At the same time, some of the larger names in private equity have been going the other direction and adding hedge funds to their product range.

Grant Thornton, an international accounting, tax and business advisory company, published a white paper this month exploring the convergence of hedge funds and private equity business. Through the Association for Corporate Growth and MARHedge, a news service that serves the hedge fund industry, the global study polled several private equity firms and hedge funds on issues relating to the convergence trends and found the chief underlying driver to be the growing amount of capital which institutional investors and ultra high net worth individuals are pouring into the two sectors.

'As the public equity markets struggle through another lacklustre year, record numbers of institutional investors are seeking the higher yields that private equity funds and hedge funds can generate. Last year, US buyout funds raised a record-breaking US$173.5 billion, according to Buyouts magazine data. This brings the total US private equity capital under management by 1,546 US private equity firms to US$811.2 billion as of June 30, 2006,' the Thomson Financial report said.

Worldwide, there are about 3,000 private equity funds managing US$1.5 trillion, according to Freeman & Co.

Harris Smith, Grant Thornton west region managing partner, said in the report: 'At the same time, MARHedge reports that 8,800 hedge funds are now managing about US$1.2 trillion in assets worldwide, with about 60 per cent in the United States.'

This large inflow of capital from institutional investors has led many of the world's larger private equity and hedge fund companies to look beyond the conventional horizons of their businesses for more creative opportunities to make money in each other's spheres of investments.

According to the Grant Thornton report, established names in private equity, including Auda Advisors, Bain Capital, Blackstone Group, Carlyle Group, Kohlberg Kravis Roberts & Co, Mesirow Financial and Texas Pacific Group, now all offer their clients private equity and hedge fund products, while hedge fund managers such as Cerberus Capital Management, D.E. Shaw and Eton Park Capital Management had become active participants in private equity-type investments.

The report noted that fundamentally private equity and hedge funds often competed in the same space. For instance, mezzanine funds competed with fixed-income strategy hedge funds, and private equity firms involved in distressed debt trading and restructuring competed against distressed securities and event-driven hedge funds. With hedge funds buying debt issued by private equity firms and becoming involved in financing pre-IPO companies, the boundaries between the two sectors had become even fuzzier.

'Convergence of private equity and hedge funds is also producing some unusual hybrid structures that blur the lines between these vehicles. With increased frequency, hedge funds that historically have offered relatively easy access to liquidity are now structured to require up to three years for an investor to receive a full redemption,' Mr Harris said in the white paper.

There is a wide consensus in the two industries that convergence between the two sectors is the status quo. According to a poll of more than 120 companies conducted by Grant Thornton in June, only 6 per cent of private equity respondents and 4 per cent of hedge fund respondents said 'there is no significant overlap' between their respective businesses.

Larry Goldfarb, managing partner of Baystar Capital, a hedge fund firm which has a long history of involvement in private equity deals, believed the real issue was whether hedge funds could compete in the private equity space.

'Why not? There are virtually no barriers to entry and there is nothing that is proprietary to the private equity or venture world as long as a manager has capital to put to work. For example, we can name numerous money managers that play in all these areas simultaneously and have been doing so for a long time. The skill set desired is second nature to hedge funds,' Mr Goldfarb said.

These skills include conducting due diligence on target companies, the flexibility to employ consultants and strategic partners in sectors that they may not be experts in, expertise in capital structuring, and access to market data for public companies. Mr Goldfarb said that there were higher barriers to entry for private equity or venture capital firms moving into the hedge fund arena due to 'infrastructural issues', including the time-consuming, complex and expensive task of establishing a trading floor.

'Trading is a skill set that really needs a long apprenticeship and the rules relating to trading securities are cumbersome. Furthermore, trading floors require large and expensive back-office operations to provide accounting, administration, valuation, prime brokerage, risk management, investor relations services, and so on,' Mr Goldfarb said.

Not all observers share this view however. George Saffayeh and Guy Lotem, senior managers at Ernst & Young, believed there was more to private equity than buying and selling securities.

In an article published in Ernst & Young's Cross Currents magazine, they wrote: 'Private equity investing requires a different mindset and set of skills. It requires investing in a company for the long haul and creating value in that company through hands-on management of the company's operations and strategic direction. For fund managers, this typically includes taking a seat on the company's board of directors or being one of the officers of the company and working day after day to build the value of the company.

'Hedge funds may lack the skills or experience to turn around or build private companies successfully. They may also lack the in-house talent required to close complex private equity deals, which can take many months to put together and typically involve the compilation of numerous legal documents and consultation with lawyers, bankers, accountants and other industry professionals.

'Hedge fund managers are very good at detecting the pricing inefficiencies in a company's traded financial instruments. But they may not have the right stuff when creating value in a company through hands-on leadership.'

Mr Harris said that however well the the two sectors performed in each other's space, the beneficiaries of the trend would ultimately be the companies they target.