It is always smart to keep some powder dry. Some of the best investment strategies depend on keeping cash on deposit when times are tough – that’s what Mr Buffett does. But for private equity firms, just how dry can this powder become before their investors start getting more than a little fidgety?

The incentives are all there for the industry to keep churning out deals. Limited partners, who have committed money to the private equity funds, open up a contingent liability on their balance sheets – and have to keep low-yielding cash on hand to fund it. Worse, they have to pay a management fee on money that is not being managed. The private equity houses, meanwhile, are itching to earn the really big percentages that come from buying something.

The problem is that, while the incentives to do deals are there, the environment is not. Funds used to juice returns from three sources: high leverage, asset prices that did nothing but rise, and a business model that nicely aligned the interests of owners and managers. Now two of those underpinnings have – temporarily, at least – fallen away. That has left an oversupply of cash-rich private equity firms competing for a limited pool of smaller deals, driving up prices and eroding returns.

During the last industry downturn after the dotcom boom, several firms had to scale back commitments, sometimes by as much as a third, when it became clear that they would not use the full amount pledged. This is preferable, from an investor’s point of view, to seeing a firm do something off-piste to create the illusion of momentum. Dabbles in public equities, for example, have so far been a disaster – see Warburg Pincus’ investment in MBIA, the bond insurer, or TPG’s in Washington Mutual. Pressure is rising on private equity houses to be flexible on commitments or struggle to raise funds next time they come asking.

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