Private equity (PE) began 2011 still in the grip of the powerful forces unleashed by the global credit crisis, reinforced by recession and cemented in place through last year's uneven recovery. But there are clear signs that the "animal spirits" are beginning to return to PE firms.

The dynamics unleashed by the financial market meltdown, recession and tentative recovery are affecting every aspect of the PE "life-cycle"—from fundraising and deal making to portfolio management, exits and returns. Bain & Company recently published the Global Private Equity Report 2011, our comprehensive examination of the conditions that will shape private equity in the year ahead. In this and posts to follow, we will share some of the key insights behind our analysis. We begin with a look at the recovery in the PE deal-making environment.

The new year got underway on the heels of a continuing pickup in deal activity that accelerated through 2010. PE general partners (GPs) are optimistic about 2011; a recent survey reveals that they overwhelmingly expect deal activity to improve through the end of the year. Economic uncertainty still looms, and could easily derail PE deal recovery, but the fundamentals look positive and demand is picking up. Active PE firms are loaded with nearly $1 trillion in dry powder (see chart below) and they're hungry to do deals. According to Bain analysis, this uninvested capital targeted for buyouts is sufficient to fuel three-and-a-half years of deal activity.

With the pace of PE deal activity gaining momentum, the sheer volume of uninvested capital is not the foremost concern to the PE industry. The bigger worry is that much of the dry powder is in the hands of GPs that, facing increasing pressure to invest, may not do so in a disciplined way. Bain's segmentation of PE funds and dry powder targeted for buyouts found that 55 percent of it is parked with GPs whose funds are nearing the end of their investment periods. And nearly half of the reserves-more than $110 billion, or about one-quarter of all dry powder slated for buyouts, by Bain's estimate-are held by GPs with below-average performance track records.

Large amounts of capital in the hands of pressured GPs willing to take risks could have spillover effects on the broader PE market, as these GPs compete fiercely for deals and drive up prices in the process. There is a way out of the cul-de-sac for pressured GPs—go to their LPs and seek fund extensions to draw out the investment period.

This post was written by Graham Elton, Bill Halloran, Hugh MacArthur and Suvir Varma, leaders of Bain & Company's Private Equity Group.