The recent sub-prime inspired credit crunch will cut returns from private equity, according to a leading global investment consultancy.

A report from consultancy firm Watson Wyatt concluded the knock-on effect of the sub-prime mortgage crisis in the United States would hurt private equity returns because of the highly leveraged nature of most transactions.

It said the first and most obvious impact of the sub-prime crisis was that banks would no longer have an appetite to finance mega buyout deals.

"Private equity managers that rely heavily on debt to finance buyouts will struggle to complete transactions," the report said. 

"Buyout funds and investors have been the beneficiaries of the banks' willingness to provide credit at historically cheap rates."

It said, however, that now that credit has been re-priced private equity funds would be forced to use more equity in their deals, which meant they would be paying less for assets, but having to hold on to them for longer.

The report also said firms would be unable to recapitalise in order to provide early liquidity when they bought a company.

"The days of recapitalisations providing early liquidity - and a significant boost to internal rates of return - seem to be, temporarily at least, over."

The private equity market has exploded in recent times. A surfeit of cheap money combined with a healthy global economy has allowed deal volumes and sizes to surge.

Recent events in the credit markets, however, have conspired to hamstring growth in the industry.

The back log of buyout financings working their way through the banking system is estimated at US$400 billion.