New private equity fund-raising was all but dormant in 2010 and was weaker even than in 2009, itself an inauspicious year. But if past patterns remain a reliable guide, the past two years likely marked a cyclical low, and fund-raising is poised for a recovery.

As we described in our Global Private Equity Report, fund-raising typically lags investing activity on the way down and, again, as the industry enters a new up cycle. Fund-raising remains high as deal activity plunges because many commitments are signed months before the market tumbles. It does not pick up again until allocation pressures and liquidity constraints ease, and PE limited partners LPs regain their footing.

Another leading indicator of a fund-raising recovery is the pace of exits. The correlation between the value of buyout exits and new buyout funds raised over the past decade is significant—again, with a bit of a lag—as the distributions that flowed to LPs provided the lubricant to get the fund-raising cogs turning. If exit activity continues to outpace investment activity, as it did in the latter half of 2010, there is no doubt that fund-raising will get back on the recovery path.

Anticipating in late 2010 that PE fund general partners (GPs) would be coming to market with new funds, many institutional investors and other LPs started penciling into their 2011 budgets higher commitments than they did a year earlier. Indeed, in a survey of 100 LPs last December by Preqin, the PE industry data provider, 54 percent said they would be committing more capital to PE this year. Only 15 percent said they would commit less.

For many LPs, budgets for new commitments this year—and how they get deployed—continue to be governed by their still-tight allocations to PE. Of course, they do have the option to lift their allocation ceilings to make room for new PE commitments, and available survey evidence suggests a minority may be doing so.

PE firms may also be able to expand fund-raising potential by attracting new investors to the asset class. For all the success PE has had winning over big institutional investors over the past two decades, there is still plenty of room to grow. Only about half of the 200 largest public and private pension funds in the US and only some 45 percent of sovereign wealth funds currently invest in PE funds.

As they maneuver to attract LP capital, PE firms still have work to fix another problem tempering LP demand—restoring the confidence of their current stable of LP relationships bruised during the downturn. Several LPs Bain interviewed raised a number of persisting concerns. They said that some GPs took advantage of the flexibility permitted in their agreements with LPs to stray from their core. Other LPs said that many GPs did not meet their expectations for transparency and frequency and quality of communications.

Despite the rebound in portfolio valuations, some LPs harbor doubts whether PE can continue to generate attractive long-term returns given the high prices paid for assets acquired in the early stages of the recovery. And they wonder particularly how well assets acquired during the boom years ultimately will perform.

Still, for all the short-term strains, the foundations of PE’s relationship with LPs are strong. Even after a few challenging years, LPs’ conviction in PE remains solid. LPs continue to believe that PE offers an attractive risk/reward profile and has a place in their portfolios. They express confidence in the ability of the PE owner-operator model to generate superior returns.

Many LPs also see evidence that GPs are strengthening their operational expertise, and they are confident they will find attractive new segments within the PE asset class, including new geographies, sectors or fund types. Finally, they praise GPs for the efforts they have made to improve their communications and transparency and to achieve a better alignment of interests.

When we look back on this year, where will LPs have deployed their 2011 budgets? The ones Bain interviewed at the end of 2010 emphasized that they would not be looking simply to add to their PE exposure broadly but would be targeting new PE segments. They planned to spurn large buyout funds, in particular, and instead look to invest with GPs that target a specific sector, geography, deal stage or fund type.