Dan Rasmussen – Private Equity Risk and Public Equity Opportunity at Verdad Advisers (First Meeting, EP.15)

Episode Summary

Executive Summary: Dan Rasmussen explains how legal/Socratic training and Bridgewater shaped an evidence-first investing philosophy, then applies it to private equity, public small-cap value, and credit. He argues PE’s historic edge came from buying cheap, levered assets, but competition, leverage, and private credit have made it riskier and less attractive. Verdad seeks similar outcomes in public markets using valuation screens, bankruptcy filters, machine learning, and contrarian crisis investing.

Main Topics: Socratic/legal thinking as an investing foundation (Priority: 5/5): Rasmussen traces his skepticism to family dinners and his father’s legal cross-examination style, which taught him to demand proof, test assumptions, and apply rules systematically rather than rely on stories. Why private equity’s historic returns were real—and why they may fade (Priority: 5/5): He argues PE worked largely because managers bought very cheap companies with leverage and could benefit from multiple expansion; as prices rose, leverage risk and competition eroded the edge. Launching Verdad to replicate PE-like returns in public markets (Priority: 5/5): Rasmussen says public markets offered hundreds of levered, cheap companies that fit his framework, allowing him to pursue the same economic logic without private deal friction. Verdad’s screening, machine learning, and portfolio construction process (Priority: 4/5): The firm combines traditional value metrics with models that estimate debt paydown and identify likely model errors, then overlays human judgment, liquidity limits, diversification, and quarterly rebalancing. Credit strategy and equity-credit signal integration (Priority: 4/5): Verdad’s credit work focuses on the bond market’s middle—higher-quality, non-investment-grade yields—and uses bond/equity divergences as signals about relative mispricing and default risk. Recession playbook and crisis investing (Priority: 4/5): Rasmussen argues recessions make simple value models more powerful and create the best opportunities in cheap, profitable, illiquid stocks and lower-rated but healthy credit, while distressed debt often disappoints. Communication, patience, and capacity constraints as edge (Priority: 3/5): He emphasizes writing research, educating investors, and keeping capacity limited so the fund can actually trade the illiquid micro/small-cap universe that most competitors cannot access.

Key Arguments: Private equity’s original outperformance was driven less by managerial genius than by buying cheap assets, using leverage, and benefiting from multiple expansion. As purchase multiples rise, PE loses the two advantages that mattered most: cheap entry points and benign leverage economics. Revenue growth is fundamentally hard to predict, so paying up for growth is usually dangerous; quality can justify a premium, but levered buyouts and compounding businesses conflict. Public markets contain many PE-like opportunities, especially in small, cheap, levered companies that can be screened and managed systematically. Machine learning is useful when it refines logical, economically grounded signals; it should not replace first-principles thinking. Bankruptcy avoidance is central to the strategy; the goal is not just cheapness but cheapness plus survivability and debt paydown. In crisis periods, value and quality signals become stronger, and buying profitable, illiquid, small cheap names historically works best. Distressed debt is often overhyped; buying things that already failed is different from buying fundamentally healthy assets sold off in panic. Management quality is difficult to identify ex ante from pedigree or prior roles, and share-price outcomes do not reliably track CEO credentials. Verdad’s edge comes from doing work others can’t or won’t do because of liquidity constraints and from staying invested long enough to capture long-term mean reversion.

Data Points: Private equity value creation threshold: less than 7x EBITDA - Rasmussen says PE made most of its money buying businesses below this valuation multiple historically. Debt leverage in LBOs: 6x EBITDA debt on a 10x purchase; 8x debt on a 15x purchase - Illustrates how higher entry prices force higher leverage and raise risk. Public-company screen result: about 500 names - His initial Capital IQ screen found hundreds of public companies fitting the cheap-and-levered profile. Machine learning debt-paydown model history: 60 years of U.S. company financials - Used to train a model predicting whether companies pay down debt. Machine learning error model backtest: 30 years - Used to find where the initial model made mistakes and create a second filter. Error-prediction accuracy: 50% accuracy - The second model predicted the worst model errors with this accuracy. Worst outcomes tagged: the worst third of outcomes - The criticism model flagged the most severe misses for exclusion or caution. Typical starting universe per region: about 100 companies - After regional screening, Verdad narrows North America, Europe, and Japan to roughly 100 names each. Position sizes: 3% to 4% positions - Describes the eventual portfolio sizing target in the core book. Daily liquidity constraint: 3 to 5 times daily volume - Maximum amount they aim to trade relative to average daily trading volume. Small value market cap example: less than $400 million average market cap - Illustrates that the cheapest value names often sit in microcap territory. Recession definition: high yield spreads rise above 6 - Used as the firm’s operational recession trigger in backtests. Private equity energy vintages: 90%+ marked above 1 - 2013–2015 energy PE funds stayed marked above cost despite an oil price collapse. Oil price drop in energy example: 70% - Shows how severe commodity stress did not fully translate into fund marks. Energy stock drawdown: SP small cap energy down 70% to 80% peak-to-trough - Used as a crisis case study for PE and public market divergence. Potential PE bankruptcy rate in a normal recession: 25% to 30% - Rasmussen’s estimate of LBOs that could fail in a typical downturn. Credit market yield example: double-B bonds yielding 12% to 13% - Used to show crisis-period opportunity in lower-rated but survivable credit.

Pivotal Quotes: "The deepest arbitrage in doing deep value and doing illiquid deep value is basically taking on volatility pain." — Dan Rasmussen: Explaining why Verdad shares research publicly and how its edge is mostly behavioral, not secret information. "Don't buy things that go bankrupt. Don't also buy things that already went bankrupt." — Dan Rasmussen: Summarizing Verdad’s core rule across both equity and credit investing. "When's the next recession? Nobody knows." — Dan Rasmussen: Arguing against market timing and for a disciplined, preplanned recession strategy.

Implications: Listeners should expect lower PE returns and more risk in levered private markets, while small-cap value and selective credit may offer better long-run opportunities. The key is patience, discipline, and buying profitable assets when others are forced sellers.