The Best Way To Achieve Private Equity Style Returns From Japanse Value Stocks? Nick Schmitz and Dan Rasmussen’s Verdad Capital Management…
Private Equity Style Returns in Japanese Value Stocks?
Nick Schmitz and Dan Rasmussen’s Verdad Capital Management is not your typical value fund. The firm uses a leveraged investment strategy based on the research conducted by Dan Rasmussen and his research partner Brian Chingono, which has been described as ‘the key to private equity.’
Amazingly, across the 2,500 deals studied, when PE firms paid more than seven times earnings before interest, taxes, depreciation, and amortization for a company, their chance of success plummeted.
Verdad’s strategy is built around these findings. Rasmussen and Chingono’s paper on the topic of leveraged small-cap investing in the public markets would have had an average annual return of 25.1% from 1965 to 2013, significantly outperforming all other styles.
By investing following a PE model in public markets, Verdad can attempt to achieve private equity style returns but with several key advantages.
Verdad is featured in the upcoming issue of Hidden Value Stocks, ValueWalk’s exclusive quarterly magazine on small caps. Below is an excerpt.
Let’s start by talking about your strategy, levered small caps. Why do you believe this strategy has the potential to beat the market?
Our roots are in private equity. Look at how dramatically the median private equity manager beat the S&P500 over the three decades from 1980 to 2010. We’ re talking 5% to 6% net of fee outperformance, or about 10% to 12% gross of fees. That’s for the average manager! If you assume that the average private equity manager is no better than the average mutual fund manager, you have to conclude there is something special structurally about private equity. We think that comes down to three factors: private equity deals are significantly smaller, significantly more leveraged and, until 2010 or so, significantly cheaper than the broader public equity markets.
We believe that we can produce returns that look like historical private equity returns by buying small, cheap, highly leveraged businesses. We’ ve done extensive quantitative research to prove this out. Our innovation is of particular importance today because the era of easy profits in private equity is over – too much money has flooded in, and PE firms have departed from their traditional playbook of buying cheap. Ironically, the purchase price is the most predictive indicator of PE deal returns historically. We think it’s much wiser to buy in public markets now at 5x to 10x EBITDA than in the modern PE environment at 11x to 12x EBITDA.
And you think Japan is the best market for this?
Japan is extremely cheap on an absolute and relative basis right now. Japan in 2017 is the most affordable market in the developed world. Indeed, the Japanese stock market is cheaper today than at the depths of the financial crisis. The country’s stocks trade at the lowest valuations in over twenty years. The gap between valuations in Japan and the United States is larger now than at any point since the peak of the dot-com bubble in 2000. Most foreign investors are familiar with the “Lost two decades” in Japan. It’s true if you invested in the Nikkei (big and expensive) . However, if you had been a buyer of small-cap value buyer according to the Fama-French model since the 90s, you would have done quite well.
Levered equities in Japan are unique. The Japanese have had a zero interest rate policy for nearly 30 years, and bankruptcy in Japan is almost non-existent for various reasons. The lack of bankruptcy is crucial to us: that’s our biggest risk when we invest in leveraged firms in the US and Europe. Finding a market where there is essentially no bankruptcy means that we can execute our strategy with significantly reduced drawdowns and volatility.
This is just part of the interview. As well as talk with Verdad, we also have an interview with GrizzlyRock Capital and four potential hidden value stocks in the summer issue of the Hidden Value Stocks magazine.
If you are interested in learning more, feel free to download this no obligation teaser. And if you want to buy the last issue, sign up for a whole year, or just find out more about what’s on offer, click here.
