On Wall Street, buyout professionals are seen as the smart money. But their new shareholders are starting to look like the dumb money. The gilded realm of...

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On Wall Street, buyout professionals are seen as the smart money. But their new shareholders are starting to look like the dumb money.

The gilded realm of private equity — in which moguls use private money to buy stockholder-owned companies — has turned into dross for everyday investors. Hedge funds, those secretive investment pools for the rich and, increasingly, the not-so-rich, have been losers for the investing public as well.

The Blackstone Group, the private-equity powerhouse led by Stephen Schwarzman, has lost a quarter of its value since it went public in June.

Fortress Investment Group, a diversified alternative-asset management company, and Och-Ziff Capital Management, a hedge fund run by Daniel Och, a former Goldman Sachs trader, have also stumbled after initial public offerings.

As the financial markets brace for another wave of large losses at Wall Street banks, the outlook for these newly public firms and their as-yet-private brethren has darkened starkly.

The tightening credit squeeze has sent the buyout industry into a funk and left some hedge funds with steep losses.

Kohlberg Kravis Roberts, which invented the modern buyout industry, is struggling to get its own IPO off the ground. AQR Capital Management, a $38 billion hedge fund, has suspended its plans for an offering.

Citigroup, which helped take Och-Ziff public in November, recently warned that Och-Ziff is likely to face head winds for the foreseeable future.

Schwarzman, by contrast, cashed out in June, a few weeks after he said public markets were “overrated.” He and his partner, Peter Peterson, sold while business was still booming.

“These are sophisticated investors and they certainly know how to time their own exits,” said Adam Zoia, managing partner and founder of Glocap, an executive-search firm focusing on the alternative-asset industry.

Blackstone’s investors, among them Fidelity Investments and the Ohio Public Employees Retirement System, haven’t been so lucky.

They would have made more money this past year investing in an old-fashioned index fund that tracks the Standard & Poor’s 500 stock index.

For now, Henry Kravis, a KKR founder, is pressing ahead with plans to take it public. But selling stock may not be easy given the turmoil in the financial markets.

Deals, and the cheap money that private-equity firms have come to depend on to pay for them, have grown increasingly scarce.

After the credit markets became unhinged in mid-2007, U.S. merger activity fell 46 percent during the second half, said research firm Thomson Financial. Merger volume in 2007 still hit a record $1.57 trillion in the United States, thanks to all the deal-making early in the year.

Life may not get easier for the buyout crowd. Weakened by mounting losses on mortgage-related investments, big banks are reluctant to risk capital on leveraged buyouts. Many are still struggling to sell the loans and bonds used to finance previous deals.

According to a recent report by PricewaterhouseCoopers, banks are sitting on about $245 billion of buyout-related debt, a backlog that could take months to clear.

The likelihood that rising financing costs will pinch private-equity returns, coupled with the possibility that Congress may eliminate a tax loophole enjoyed by buyout funds, adds to the gloom hanging over the industry.

Blackstone’s sinking stock price will not help other alternative-investment firms looking to tap stock investors, said John Fitzgibbon, the publisher of IPOScoop.com.

“When the leader of the group goes public and hits the wall, the rest don’t go out the door,” he said.

While many on Wall Street have focused on Blackstone’s slump, several large hedge funds have also disappointed new shareholders. Brevan Howard Asset Management, a British investment firm, raised only $1 billion in an initial public offering in March, half as much as it had hoped.

New shares of GLG Partners, one of Europe’s biggest hedge fund managers, and of Third Point Offshore, a public offshoot of the New York hedge fund run by Daniel Loeb, have fallen, too.

Despite all the gloom, more private-equity and hedge-fund firms are likely to go public once the markets stabilize, said Zoia of Glocap. But these latecomers may have to accept lower valuations, he said.

“This is the tip of the iceberg,” he said.

Wall Street, after all, adheres to theory that you can always make money trading in securities, whether they are overvalued or not, because there will always be someone willing to pay more for them than you did.

As Fitzgibbon put it: “What Wall Street is about is smart guys thinking about ways to make money from dumb ones.”