insufficiently mature. But the ongoing industrial reshuffle is good news for PEs with adequate funds. For some time recently, due to investment excess and the relative scarcity of high-return projects, investors have become more impatient, and project prices unreasonably high. Now, with their rivals out for the count and investment prices on the decline, finding attractive investment opportunities has become much easier.