Podcast Summary: The Long View – Daniel Rasmussen: ‘Be Very Wary of Illiquid Asset Classes’

Episode Information:

• Title: Daniel Rasmussen: ‘Be Very Wary of Illiquid Asset Classes’
• Host: Dan Lefkovitz, Morningstar
• Guest: Daniel Rasmussen, Founder and Portfolio Manager of Verdad Advisors
• Release Date: May 6, 2025

Introduction

In this insightful episode of The Long View, host Dan Lefkovitz engages in a deep conversation with Daniel Rasmussen, the founder and portfolio manager of Verdad Advisors. Rasmussen, with an unconventional academic background in history and literature, shares his journey into investment management, his investment philosophies, and his critical views on illiquid asset classes such as private equity and private credit.

Daniel Rasmussen’s Background

Rasmussen’s path to hedge fund management is rooted in his academic pursuits at Harvard and Stanford, where he focused on history and literature. He explains how his love for ideas and intellectual honesty drew him to investing. “Investing seemed like a career where you just got to come up with ideas and if they were right, you made money and if you were wrong, you lost money. But it seemed so intellectually honest and interesting” (01:30). His tenure at prestigious institutions like Bridgewater Associates and Bain Capital Private Equity further solidified his investment acumen.

Investment Philosophy: Meta Analysis and Humility

Rasmussen emphasizes the importance of "meta analysis" in investing—the practice of analyzing the forecasted actions and beliefs of others. He asserts, “Investing is not a game of analysis, it's a game of meta analysis” (16:37). This approach involves understanding how other investors think and act, allowing one to anticipate market movements more effectively.

Central to his philosophy is humility. In his book, The Humble Investor, Rasmussen argues that humility helps investors navigate the unpredictability of markets. He shares compelling stories, such as the Greek ship owners’ "competition neglect" and economist Kenneth Arrow’s realization about the limitations of long-term forecasting (06:41). These narratives illustrate the pitfalls of overconfidence and the necessity of acknowledging uncertainty in investment decisions.

Verdad Advisors: Strategies and Focus

At Verdad Advisors, Rasmussen manages over a billion dollars across various strategies:

• Micro Cap and Deep Value Internationally: Focusing on undervalued small companies, particularly in Japan, where he bets on corporate governance reforms.
• High Yield Credit: Investing in bonds with higher yields, though Rasmussen is critical of this approach.
• Crisis Investing: Preparing for and capitalizing on market crises by identifying investments that perform well during downturns.
• Market Neutral Multi-Strategy: Aiming to balance risk and return akin to strategies used by macro hedge funds like Bridgewater.

The name "Verdad," meaning "truth" in Spanish, was chosen after numerous naming attempts, reflecting his commitment to transparency and factual investment strategies (04:28).

Value Investing and Performance Dynamics

Rasmussen delves into value investing, highlighting how it counters overconfident market forecasts. He discusses the phenomenon where excessive optimism drives up valuations, which eventually correct themselves as unrealistic expectations fail to materialize. “Value investing... is an arbitrage of betting against the hubris of other people's predictions” (19:54).

Despite value investing's historical success, Rasmussen acknowledges recent underperformance in the U.S. market, attributing it to an unprecedented wave of innovation by large-cap tech companies. However, he notes that value strategies remain effective internationally, where markets are more rationally priced (20:04).

Global vs. U.S. Investing and Skepticism Towards Emerging Markets

Rasmussen advocates for global investing, pointing out that international markets are often undervalued compared to the U.S. He explains that passive investing trends have led to a significant U.S. bias, keeping U.S. valuations elevated. “International stocks... are irrationally undervalued irrationally in the sense that it's not justified by the fundamentals” (26:16).

Conversely, he expresses skepticism towards emerging markets due to their higher crisis risk and lower recovery rates. Rasmussen emphasizes the importance of property rights and stable governance, which are less reliable in emerging economies. “There are some emerging markets that elect the wrong government, that government seizes all assets and the market essentially goes to zero and never recovers” (29:02).

Critique of Private Equity

One of the episode's focal points is Rasmussen's critique of private equity. He argues that private equity represents one of the biggest mistakes investors make today due to over-allocation to illiquid and risky micro-cap companies. Key points include:

• Misallocation of Capital: Private equity accounts for a disproportionate share of aggregate profits relative to publicly listed firms.
• High Risk and Leverage: Private equity deals often involve highly levered, small companies, increasing bankruptcy risk.
• Inflated Valuations and Fees: Rasmussen points out that private markets frequently report proforma earnings, masking true financial health and leading to inflated valuations.
• Overcrowded Market: With significant capital flowing into private equity, the competitive landscape reduces the potential for outsized returns. “Debt fueled, illiquid asset over allocation rarely does” (30:46).

Rasmussen contends that the influx of capital into private equity is unsustainable and likely to result in disappointing returns, especially as fund inflows begin to wane.

Private Credit as Fool’s Yield

Expanding his critique, Rasmussen labels private credit as "fool's yield." He explains that the high yields offered by private credit are primarily compensation for default risk, which is often underestimated. “The only thing that incremental yield can be pricing is bankruptcy risk” (37:27). He warns that yields above a certain threshold (e.g., 12%) are unsustainable and typically result in lower realized returns due to higher default rates. Rasmussen illustrates this with examples like Lending Club, where high yields led to disappointing returns, reinforcing his caution against chasing excessive yields without proper risk assessment.

High Yield Spreads as Macroeconomic Indicators

Rasmussen highlights the predictive power of high yield spreads—the difference in yield between high-risk bonds and equivalent Treasury securities. He asserts, “High yield spreads are predictive across a wide range of things” (41:26). These spreads not only signal bankruptcy risk perceptions but also influence investor behavior and economic conditions. For instance:

• Predicting Economic Growth: Wide spreads often precede economic slowdowns, while tight spreads indicate growth.
• Informing Investment Strategies: Rasmussen uses high yield spreads to guide portfolio decisions, such as optimizing for volatility and correlations.

He emphasizes that monitoring high yield spreads can provide valuable insights into market dynamics and potential investment opportunities.

Crisis Investing Strategy

A significant portion of the discussion centers on Rasmussen's crisis investing strategy. Defined by high yield spreads exceeding 600 basis points, a crisis presents unique investment opportunities. Rasmussen outlines his approach:

• Identification: Recognizing crisis periods through widening high yield spreads.
• Investment Focus: Emphasizing small and micro caps, which are most affected by liquidity withdrawal, and value stocks that recover strongly post-crisis.
• Behavioral Edge: Leveraging the fact that many investors panic and make poor decisions during crises, creating opportunities for disciplined, well-planned investments.

He shares, “If you can go buy the really cheap things... those stocks that you bought... are often the ones that have actually the highest growth coming out of the crisis” (44:24). This strategy relies on preparation and a contrarian mindset, ensuring that investors are positioned to capitalize on market dislocations.

Reflections and Evolution of Views

Throughout the conversation, Rasmussen reflects on how writing his book has reinforced his investment principles. Despite periods where international investments underperform the U.S., he maintains confidence in his global strategy, drawing lessons from historical data and lived experiences. He notes the value of intergenerational knowledge, appreciating insights from seasoned investors who have navigated multiple market cycles.

Conclusion

Daniel Rasmussen’s episode on The Long View offers a compelling analysis of investment strategies grounded in humility, historical insight, and meta analysis. His critical perspectives on illiquid asset classes like private equity and private credit serve as a cautionary tale for investors seeking higher yields without fully accounting for associated risks. By emphasizing the importance of planning for crises and leveraging macroeconomic indicators such as high yield spreads, Rasmussen provides actionable insights for investors aiming to adopt a long-term, disciplined approach.

Notable Quotes:

• “Investing is not a game of analysis, it's a game of meta analysis.” (16:37)
• “Value investing... is an arbitrage of betting against the hubris of other people's predictions.” (19:54)
• “How do you find a way to profit by betting against people's hubris.” (16:53)

Timestamps:

• 01:30 – Daniel Rasmussen on transitioning from history to investing.
• 06:41 – Importance of humility in investing.
• 16:37 – Explanation of meta analysis.
• 19:54 – Reflection on value investing during underperformance.
• 20:04 – US vs. international value investing performance.
• 26:16 – Reasons for global investing conviction.
• 29:02 – Skepticism towards emerging markets.
• 30:46 – Critique of private equity.
• 37:27 – Labeling private credit as “fool's yield.”
• 41:26 – High yield spreads as macroeconomic indicators.
• 44:24 – Overview of crisis investing strategy.

Final Thoughts

For investors seeking a nuanced understanding of long-term investment strategies and the inherent risks of illiquid asset classes, Daniel Rasmussen’s insights on The Long View provide invaluable guidance. His blend of historical analysis, empirical research, and strategic foresight underscores the importance of humility and disciplined planning in navigating complex financial landscapes.