Dan Rasmussen - “The Crown Jewel of the Alternative Universe is Private Equity" | #90

Episode Summary

Executive Summary: Dan Rasmussen argues private equity’s historical outperformance was driven less by operational genius and more by buying cheap, levered small businesses at low multiples. With capital flooding into PE and purchase prices rising, he says the return opportunity has largely disappeared. His firm, Verdad Capital, tries to replicate the old PE return engine in public markets using levered small-value equities, with Japan as a particularly attractive arena.

Main Topics: Dan Rasmussen’s background and Verdad’s origin (Priority: 4/5): Rasmussen summarizes his path from Harvard and journalism to Bridgewater, Bain Capital, Stanford, and founding Verdad Capital, which was built to replicate private equity-like returns in public equities. Why private equity historically worked (Priority: 5/5): He argues the classic PE model succeeded because firms bought small, cheap companies, used substantial leverage, and benefited from multiple expansion and debt paydown, especially in the 1980s and early 1990s. How fund flows distorted private equity (Priority: 5/5): Massive institutional allocation to alternatives pushed prices higher, compressed future returns, and created a herd mentality that made PE look safer and more attractive than it really is. Public markets can replicate PE economics (Priority: 5/5): Rasmussen explains that a public portfolio of levered small-value stocks can capture the same economic drivers as PE—size, value, and leverage—without fees, illiquidity, or control premiums. Debt as a return driver, not just a risk (Priority: 4/5): He argues debt is dangerous when buying expensive assets, but highly beneficial when paired with cheap, cash-generative firms that can delever over time and create equity value. Japan as a favored global market (Priority: 4/5): Japan is highlighted as a compelling market because of cheap valuations, low bankruptcy risk, cultural emphasis on stability, and strong deleveraging dynamics that suit Verdad’s strategy. Quantitative process plus human judgment (Priority: 3/5): Verdad uses quantitative screens and quarterly rebalancing, but also applies analyst judgment to avoid hidden risks such as fraud, accounting issues, and bankruptcy risk, especially in levered names.

Key Arguments: Private equity’s historical returns were largely a function of buying micro-cap businesses cheaply, levering them, and waiting for debt paydown and valuation expansion, not necessarily superior operational skill. Institutional investors have overallocated to private equity because they chase high returns and dislike mark-to-market volatility, creating a crowded and expensive market. As purchase multiples rose above 10x EBITDA, the economics of PE deteriorated sharply; Rasmussen argues the industry no longer has the same return potential it once did. A public-equity strategy focused on levered small value can reproduce the PE return profile more efficiently, with better liquidity, lower fees, and often better tax management. Debt should not be viewed as inherently bad; when applied to cheap, cash-generative businesses, it can amplify free cash flow and equity returns through deleveraging. Japan offers an especially attractive setting because debt is cheap, bankruptcies are rare, and companies/capital providers are culturally oriented toward balance-sheet stability and debt paydown. Short interest is a useful risk signal for small-cap value portfolios and can help avoid names with deteriorating fundamentals or hidden problems. Quantitative evidence should dominate investment decisions, though human judgment can still improve portfolio quality by filtering out bad accounting or bankruptcy risks.

Data Points: Harvard graduation year: 2009 - Rasmussen notes he graduated from Harvard in 2009. Book publication year: 2011 - His book American Uprising came out in 2011. Private equity market cap: $200 million - He says the median market cap of a private equity deal is about $200 million. Private equity leverage: 65% - He describes median leverage in PE deals as roughly 65% net debt to enterprise value. S&P 500 drawdown in 2008: -50% - Used as a comparison point for public equities during the financial crisis. Private equity drawdown in 2008: -30% - He says private equity was down about 30% in 2008. Institutional belief in PE outperformance: 49% expect +4%/yr; 45% expect +2% to +4%/yr - Citing a Preqin survey of institutional investors. Historical PE outperformance: +6% net of fees per year - He says PE beat public equity markets by about 6% annually from 1980 to 2010. Implied gross manager outperformance: +12% per year - He translates 2 and 20 fees into roughly 12% gross annual outperformance for the average manager. Cheap PE buyout multiples in early era: 4-6x EBIT / 3-5x EBITDA - He says early PE firms bought businesses at these low multiples in the 1980s and early 1990s. Concern threshold for PE returns: >10x EBITDA - He says deals above 10x EBITDA historically generated zero net returns in aggregate. Share of PE industry profits from cheaper deals: 60% - He says about 60% of industry profits came from deals done below 7x EBITDA. Annual PE commitments: $200-$300 billion per year - He cites this as the scale of institutional capital flowing into PE after the crisis. Portfolio free cash flow yield: 18%-20% - He says Verdad’s aggregate portfolio free cash flow yield is around this level. Japan bankruptcy rate: ~1/100th of the U.S. - He claims Japan’s actuarial bankruptcy rate is dramatically lower than in the U.S. Short interest use: Recent addition - He says short interest became a newer negative screen in their process. Rebalancing frequency: Quarterly - He says the portfolio is rebalanced quarterly as data updates. Sector concentration cap: 10% max per sector - He says they generally cap any one sector at 10% of the portfolio. Japanese company example valuation: 3.5x EBITDA - He describes Ishihara Sangyo Kaisha as trading at about 3.5x EBITDA. Global peers in example valuation: 11-12x EBITDA - He compares the Japanese chemical company to global peers trading at much higher multiples.

Pivotal Quotes: "when everybody agrees on something, and when they're borrowing money to bet on it, beware." — Dan Rasmussen: His core warning about crowded capital flows into private equity. "private equity is highly levered micro caps" — Dan Rasmussen: His concise summary of what PE really owns beneath the branding and prestige. "it's the importance of the interaction of value and leverage." — Dan Rasmussen: He identifies the central mechanism behind PE-style returns and Verdad’s strategy.

Implications: The episode suggests private equity may be much less attractive at today’s prices, while public investors can potentially capture similar economics through levered small-value stocks. It also points to Japan and other cheap markets as fertile ground for disciplined, quantitatively driven capital allocation.