“This trend persisted into the first half of 2007 and is an issue for the industry,” Francis says. “We focus our research on the firms which show they are disciplined in debt and pricing. We still believe there are some high quality managers in private equity.” Over the longer term, winners in private equity will be those with genuine expertise in driving operational change. “There is some evidence that public markets are starting to ‘get it’,” Francis says. “Investors want an efficient balance sheet. So, private equity’s historic advantage in optimising capital structure should be arbitrage away.”

In the 1980s most value-add in private equity came from the leverage in the deals. This was replaced in the 1990s with multiple expansion, as the stock markets ran. Operational improvements started to overtake leverage as the most important source of value-add this decade and this trend should continue for the next few years at least, according to Watson Wyatt.

The consultant believes that private equity may be about to take a further public relations hammering, with the possibility of material leveraged buyout defaults. But Orleow says that private equity returns are likely to normalise at about 4-5 per cent above the listed markets.