Bosses of some of the world's largest private equity groups told the industry's annual get-together that their growth into alternative asset managers, investing in everything from credit to real estate, was necessary for their investors to beat the economic cycle.

Private equity, one of the alternative asset classes offering diversification from stocks and bonds, has traditionally been about leveraged buyouts - where the buyer funds the purchase price through borrowing, using the target company's assets as collateral.

But tighter financing conditions have restrained this kind of financial engineering and investors accustomed to double-digit percent returns in private equity have had to settle for outperforming public markets by only a few hundred basis points.

Financial industry titans, who have amassed vast fortunes by buying and selling companies, said the best opportunities now lay in cherry picking the offerings of major asset managers.

Buyouts, which is what people normally think of when they think of private equity, are going to be an increasingly small part of a more specialized product base available to the limited partner community, James Coulter, co-founder of TPG Capital LP, told the annual SuperReturn International conference in Berlin on Tuesday.

Many major buyout firms have developed funds for investing in other alternative assets.

These include corporate debt, real estate, infrastructure, hedge funds and venture capital. They have grown to such an extent that in many of the major firms they have collectively overtaken private equity in assets under management.

TAKING CONTROL

Coulter likened the evolution of the private equity industry to the mutual fund industry, where Fidelity Investments used to be known for its flagship Magellan fund before it diversified into other investment products.

This is going to continue to grow and if anything accelerate. more and more specialized products as people begin to take more and more control of the choices in their own portfolio.

Multi-platform offerings have allowed private equity firms to capture major mandates from investors seeking economies of scale, such as the Teacher Retirement System of Texas giving KKR & Co LP and Apollo Global Management LLC $3 billion (1.9 billion pounds) each to invest on their behalf across their funds.

You have got 4,000 to 5,000 private equity funds in the world. There will be about 6 or 7 that will be managing a wide array of assets and be asset managers as you might call them, David Rubenstein, co-founder of Carlyle Group LP, told Reuters on the sidelines of the conference.

It's a relatively small percentage but there is no doubt these firms are going to have wide array of things to offer investors.

Many investors do not have the resources to decide which firms to invest in for every discipline, said Rubenstein, whose firm boasts 89 active funds spanning various alternative asset classes.

This could tempt many to invest with large firms like Blackstone Group LP , KKR and Carlyle, that can offer exposure to a myriad of subsectors.

In the case of Blackstone, for example, private equity made just over a quarter of the firm's $166 billion assets under management as of December 31. It was not its top performer in terms of investor returns either.

Blackstone said earlier this month that its private equity portfolio was up 5 percent in 2011, its real estate portfolio was up 17 percent and credit-oriented hedge funds were up 9 percent. The S&P 500 U.S. stocks index was flat in 2011.

Large (private-equity) firms are diversifying their assets and strategy in order to get a diversified fee string. That makes a lot of sense, said Joseph Landy, co-president of Warburg Pincus LLC, a buyout-focused private equity firm.

FEE FOCUS

Firms that grow into diverse asset managers tend to generate more of their profits from management fees rather than carried interest, as fees are charged based on assets under management rather than performance. This has led to concern that publicly listed asset managers will become distracted by relying on fees to pay dividends to their shareholders.

Analysts are often putting much higher multiples on management fees than performance fees. As we have a lot of the leaders in the industry going public, and if they get much higher values, for management fees than performance fees, will that affect how they approach the market? We have not seen evidence of that yet, TPG's Coulter said.

Many private equity firms have adopted a wait-and-see approach in response to the flotation of their rivals, acknowledging that the capital raised in IPOs can help their peers seed new funds and give them a competitive advantage.

It is an area we have watched carefully over time, said Rob Lucas, managing partner at CVC Capital Partners, on the sidelines of the conference. We have to remain competitive and if we felt there was a significant benefit being achieved by that model we would look at it.

However, he said the listed model was not right for CVC and its investors at this point in time.

THE NEW INVESTMENT BANKS?

The capital requirements forced on banks across the world following the financial crisis of 2008, including the U.S. Volcker rule designed to curb banks' trading for their own profit, have left a void which private equity firms want to fill.

Rubenstein said that it was too early to assess the impact of the Volcker rule: it may offer opportunities for private equity to buy business lines divested by banks but it may also weigh on the funding capacity of banks for leveraged buyouts.

With a huge pool of capital provided by institutional investors such as pension funds and endowments, private equity firms have the funds to buy assets from retrenching investment banks and other financial institutions at knockdown prices.

But regardless of the diversification that the major private equity firms engage in, even leaders of the major asset managers acknowledge they will never squeeze out the niche players.

There is always going to be room for a specialized player, someone who just does one thing, Rubenstein said.

(Additional reporting by Arno Schuetze; Editing by Jodie Ginsberg)