Public markets and private equity can sometimes make uneasy companions. No more so than in 2008, when a combination of moribund debt markets, the limited ability of private equity companies to sell on their investments and fears over the underlying value of their portfolios caused the sector to fall to an all-time low. Last month, listed private equity in Europe was collectively trading at less than half its reported book value – a 52 per cent discount to reported net asset value, cheaper than at any other point since the post2001 sell-off, its previous nadir.

Evidence of that predicament is everywhere. Shares in 3i Group, the British sector’s grandaddy, have lost more than three quarters of their value this year, making it the fifth-worst performer in the FTSE 100 and taking it below its issue price for the first time since it floated in 1994. Elsewhere, SVG Capital, which backs investments made by Permira, has written down the value of its funds by £467 million. Two weeks ago it launched a heavily discounted £200 million rights issue. In total, the seven most closely tracked UK-listed private equity vehicles (see table) have lost more than 60 per cent of their value this year, a sharp contrast to most of this decade. In the five years to 2007, the AIC private equity price index rose by a compound 18 per cent a year, comfortably outpacing the FTSE all-share index.

But has the stock market overreacted to what might otherwise be seen as a cyclical setback in the industry’s long-term structural growth? Certainly, the short-term challenges posed by recession are formidable.

First, the default rate on leveraged buyout debt cannot help but rise. On Standard & Poor’s data, only 1 per cent of the debt payments backing private equity deals were not met in 2007, against a long-run average of about 4 per cent. However, with company profits starting to fall, more and more buyouts are set to run into debt-servicing problems. UBS expects default levels to rise to “at least” 10 per cent next year.

Second, having been reasonably stable in the first half of the year, net asset values for private equity funds are due to follow the stock market sharply lower. The value of quoted investments will be marked to market, while those of unquoted companies will have to reflect the decline in earnings multiples of their quoted peers – a drop that is all the more severe if those investments are also heavily geared.

Third, falling stock markets make it more difficult for private equity firms to realise cash from their investments. Flotations become unattractive or impossible to achieve, and potential trade buyers with the necessary funding can push for better terms. Not only are private equity investors not getting their cash back, but it becomes harder to finance further buyouts, meaning that they have to invest more equity and so dilute their returns. It used to be that private equity funds had more cash than they could swiftly invest, leading to a “cash drag” on their portfolio returns. Now, however, the opposite problem applies: that they have committed to make follow-up investments that they cannot honour.

Fourth, some funds made the bulk of their investments near the top of the market, making the scale of potential writedowns all the greater. UBS points out that Electra Private Equity has a relatively immature portfolio, having made more than 80 per cent of its unquoted investments in 2006 and the first half of 2007.

Investors should be in no hurry to buy into listed private equity until the full-year reporting season provides greater clarity on how their portfolios are faring. But for those willing to be patient, and to take a three- to five-year view, discounts of the scale of those on offer historically have proved a good point of entry.

Although HgCapital Trust, up 5½p to 663½p, has not fallen nearly as far as its peers, because of its 493p a share in cash, its lack of gearing, its strong track record and its midmarket focus make it one of the better places to start.

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