Heady, because of the high valuations put on just about any company connected with private equity. Listed vehicles investing in private equity are trading at or near record premiums.

Heady, because of the lashings of debt thrown at private equity deals. Debt as a multiple of earnings before interest, tax and depreciation has rocketed from five or less four years ago to eight or more today.

For most stock market investors this is all a bit a sideshow. By definition, private equity — investment in unlisted companies — is not for them. Private equity groups are those chancers who buy listed companies on the cheap and then have the gall to float them a few years later at triple the price.

In fact, stock market investors have always been able to participate in the private equity boom, through specialist investment trusts. These are the listed companies that invest in buyouts and the like. (They are not to be confused with Venture Capital Trusts, smaller tax-efficient vehicles providing early-stage capital.)

The grandaddy of the sector is 3i, but there are several other meaty players including Candover Investment Trust, Electra Investment Trust and SVG Capital. With the exception of 3i — which was disproportionately hit by the technology stocks bust — they have been pretty good investments over the past few years.

The formula has been simple and effective. 1: buy undervalued, cash-generative companies from the share market or from larger, neglectful parent groups. 2: use cheap, plentiful debt to gear up returns. 3: lavish performance- related incentives on management. 4: cock a snook at listed rivals grappling with heavy disclosure and corporate governance rules. 5: collect winnings.

Things can go wrong, of course. Older investors will remember disasters such as Isosceles and Magnet from the 1980s, but the past two decades have for the most part been accident-free.

Can it go on? Even those in the industry acknowledge that future returns are likely to be more modest. Buying prices have been bid up and may continue to rise because of a wall of money being channelled into the big private equity houses. Most of the obvious candidates have long since gone though the buyout mill.

Squeezing extra returns through gearing has gone as far as it can. There is growing evidence, certainly in bigger deals, that higher gearing is already leading to lower returns. The era of ultra-low borrowing costs is fading. A number of private equity-backed ventures are in danger of breaching their loan covenants, Standard & Poor’s said this week.

Increasingly, too, private equity houses are buying assets from one another, a bit like antique dealers selling the same dining table, one to another, because there are no end customers. These so-called secondary deals used to be frowned upon. How many times could the same asset have more value squeezed from it? Now secondary deals are ten a penny.

More than ever, therefore, investors need to pick good trust managements. Among the larger investment trusts, past records are pretty good, as the table shows. The top house over five years is Candover, whose Candover Investment Trust has turned £1,000 into £2,316. Dunedin, HgCapital and Rutland also show up well.

But investors need to look at value as well. Some of these trusts are trading on very high valuations. Candover Investment Trust is priced at 30 per cent more than the net assets it owns. SVG Capital, which has close ties to the Permira stable, is another highly regarded vehicle, but sits on a 22 per cent premium to net assets. In both cases the premium is 10 percentage points wider than its long-term average.

Another potential concern, according to investment trust analyst Charles Cade of Close Wins, is the cash position of many private equity investment trusts. The past two years have been favourable for realisations — selling past investments. The downside is that many trusts are now seriously cashed up.

Kleinwort Capital is 60 per cent in cash, Graphite 50 per cent and Candover about one third. With buying opportunities thinner and prices high, they may struggle to find suitable investment opportunities. The problem is called “cash drag”.

HgCapital Trust looks a better pick. The house, formerly part of Merrill Lynch, has a smashing record, specialising in mid-sized buyouts. Past acquisitions include the music publisher Boosey & Hawkes, the self-catering holidays provider Hoseasons and the bookies Sporting Index. The trust is less cash-heavy than most. And the current share price looks less overstretched — just 1 per cent above net assets, no pricier than its long-term average.

Individual investment trusts rarely have more than a few dozen investments. One big dud can therefore seriously dent overall performance. Investors looking for diversification should consider fund-of-funds investment trusts.

Pantheon International Participations, the investment trust of Pantheon Ventures, has many fans and through its fund investments is indirectly invested in 3,000 unlisted companies across the globe.

It also has another string to its bow. It specialises in snapping up private equity portfolios from distressed sellers — for example pension funds making a big shift in strategy — and this can be lucrative.

The downside of funds-of-funds, of course, is that returns are dampened by an extra layer of fees.

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