Private equity firms with pockets still full after raising billions of dollars during the credit bonanza, but their traditional leveraged buy-out market practically dried up, private equity firms will be forced to look elsewhere, and can hang on to distressed assets for years to make big returns. In contrast, hedge funds, which report performance data to investors every month and have to mark investments to market value, are not yet ready to take such an active approach.

"Private equity players have locked-in money,” said Chris Goekjian, chief investment officer at Altedge Capital. “Distressed hedge funds can have quarterly or annual redemptions rights, so they definitely can get money pulled. If they take on larger deals and get redemptions, it hurts." Private equity firms, once financed by banks, have now reversed the role and turned into financiers of large institutions such as Citigroup or Merrill Lynch, which are under investor pressure to get rid of risky assets. Meanwhile, hedge fund managers are hesitant to commit too much capital to distressed assets yet, having been burned buying some cheap assets only to see them become even cheaper. Distressed funds lost 3.92% from the start of the year to end-July, according to Credit Suisse/Tremont.

With some bankruptcies delayed because firms are still benefiting from "covenant-lite" deals struck in the first half of 2007, and structured credit assets simply not liquid enough yet, hedge funds are keeping their powder dry. "Most hedge fund managers we speak to think it's a little early to go in (to structured finance), because if you buy paper now you may own it for a long time," said Altedge's Goekjian.