Dan Rasmussen - Private Equity Returns in Public Markets

**Patrick O'Shaughnessy** (0:00)
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Hello and welcome everyone. I'm Patrick O'Shaughnessy and this is Invest Like the Best. This show is an open-ended exploration of markets, ideas, methods, stories, and of strategies that will help you better invest both your time and your money. You can learn more and stay up-to-date at investorfieldguide.com.

**SPEAKER_2** (0:59)
Patrick O'Shaughnessy is the CEO of O'Shaughnessy Asset Management. All opinions expressed by Patrick and podcast guests are solely their own opinions and do not reflect the opinion of O'Shaughnessy Asset Management. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions.
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**Patrick O'Shaughnessy** (1:24)
It's been a while since we discussed private equity on the show, so I was excited for this week's conversation. My guest is Dan Rasmussen, the founder of Verdad Advisors. Dan worked in private equity but has also spent years studying the entire field.
Dan identified several key drivers of private equity's outsize returns, size, value and leverage. His firm uses these factors as a starting point to build a portfolio of public equities that behave like their private brethren. We cover a ton of ground discussing the perspective returns for all equities, forecasting and tons of different investment strategies. Please enjoy this wide-ranging conversation with Dan Rasmussen.

**Dan Rasmussen** (1:59)
Private equity is a really fascinating world and I think it's an asset class that very few people understand.
From 1980 till 2010, it was probably the best place you could possibly invest. Returns, you know, net of fees were about 6% in access to the public market. And private equity, you know, this is all the more remarkable because we know so much about how difficult active management is and how high fees can drag on returns. And here you had a very complex, clearly very active, you know, they're taking control of every company and very high fee asset class, dramatically outperforming.
And the question is, why was that? Why did it work? And then even more interesting, perhaps, is that it hasn't worked since 2010 So if you look at the Cambridge Associates benchmarks, private equity has actually underperformed since 2010 And so the key question is, what's changed?
And I think that if you look at what's changed, probably the biggest thing is that, and you see this all the time in investing, where something that really works well and is a very good idea gets adopted by everybody, money pours in and the returns go down. And that's what you see happening now in private equity, where every institutional allocator believes that the ongoing forward returns of private equity are going to look like that 1980s, 90s, 2000s history. And so they're saying, well, we should have a 20% allocation to private equity and we only have 12% today. So let's deploy a ton of capital into this asset class. And as that money is rushed in, private equity firms have sprouted up. They've raised huge amounts of money and they're all competing for the same limited set of opportunities. The number of businesses going up for auction has not changed. What has changed is the number of competitors in the auction. And if you think about that from sort of a public equity market perspective, you know, these are tiny little businesses, you know, 15, 20, 30, 100 million of EBITDA.
And they're selling for absolutely insane prices, you know, 11, 12 times EBITDA, you know, 6 to 7 times net debt to EBITDA of debt financing. And it's just a crazily competitive market. And it's almost to some extent like a gold rush, Patrick.

**Patrick O'Shaughnessy** (4:10)
Can you talk about the three levers which you explore in the piece describing kind of how private equity firms profess to have earned such impressive results and why maybe those things aren't necessarily even true? Or at the very least may be very different looking forward?

**Dan Rasmussen** (4:24)
Yeah, you know, I think the three sort of persistent myths of private equity are first that private equity makes money through operational improvements, right? This is actually the whole rebranding, right? It used to be the leverage buyout industry. Now it's the private equity industry. And they're even trying to rebrand it as growth equity now, which is, I find, amusing. But the first myth of private equity is that private equity creates value through operational change, that you have these brilliant managers that went to Harvard Business School that can come in and turn around a business. The second myth is that private equity is lower risk and less volatile than the public markets.