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

Episode Summary

Executive Summary: Dan Rasmussen explains how a Socratic, evidence-first mindset led him from Bain Capital to founding Verdad Advisors, where he seeks private-equity-like returns in public markets. He argues private equity’s edge has been arbitraged away by higher prices and leverage, while public small-cap value—especially cheap, levered, cash-generative names—still offers mispriced opportunity, particularly when paired with rigorous bankruptcy-risk screening and patient investors.

Main Topics: Socratic upbringing and investment philosophy (Priority: 5/5): Rasmussen traces his skepticism to family dinners where his father challenged every claim, shaping a legal-style habit of demanding evidence, second-order questions, and rules that can be tested empirically. Private equity’s historical edge and current deterioration (Priority: 5/5): He argues PE worked when it bought cheap companies with moderate leverage, but higher purchase multiples, more competition, and heavier leverage have reduced returns and increased bankruptcy risk. Private credit as a destabilizing force (Priority: 5/5): Rasmussen says private credit has filled the gap left by banks, offering covenant-light, highly levered loans and extending distressed companies’ lives, which suppresses defaults and hides risk. Launching Verdad to replicate PE in public markets (Priority: 5/5): He founded Verdad after finding hundreds of public companies with PE-like characteristics—low EBITDA multiples and leverage—making public markets a better hunting ground than private deals. Quantitative screens and machine learning for stock selection (Priority: 4/5): Verdad combines value screens with models estimating debt paydown and model-error risk to identify cheap, levered companies likely to survive and re-rate, while excluding bankruptcy traps. Portfolio construction, liquidity, and capacity constraints (Priority: 4/5): He emphasizes diversification, careful sizing, and accepting low capacity as an advantage because the best opportunities are often microcaps too illiquid for large managers. Recession playbook and crisis opportunities (Priority: 4/5): Rasmussen argues value and quality signals become more powerful in downturns, and investors should lean into profitable, cheap, illiquid names during crises rather than flee risk assets.

Key Arguments: Private equity originally succeeded by buying cheap businesses, using leverage prudently, and benefiting from multiple expansion; that edge has largely been arbitraged away as purchase prices rose and competition intensified. Higher leverage now magnifies risk because many LBOs are effectively microcap, single-B or triple-C quality businesses that may struggle to cover interest in a downturn. Growth is a weak justification for paying high prices because revenue and earnings growth are notoriously hard to forecast and highly volatile. Private equity can improve margins through cost cuts, but too often cost cutting becomes destructive when firms are bought from other PE owners and operational gains are overused as a narrative. Private credit is enabling more aggressive leverage and delaying restructurings, which may keep reported returns looking stable while increasing hidden downside risk. Public markets contain a large pool of PE-like opportunities; the key is filtering out firms likely to bankrupt and focusing on cheap, levered, cash-generative companies. Machine learning adds value mainly by refining logical, fundamental signals such as debt paydown, free cash flow, and impairment risk rather than discovering magical new factors. In Japan, bankruptcy risk is so muted that the strategy can be much simpler, while North America and Europe require stronger quality controls. Small-cap value works best as a long-term allocation because its return pattern is volatile; crisis periods can be especially attractive entry points. Credit investing should focus on the 'Goldilocks' middle—high-quality but still attractively yielding bonds—rather than yield-chasing or blindly buying investment-grade names.

Data Points: Bain Capital study trigger: 2011 - Rasmussen was assigned to study Bain’s pre-crisis funds and what went wrong in 2006 and 2008 vintages. PE value creation threshold: Less than 7x EBITDA - He says private equity made most of its money in deals bought below this level. LBO leverage example: 6x to 8x EBITDA debt - He describes typical leverage when buying 10x and 15x EBITDA deals. Public-market screen result: About 500 names - His first Capital IQ screen found roughly 500 public companies fitting PE-like criteria. Small value market cap: Less than $400 million - Average market cap of the cheapest decile in a price-to-book screen, illustrating microcap concentration. Position sizing: 3% to 4% positions - He says Verdad tends to end up near this size in practice, though equal weighting is only theoretical. Debt-paydown model training set: 60 years - First machine-learning model used 60 years of U.S. company financials. Error-model backtest: 30 years - Second model was trained on 30 years of history to identify model mistakes. Model-error prediction accuracy: 50% - He says the error model predicted mistakes with 50% accuracy. Recession definition: High-yield spreads above 6 - Verdad defines recessionary stress using this market threshold in its crisis research. Crisis model power: 8x - Simple quantitative models had about eight times the statistical power during recessions versus growth periods. Default-wave estimate: 25% to 30% - He estimates this share of LBOs could go bankrupt in a normal recession. Energy PE mark example: 90% of 2013-2015 funds above 1x - Even after oil crashed, most energy private equity funds were still marked above cost. Market inefficiency in deep value: 50% of years - He says the main challenge is enduring volatility because roughly half of years are painful for small value.

Pivotal Quotes: "everything you do should be based on logic and that logic should be applied systematically" — Dan Rasmussen: He explains the intellectual foundation he took from his upbringing and from Bridgewater. "don't buy things that go bankrupt" — Dan Rasmussen: He summarizes the core rule behind Verdad’s equity and credit approaches. "the easiest way to win in small value is just last enough years that you're actually hitting that 50% of years that are winners" — Dan Rasmussen: He describes why patience and investor education are central to the strategy.

Implications: Listeners should expect more skepticism toward private equity, private credit, and growth-at-any-price narratives. The episode argues that patient, research-driven investors can still find mispriced opportunity in small-cap value and quality credit, especially by leaning in during downturns.