Many general partners' recent letters to investors have sought to reassure that, despite market turbulence, current portfolios remain healthy overall and investment capabilities credible. Several firms' founders have also offered perspectives on general economic conditions. Private Equity International here provides excerpts of five “Dear LP” letters issued during the first quarter.

“What does a long-term private equity investor do in a worsening economic environment? There are three main options, and only one makes sense to me.

The first option is simply not to invest. However, not investing for a sustained period of time is not really an option because limited partners have made an asset allocation decision to invest in private equity.

The second option is to switch investment strategy. With the change in return expectations in Europe and the US for large deals, some private equity groups that previously focused on large buyouts have suddenly become distressed debt investors, while other firms with little or no experience beyond their local markets are “looking to Asia”, where the economic climate seems rosier. Successful private equity investing attracts people who are creative and innovative, and investment strategies do, of course, have to evolve. However, some of the recent “evolutions” look like knee-jerk reactions to the market rather than well-thought out strategic moves and what is more, this approach means using the capital entrusted to one strategy, to pursue another. If a firm wants to undertake new investment strategies, it should hand back the committed, but undrawn, capital to LPs, and ask for their re-commitment.

There is a third option: to invest in areas which are less likely to be affected by a downturn. Whilst following this strategy early in a bear market may still lead to investors suffering mark-to-market losses in the short term, most private equity investors are more concerned about creating value over the whole economic cycle, than they are with achieving performance in any particular part of that cycle.

These times are not going to be easy for any private equity practitioner. But while the Terra Firma portfolio may be purely long, I believe it will weather the current conditions to deliver long-term value. However, we will have to work harder than ever and focus even more on our strategy and our businesses to create and maintain that value. Such value creation – rather than looking for new ways to earn fees – will be the focus of Terra Firma.”

Guy Hands, chief executive of London-based private equity firm Terra Firma Capital Partners.

“A canard gained broad acceptance over the last decade or two, as faith in the ability of the free market to optimally allocate assets morphed into an irrational expectation that the free market would produce a continually rising tide, lifting all boats and bringing a better life for everyone.

Clearly, however, the events of recent years attest to excesses prompted by the profit motive. More was better: more leverage, more innovation, higher ratings for a given security and more activity in areas like residential real estate. Equally clearly, not all of the free-market decisions were salutary; the proof can be found in the fact that laissez-faire has landed us in a financial crisis that some observers consider the potentially most serious since the Depression.

Free markets allocate resources efficiently in the long run. But they can't make the tide rise continually, and while some boats rise, others will crash. Properly functioning free markets will give rise to times that set the stage for ruin, and then to times of ruin itself.

There's an old riddle about ten birds sitting on a telephone wire. A hunter shoots one. How many are left? The usual response is nine. But the correct answer is none; the rest are frightened by the gunshot and fly away. Maybe it's a joke, but it illustrates the ease with which ramifications – what my British friends call “knock-on effects” – are overlooked.

In [a past memo] I discussed the way people were describing the events of last summer as an isolated subprime crisis and ignoring the potential for contagion. Now most see that the “subprime crisis” was just the first act in what might be a long period of generalised economic difficulty and market weakness.

Please note that a depressed economy isn't the end of the line. Slower consumer and industrial activity could feed back to the beginning of the process, causing further house price depreciation, further write-downs, a further credit contraction and so forth. And then, when levels get low enough, something mysteriously will cause the cycle to turn positive.

Things don't happen in isolation in economies and markets. Birds do flock together. The implications of past events will spread further.

So you want to know, “Is it over?”

The outlook continues to call for prudence … although not as much or as urgently as a year or two ago. Then, people were investing at low returns in the belief that nothing could go wrong. Today, that optimism has been dispelled and prospective returns embody more generous risk premiums.

However, only when a great deal of caution has been built into the markets – and hopefully an excess of caution – is it time to turn highly aggressive. We're not there yet, but there's reason to believe we're moving in that direction.”

Howard Marks, chairman of US private equity firm Oaktree Capital Management

“The first quarter of 2008 saw the storm clouds of the prior quarter become more ominous, as the credit crisis deepened, the price of oil rose…the relative value of the US dollar continued to fall, and some degree of recession became more likely than not. Fortunately, we have seen very limited impact on the business operations of our portfolio companies, although we are adjusting plans to prepare for the worst.

Certainly the negative impact on financial markets, and the constraint on liquidity opportunities for venture-backed companies, has been more pronounced. The IPO window remained essentially closed for the quarter with only five companies successfully completing offerings, a level more akin to the post-bubble years of 2002-2003. Perhaps more concerning, M&A activity for venture-backed companies was at the lowest level in over a decade, with only 56 transactions.

Despite this environment, most Fund VIII companies continue to make good progress… we continue to monitor carefully the capital resources and requirement for Fund VIII, and are taking steps to maximise the capital available to support our many promising companies. The very slow exit markets are becoming increasingly problematic as the capital required to reach liquidity is extending beyond our original forecasts and stressing our reserves. We will likely be in touch over the coming months with regards to steps we are taking, as well as those we will recommend, to maximize the value to you of this large and promising, but still capital-hungry, portfolio of companies.”

GPs of a US venture firm