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Dan Rasmussen

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69
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2018-02-27
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2018-02-27
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  1. “Probably one of my most formative experiences was I spent a summer at Bridgewater Associates, and you don't need to spend long at Bridgewater to get infected with their way of thinking and Ray Dalio's influence. And it really shaped a lot of how I approach investing today. And Ray's approach investing said, first, come up with a logical principle. Something that makes sense. It's simple. Second, since most good ideas don't work, test that logical, simple principle across as much, you know, as many market cycles as many regions or geographies, as long as the time period is possible and see whether you're logical intuition matches the empirical evidence. And then third, if both of those two things work, try it out in live trading and see if it works out of sample, you know, the great out of sample market, which is the future. And I think that's how I approach investing. And so I think my logic is very simple, which is that private equity dramatically outperform the market from 1980 to 2010. The way they did that, if you look”

    2018-02-27 · Invest Like the Best · Dan Rasmussen - Private Equity Returns in Public Markets - [Invest Like the Best, EP.78] · IDENTIFIED FROM THE TRANSCRIPT · source

  2. “Yeah, so I think ultimately investing is about making good forecasts. And I think too many investors subscribe to this sort of clinical or expert-based judgment that, right, if I know a lot about”

    2018-02-27 · Invest Like the Best · Dan Rasmussen - Private Equity Returns in Public Markets - [Invest Like the Best, EP.78] · IDENTIFIED FROM THE TRANSCRIPT · source

  3. “Because they found a corner of the market that was deeply undervalued. And I think that when you then think about these reference classes of these great investors, they were finding places that were undervalued where other people weren't doing this. Ah, you know, I don't know. It seems crazy to go out of the public equity market and buy small private companies with debt. I don't know. That sounds really risky to me. Or, gee, putting insurance money into common equity, I don't know. That sounds really, really risky. And I think it's Peter Thiel who says that good ideas are sort of the intersection of something that could be a good idea, but it sounds like a bad idea, so it scares enough other people away. I mean, I think anything where there's consensus is unlikely to provide a good investment opportunity. Investment opportunities are almost always found in non-consensus, contrarian places.”

    2018-02-27 · Invest Like the Best · Dan Rasmussen - Private Equity Returns in Public Markets - [Invest Like the Best, EP.78] · IDENTIFIED FROM THE TRANSCRIPT · source

  4. “So I went back and read all Mitt Romney's early letters when he was investing. And I found one from about 10 years into his career. And he said, prices this year are getting more expensive. We used to buy things at four to six times EBIT, but we're having trouble finding things at those valuations, which worries us about our ability to generate alpha at higher valuations. And, you know, we're seeing some of our competitors get involved in auctions, which just seems crazy to us. And I'm paraphrasing, but you look back and say four to six times EBIT, right? You were buying things at four to six times eBit. Of course that worked, you know. And I think that your idea that a reference classes is exactly right, right? Did Buffett succeed because he was a genius or because he realized the value of using insurance flow as a form of permanent capital? Did Mitt Romney and Kravis and Roberts and all these guys, did they succeed because they were the best stock pickers in the world?”

    2018-02-27 · Invest Like the Best · Dan Rasmussen - Private Equity Returns in Public Markets - [Invest Like the Best, EP.78] · IDENTIFIED FROM THE TRANSCRIPT · source

  5. “Market. It's a huge feel load. You're locking up your capital for seven or eight years, maybe more. Be careful. And if you are going to allocate to private equity, allocate to the firms that are buying companies cheaply, those still exist, and allocate to firms that can actually prove to you that they can create value across their portfolio and in aggregate rather than just being seduced by anecdotes.”

    2018-02-27 · Invest Like the Best · Dan Rasmussen - Private Equity Returns in Public Markets - [Invest Like the Best, EP.78] · IDENTIFIED FROM THE TRANSCRIPT · source

  6. “Or restructuring, or they'll just hold them for seven or eight years or nine years before you ever get your money back. And so I think the biggest advice to investors, I think, is to say be really, really careful because it's unlikely that those expensive investments are going to perform to the extent that you think that they are. And it's shocking to me, but the consensus among institutional investors about private equity outperformance is so firmly held. I mean, I think it's something like 50% of institutional investors believe private equity will outperform the market by 4% per year. And I think there's maybe less than 10% who think it'll even be even. And I'm just saying, I'm not a radical or an extremist. I'm just saying, look, over 10 times EBITDA even Cambridge Associate status suggests this underperforms the public equity market. And so my view is if they're doing deals at 11, 12 times EBITDA, which is where prices are this year, it's just not going to work. It's going to lag the public.”

    2018-02-27 · Invest Like the Best · Dan Rasmussen - Private Equity Returns in Public Markets - [Invest Like the Best, EP.78] · IDENTIFIED FROM THE TRANSCRIPT · source

  7. “Yeah, I mean, I think the biggest developments, I mean, I think you're going to see these large institutional investors, you know, the Dubai pension funds, the Abu Thabi investment corps of the world taking up their increasing their allocations to private equity. And so I think you're going to see massive increased flows into the asset class for years to come. And that's going to continue to drive purchase prices higher. And so I think any firm where you're seeing the aggregate or average buyout multiple for their deals north of 10 times EBITDA, you shouldn't expect those funds to return higher than the public equity markets. It's just not likely, at least in aggregate. Now, because these portfolios are so small, right, if they do 10 or 15 deals per fund, they could just have one or obviously everything's a probability distribution, right? Some of the funds that do really expensive deals are going to work. But I think in aggregate, they're not going to. And a lot of those deals are going to end in bankruptcy.”

    2018-02-27 · Invest Like the Best · Dan Rasmussen - Private Equity Returns in Public Markets - [Invest Like the Best, EP.78] · IDENTIFIED FROM THE TRANSCRIPT · source

  8. “I think I'm an empiricist, right? I think that let's just take the data and look. So take every LBO that the firm has done, look at the financials, three years pre-acitis.”

    2018-02-27 · Invest Like the Best · Dan Rasmussen - Private Equity Returns in Public Markets - [Invest Like the Best, EP.78] · IDENTIFIED FROM THE TRANSCRIPT · source

  9. “But you're also decreasing the numerator because you're adding interest costs. And so any increase in valuation actually has almost an exponentially negative effect on free cash flow yield. And conversely, as you get sheep, the cheap levered equity is right. The 1980s, 1990s LBOs done at six, seven times EBITDA. In those cases, you had the increase in leverage far outweighing the increase in interest payments. But there's essentially this exponential curve as you increase valuation. And so that's what makes private equity much more price sensitive is that the expensive companies are to hire us for bankruptcy. Their interest payments are substantial relative to their free cash flow. And that means that you have a lot more downside in those expensive LBOs than you might in an expensive public equity that's not levered.”

    2018-02-27 · Invest Like the Best · Dan Rasmussen - Private Equity Returns in Public Markets - [Invest Like the Best, EP.78] · IDENTIFIED FROM THE TRANSCRIPT · source

  10. “Yeah, and this is probably one of those things that's the most misunderstood about private equity from the outside and the most clearly well understood by people that actually do the transactions. And that's the importance of valuation. I would say that private equity valuations are even more important than public equity valuations. And the reason for that is that every private equity transaction, or at least the vast majority, are in aggregate, are debt financed, usually about 65% net debt to enterprise value. And so as you increase purchase price, you're increasing debt levels and you're increasing interest payments. And that has an effect, you know, if you think of free cash flow yield as being at least theoretically the driver of equity returns. If you increase the purchase price, you're not only decreasing the size of the denominator in that free cash flow equation, right, because you're increasing the amount you pay, increasing the market cap, or the equity value.”

    2018-02-27 · Invest Like the Best · Dan Rasmussen - Private Equity Returns in Public Markets - [Invest Like the Best, EP.78] · IDENTIFIED FROM THE TRANSCRIPT · source

  11. “And before we get into this specifically, I think there's sort of this analogy, which I keep coming back to, which is that in private equity, they keep saying we make operational improvements or we do X, Y, or Z, we do deep diligence, right? Et cetera, et cetera, et cetera.”

    2018-02-27 · Invest Like the Best · Dan Rasmussen - Private Equity Returns in Public Markets - [Invest Like the Best, EP.78] · IDENTIFIED FROM THE TRANSCRIPT · source

  12. “And they should get the same returns because factors in their minds purchase price or leverage levels are not the core driver of the outcomes. And so just because those things change doesn't to them Signal change and the asset class is potential for outperformance. And those are, I think, the three myths of private equity. And I'm happy to dive into each of them individually or whichever one you'd want to start with.”

    2018-02-27 · Invest Like the Best · Dan Rasmussen - Private Equity Returns in Public Markets - [Invest Like the Best, EP.78] · IDENTIFIED FROM THE TRANSCRIPT · source

  13. “Is actually, if it were a public market equivalent, would be much more volatile than the public markets. So there's this aspect of Misunderstanding the risk. And then third and finally, I think that although every disclaimer in every fund presentation says past returns are not a predictor or future returns, everybody looks at private equity and says, in this case, past returns are a predictor, future returns. Because they don't necessarily have another way of thinking. Through what are the factors that drive returns that would change the expected return? And because they think The source of return is operational change, then all they need to do is find a great operational change agent.”

    2018-02-27 · Invest Like the Best · Dan Rasmussen - Private Equity Returns in Public Markets - [Invest Like the Best, EP.78] · IDENTIFIED FROM THE TRANSCRIPT · source

  14. “Know, I guess we'll say that it's flat, it's you know, we'll market it once. Patrick, if you and I could do that with our public market portfolio, we'd say, Well, nothing's changed about this business No new information since we bought it. There's no new catalyst, so it's flat. But of course, that's not how markets work, right? Markets are dramatically volatile. They go up and they go down sometimes for a reason and sometimes like they did in early February for seemingly no reason at all. And the private markets don't experience that because it's just based on the judgment of an accountant or the private equity firm itself. As a result, private equity looks less volatile But in reality, what they're doing, which is buying small companies using a ton of debt.”

    2018-02-27 · Invest Like the Best · Dan Rasmussen - Private Equity Returns in Public Markets - [Invest Like the Best, EP.78] · IDENTIFIED FROM THE TRANSCRIPT · source

  15. “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. And that's a myth because private equity firms mark their portfolios quarterly. Their private companies. And so they decide every quarter, you know, what is this worth? And generally they look at it and they say, well, EBIT does up a percent or down a percent.”

    2018-02-27 · Invest Like the Best · Dan Rasmussen - Private Equity Returns in Public Markets - [Invest Like the Best, EP.78] · IDENTIFIED FROM THE TRANSCRIPT · source

  16. “And they're selling for absolutely insane prices 11, 12 times EBITDA, you know, six to seven times a 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.”

    2018-02-27 · Invest Like the Best · Dan Rasmussen - Private Equity Returns in Public Markets - [Invest Like the Best, EP.78] · IDENTIFIED FROM THE TRANSCRIPT · source

  17. “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 has 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, 15, 20, 30, 100 million of EBITDA.”

    2018-02-27 · Invest Like the Best · Dan Rasmussen - Private Equity Returns in Public Markets - [Invest Like the Best, EP.78] · IDENTIFIED FROM THE TRANSCRIPT · source

  18. “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 net of fees were about six percent in excess of the public market. And private equity, 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 is 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”

    2018-02-27 · Invest Like the Best · Dan Rasmussen - Private Equity Returns in Public Markets - [Invest Like the Best, EP.78] · IDENTIFIED FROM THE TRANSCRIPT · source

  19. “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. Clients of O'Shaughnessy Asset Management may maintain positions in the securities discussed in this podcast.”

    2018-02-27 · Invest Like the Best · Dan Rasmussen - Private Equity Returns in Public Markets - [Invest Like the Best, EP.78] · IDENTIFIED FROM THE TRANSCRIPT · source