Private equity firms will need to become more like asset managers, offering buyouts as just part of their portfolio, or else focus tightly on specific sectors in order to prosper, industry participants said.

The industry -- once booming, but hit hard by the credit crunch -- must also become better in adding value by turning businesses around rather than pure financial engineering, investors and fund managers said at a conference.

Many investors are building exposure to different types of risk, such as equity or credit, rather than investing in traditional asset classes, as they look for the cheapest way to beat markets, said Charles Baillie, global co-head of alternative investments at Goldman Sachs .

Our view is that the future will be dominated by multi-asset class models or very focused models, Baillie told the SuperInvestor conference in Paris on Wednesday.

As they have grown in size, large U.S. private equity firms, such as Blackstone , KKR and Apollo , have spread their wings into new fields like real estate, hedge funds and general asset management.

The so-called supermarket model is heavily criticized though, and large counterparts in Europe have remained focused on buyout deals, expanding their scope out of western Europe into eastern Europe, Asia and the Americas.

As they look to maximize returns, some investors are demanding a clearly focused strategy and are backing firms that can show they are different from the rest of the pack.

We probably have a preference for more focused groups, said Ralph Aerni, chief investment officer of investor Strategic Capital Management (SCM).

Despite its preference, SCM is still backing firms like TPG , Blackstone or KKR, as they provide the only means of getting exposure to the big buyout deals that have outperformed the market, said Aerni.

HANDS-ON

Big buyout firms in the boom years became populated with banking experts as their deals took on more of a financial focus, fed by easily available credit which they used to fund their huge leveraged buyouts (LBOs).

They have been struggling to do new deals as debt financing has become harder to secure, while at the same time witnessing existing portfolio companies pushed to breaking point by the excessive use of leverage and a downturn in sales.

But as they look forward to an anticipated pick up in deals, both investors and private equity houses say hands-on management will characterize the next phase of the buyout cycle, rather than financial engineering.

Going forward, (buyout firms) will work on fewer deals and their focus will be on driving real operational and strategic value in businesses, said Terra Firma founder and Chairman Guy Hands.

It's a shift that could see the industry step back 15 to 20 years, said Tim Jones, partner at Coller Capital.

The need for people experienced in hands on work will favor U.S. firms with larger teams of operationally minded people, said SCM's Aerni.

Hands argues that the next wave of people to join the private equity industry will have that operational ability and a genuine interest in business.

In the future, the private equity industry will be smaller and more humble, but it will be considerably better at delivering long-term value, which is exactly what the LBO model should be about, said Hands.

(Editing by Jon Loades-Carter)

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