“PRIVATE-equity firms are only now starting to do aggressive branding,” says David Rubenstein, boss of the Carlyle Group, a top private-equity company that has probably devoted more thought to its brand strategy than anyone else in the industry. This task has been complicated by Carlyle's recent elevation to public enemy number one, on film by Michael Moore and, more thoughtfully, in Dan Briody's book, “The Iron Triangle”.

Carlyle's critics note that many former politicians have taken the company's shilling, and that some members of the bin Laden family and other Saudis not only invested in the firm but were attending its annual investors' meeting on September 10th-11th 2001. This, they aver, shows that Carlyle is at the heart of a worrying global military-political-industrial complex.

The company fiercely rejects such charges. It says that hiring politicians was not meant to secure deals; it was a marketing initiative intended to “help people get to know us”. This approach has been widely imitated, says Mr Rubenstein: “Every private-equity firm now has its former senior government official hanging around, but it got identified with us.” He says that, contrary to the firm's (un)popular image, “we are as ethical as any business in the world, and are proud that in over 17 years no government agency has ever fined us for anything.” The bad press, he says, seems to have had no effect on private-equity investors, a smallish group who hold the firm in high regard. “We are raising more money than ever, recruiting more people than ever, doing more deals.”

For what it's worth, Carlyle's rivals in the private-equity business also dismiss the conspiracy theories and, in a back-handed way, pay tribute to the firm's marketing prowess. Wooing the people in public-pension funds who invest in private equity may well be good policy. They tend not to be high-flyers, and may be influenced by rubbing shoulders with the great and good in a luxurious venue.

“Carlyle is the McDonald's of the industry—big, everywhere, schlocky,” says one well-known deal-maker. Carlyle, he notes, is always on the road drumming up money to fill the constant stream of new fund “franchises” it opens. The company currently manages 22 funds of various sorts; the industry norm is to start one new fund every few years, typically involving a laborious fund-raising process that often lasts the best part of a year. “Carlyle is about as in charge of the world as McDonald's is,” concludes the rival deal-maker.

Just like Carlyle, other leading private-equity firms now hope that establishing a strong brand will give them an edge. As private equity matures, they think, it will become like many other industries, with a few leaders that can use their strong brands to charge higher prices, launch new products more easily, recruit top talent and attract the best business partners. Impressive past performance is likely to be a prerequisite for becoming a strong brand. But in an industry once dominated by lookalike generalists, the top firms are now pursuing very different strategies.

The main variables are the size of their funds and the degree of specialisation. Some have established a niche in particular kinds of deals or industries or geographical regions; others cover the whole range of private equity, or are even moving beyond private equity into other assets such as hedge funds. The market seems well aware of these distinctions. Increasingly, limited partners “divide funds into particular categories, sectors, types of deals, then go to the best of breed in each group,” says David Thomas of Citigroup Venture Capital (a global technology-oriented buy-out firm, despite its name).

One crucial strategic choice is the size of deal to be pursued. It is fashionable to argue that competition is fiercest—and thus returns likely to be lowest—in the biggest deals, of $1 billion and up. These are in relatively short supply. All of them involve auctions among the largest, most competitive funds. Mid-sized deals are often seen as a better bet—more common and more diverse, and thus providing more opportunities for specialist private-equity firms.

Yet mid-sized deals are increasingly allocated by auction, too. The poorest performers in private equity are concentrated in this part of the market. “A lot of firms in the mid-market know they are never going to be able to raise another fund, so they're throwing their money around,” says the boss of one of the firms that concentrate on bigger deals. Mid-sized auctions tend to involve many more bidders, perhaps dozens. Bigger deals are often fought out by no more than three funds or consortia.

Consortium deals—known as “club deals”—have become increasingly common. A recent example was the joint purchase in July by KKR, Blackstone, TPG and Hellman & Friedman of Texas Genco, an energy firm, for $3.65 billion. Some clubs include non-financial firms: TPG and Providence Equity Partners recently teamed up with Sony to buy MGM.

But club deals are controversial. On the plus side, a consortium can do bigger deals. Most funds have an upper limit on how much of their capital they can put into any one deal, typically around 10%. So even a $5 billion fund, assuming it could borrow, say, three times the equity it puts in, might not be able to bid more than $2 billion for any target firm on its own.

On the minus side, some sellers suspect big private-equity firms of forming (loose) cartels to make bidding less competitive. There is also the practical question of which member of the club will be in control of the company after it has been bought. Jack Welch, the former boss of GE, who now works for Clayton, Dubilier & Rice (CDR, see article), worries about what happens when the purchasers disagree about what needs to be done to improve the company, or when to sell it. But that risk does not trouble Mr Lee, whose firm is involved in lots of club deals. “All the top people in the big private-equity firms have known each other for years, and it is unlikely we are going to disagree fundamentally,” he says. “Put the chance of a difference of opinion versus the opportunity to make lots of money, I'm prepared to take the chance.”

Many of the most upbeat people in private equity today concentrate on small deals, not least because in this area there is little competition from thebig funds. The funds pursuing small deals tend themselves to be small. “There is a stark contrast between small private-equity funds—maybe $10m-50m, truly lean, often largely funded by the general partners, who have often been successful managers—and big firms that are really asset managers whose main expertise is fund-raising,” says Roy Bingham of Health Business Partners, an investment banking firm specialising in small health-care-related deals.

Sentinel Capital, based in New York, goes for firms in the $25m-125m range. There are lots of them, the scope for remedying inefficiencies is much greater than in medium-sized and large firms, and competition for deals is less intense—though that may change as the mid-market funds become more desperate for promising opportunities. Indeed, says David Lobel of Sentinel, mid-market firms are already keen buyers of companies that Sentinel has acquired and knocked into shape.

The leading private-equity firms have long claimed to add value to the companies they have bought. As the industry matures, they say, operational improvements will become the main source of profits, so they are upgrading their methods. CDR hired “Neutron Jack” to add rigour to the oversight of firms in its portfolio. KKR now draws up a detailed “100-Day Plan” (“not three pages, a line-by-line blueprint”) for a firm immediately after its acquisition, in which its in-house consulting firm, Capstone Consulting, plays a crucial part.

“From now on, specialists will outperform generalists,” says Glenn Hutchins of Silver Lake Partners, an American private-equity firm specialising in large, mature technology companies, a sector in which “you really have to understand the companies you invest in”. Increasingly, all but the biggest firms are claiming to be specialists in particular sorts of deal.

And even some big firms are claiming to specialise in several things: for example, Apax says it has built expertise in six carefully selected industries. Electra Partners, a big British private-equity firm, says it specialises in finding firms with low growth and complex challenges that it thinks it can clean up and put on a faster growth track. Elevation Partners was launched in June by Roger McNamee, formerly of Silver Lake, and Bono, a rock star, to seek out deals in the media and entertainment industry. But specialisation itself is no guarantee of success: a private meeting with Bono persuaded investors to stump up $1 billion, but can his fund do better than experienced and equally specialised rivals?

Some firms are trying to differentiate themselves by aiming for a wider geographical spread. For most American private-equity firms, “going global” is shorthand for beefing up their continental European operations. Several have now established a foothold in Europe, having tried but failed a decade ago. This time round they have realised that to succeed in Europe, with its many languages, cultures and legal systems, they need a strong local presence, mostly of local staff. Conversely, European private-equity firms are not seriously trying to crack the American market.

Europe has seen far more buy-out deals than other parts of the world in recent years, a trend that is widely expected to continue. “In Europe, unlike America, there will be opportunities to exploit inefficiencies for years,” argues Graeme Johnson, European head of Deutsche Bank's private-equity-funds group. One reason, says Damon Buffini of Permira, is that whereas America has already unbundled most of its badly run conglomerates, Europe is only now starting to do so. But even in America, there are still a few opportunities to be found. Wilbur Ross, of WL Ross, for instance, made a remarkable—and remarkably lucrative—job of rationalising America's steel industry and shepherding it through the bankruptcy courts in 2002-03.

Asia has mixed appeal for private-equity firms. Most think that it has huge potential but are uncertain about their ability to take advantage of it. Many are now looking hard at Japan, following the success of Ripplewood and Christopher Flowers in buying Shinsei Bank out of bankruptcy, cleaning it up and floating it. Gillian Tett's gripping book about the deal, “Saving the Sun. How Wall Street Mavericks Shook Up Japan's Financial World and Made Billions”, makes it clear that foreign private-equity firms with brains, patience and connections can make a fortune in Japan.

Private equity is growing in India too. Gaurav Dalmia of First Capital India, a private-equity boutique, says this ranges all the way from big foreign funds negotiating equity stakes in large Indian public companies to Indian entrepreneurs returning from Silicon Valley to put their money into tech start-ups. “India is one of the few markets in the world that offers opportunities to deploy large amounts of private equity,” says Mr Dalmia. Private-equity investment in India this year is expected to reach $1.3 billion, up from $800m in 2003.

China, which has no lack of capital and a tendency quickly to create overcapacity in any successful business, still has many foreign private-equity firms wondering how to make money there. General Atlantic Partners, long one of the savvier and more globally oriented American private-equity firms, has astutely teamed up with AIG, an insurer with great connections in Asia, and particularly in China. “We prefer to find partners in those parts of the world, as we would otherwise spend years trying to understand local conditions,” says Steve Denning, General Atlantic's boss. Having started to invest in China and India three years ago, the firm this year floated one of its Indian firms, Patni Computer Systems, and recently bought a stake in GE's business-process outsourcing unit in India.

Carlyle and Blackstone, with TPG and Bain Capital following close behind, have decided to diversify well beyond private equity. This strategy is not entirely new. Many private-equity firms have long had mezzanine or distressed-debt funds. Blackstone has run a property fund since 1992. One reason for branching out is to provide a “one-stop shop” for limited partners such as big pension funds, which now want to reduce the number of private-equity firms they deal with, but without necessarily making their investments less diverse. Carlyle says it allows investors to pick and move among different market niches, and allocate capital across many funds without being charged the double fee that a fund-of-funds would incur.

Yet as firms concentrate on expanding their assets under management, they may start to care less about performance—which may anyway be affected by the sheer difficulty of evolving from “craft” businesses into huge institutions. And, say, Carlyle's 1-2% annual fees on the $18 billion it manages add up to more than enough to provide its team of 280 investment professionals with a comfortable living even if their results are mediocre—which, to be fair, so far they have not been.

Is there any synergy between different sorts of so-called alternative assets? Blackstone, which tries harder than Carlyle to get its different sorts of fund managers to exchange ideas, says that, for example, during the tech bubble sceptics in its private-equity group saved its property group from investing in office space intended as cheap “telecoms hotels” for internet firms.

Yet even as Blackstone, Carlyle and TPG diversify, private-equity firms are complaining that hedge funds are moving on to their turf. Mr Kravis, noting that in the auction for Texas Genco the KKR club had only narrowly defeated a rival one made up of hedge funds, observed that “hedge funds know how to pick stocks and make a lot of money. But that is not the same thing as creating value through ownership of an asset over the long term in a hands-on way.” Nor do hedge funds have the right valuation skills, say other private-equity bosses. One of them competed unsuccessfully for a stake in Air Canada against Cerberus Capital, a big hedge-fund firm. He reckons that, at $185m, “Cerberus paid three times too much.” Yet Cerberus is the hedge-fund firm most admired, and feared, by private-equity rivals.

Compared with private-equity funds, hedge funds are short-term vehicles from which investors can readily withdraw their capital, usually at least once a year. There is a risk that in the event of a run on them (and private-equity folk all agree that there is now a hedge-fund bubble), hedge funds might have to sell fairly illiquid private-equity investments fast. On the other hand, private-equity firms, with their long-term perspective, have no obvious claim on the short-term trading skills needed to succeed in the hedge-fund business.

But if the buy-out side of private equity faces big challenges, much of the venture-capital business is having an even tougher time, as the next article will show.

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