October 17, 2024

Episode 327 - Building Better Portfolios with Don Calcagni

October 17, 2024

What does it take to manage a $60 billion wealth management firm while keeping investment strategies grounded in scientific thinking? In this episode, we’re joined by Don Calcagni, Chief Investment Officer at Mercer Advisors. Don chairs the firm’s investment committee and provides guidance on mergers and acquisitions, investment integration, and long-term strategic planning. His expertise spans fiduciary oversight, portfolio management, private equity, and financial mathematics. In our conversation, we discuss how his firm constructs client portfolios, engages with academic and industry experts, and leverages a factor-based investment approach. He also explains the importance of having an investment philosophy rooted in fiduciary principles and delves into how Mercer Advisors manages fiduciary oversight for billions of dollars in assets across thousands of families. Explore the details of portfolio governance and the role of the firms’s alternative investment platform space. Gain insights on value metrics, factor investing, and how Mercer works to provide a family-office experience for everyday clients. Tune in for a deep dive into portfolio construction and the evolving landscape of wealth management with Don Calcagni!

Key Points From This Episode:

(0:05:22) Learn about Mercer Advisors and the range of services it has on offer.

(0:07:10) Unpack Mercer Advisors’ approach and philosophy to portfolio construction.

(0:11:55) The Building Better Portfolio Summit and the purpose of the event.

(0:17:08) How the meetings are structured and the main takeaways from the last event.

(0:24:45) What topics cause extreme points of agreement and disagreement at the meetings.

(0:29:21) Find out how takeaways from the events are implemented into client portfolios.

(0:31:19) Mercer Advisors’ recently launched alternative investment platform space.

(0:40:23) Don shares valuable recommendations and advice for the average investor.

(0:42:23) Aftershow: the controversy surrounding the RBC options trading incident.

(0:49:57) Listener feedback, reviews, updates, and upcoming events.

Read the Transcript

Ben Felix: This is the Rational Reminder Podcast, a weekly reality check on sensible investing and financial decision-making from three Canadians. We are hosted by me, Benjamin Felix and Dan Bortolotti, Portfolio Managers at PWL Capital, and Mark McGrath, Associate Portfolio Manager at PWL Capital. Welcome to episode 327.

Mark McGrath: Like you said before you recorded that you're saying the intro is changing all the time, because of the revolving door of who's here and who's not.

Dan Bortolotti: You should record all the variations and just have them as stock.

Mark McGrath: There you go.

Dan Bortolotti: Two Canadians. Three Canadians.

Ben Felix: Yeah. It's a lot of variations. I don't know. All right, so this week we have a conversation with Don Calcagni. He's the CIO at a large RIA in the US. Their firm is in many ways similar to PWL. Don tells us, he tells Cameron and I, we recorded this at a different time, tells us how their firm approaches portfolio construction and how they approach getting input from industry and academic experts. It's a really interesting conversation. Don's a very thoughtful guy. So, we'll go to that in a minute.

Before that, I wanted to mention, I spoke with someone recently who listens to this podcast religiously. They never miss an episode. But they've got their money with an advisor at a firm that uses actively managed funds. They told me this and I was like, why? They get it. They listen to the podcast. Yeah. I asked them and their question back to me was, “Well, what would be better for me if I were at PWL?” I think that's pretty common, where there's a lot of inertia in financial advice relationships. If it's working, people are nervous, or hesitant to change it, which I get, it's a big decision. But my answer to that question would be that PWL has very competitive fees for our advisory fees.

We use financial products to build portfolios that themselves have really low fees. Combined, our fees tend to be a lot lower. We provide what I think is the best financial planning advice in the country. I don't say that lightly. I think if you're listening and you have an advisor, always feel free to reach out to PWL to see what working with us might look like.

Mark McGrath: Yeah, it's really interesting. I think when I've talked about this before, but people don't really know what financial planning is. They think they're getting it, no matter who they're dealing with. There's been studies on this. I think it was at JD Power, I want to say, does the study, I don't know if it's annual, but there was at least one a couple of years ago, where they pulled people and asked them if they had a financial plan. I'm going to botch the numbers, but something like 48% of people said, “Yes, we have a financial plan.” But upon further review, JD Power determined that only 7% of those people who actually believed they had a financial plan had something that JD Power's interviewers or pollsters believed was actually a quality financial plan. People just don't know what a financial plan is, right?

They get a meeting once in a year, they get a portfolio review, maybe a really retirement projection, and they say, “I've got a financial plan,” right? I think that's where a lot of that inertia comes from is they think they're getting the thing that they're being sold, but it's not always the case.

Dan Bortolotti: Yeah, I think there's such wide variation of the scope of services that advisors deliver. As you said, Mark, you don't really know what you're getting relative to what's available, right? If you've been working with the same advisor for years, you think it's normal. If you're not getting some fundamental part of a plan, you might not even be aware that other advisors offer that. I mean, on the other side of it, too, I mean, I've definitely had prospective clients call me and have said things like, “I'm very happy with the advisor I'm working with. I'm very comfortable with the investment strategy. Why would I move?” My first thought is, you may not want to, or need to.

I mean, I think we're open-minded enough to know that if you have a very good relationship with an advisor, as long as the fees are reasonable and the investment strategy is reasonable, it doesn't have to be exactly what we do. We're looking for long-term relationships too, right? We don't want to work with somebody who's going to come onboard, feel six months later that it's different from what they're used to and then move on. It really is about finding a good fit. But I would agree with you that the vast majority, I think, of offerings out there are not as comprehensive as what we're able to offer here. If it is, it's likely for a higher fee.

Mark McGrath: Yeah, fair enough.

Ben Felix: Yeah, I agree with all that. Good point, though, on the fit really has to be there, and when we don't want to start relationships that are going to be short-term. Okay, so I'm going to explain really quickly who Don is, and then we'll go to his conversation with Cameron and I, and then we'll jump into the after-show after that. We've got a few more things to talk about, so make sure you stick around. Don Calcagni is the CIO at Mercer Advisors, which is about, I think he says about a 60-billion-dollar RIA in the US. So, a sizeable firm. His expertise is in fiduciary oversight, economics, financial mathematics, portfolio management, corporate finance, and taxation.

He has served as an adjunct professor at Widener University and as a guest lecturer at the University of Colorado at Boulder. He got his MBA from the University of Chicago Booth School of Business and his master's in taxation from Widener University, and he is a certified financial planner professional. All right, so we'll go to our conversation with Don.

***

Ben Felix: Don Calcagni, welcome to the Rational Reminder Podcast.

Don Calcagni: Thank you, Ben and Cam. It's great to be here.

Ben Felix: I'm very excited to be talking to you. To kick off this conversation, Don, can you explain to us what Mercer Advisors is?

Don Calcagni: Sure. Mercer Advisors is a national fiduciary fee-based wealth management firm in the United States. We provide a full suite of what we call family office services. We characterize ourselves as a family office for real families. Our listeners may be asking themselves, “Well, gee. What are family office services?” Well, it's everything from financial planning, to investment management, to tax advice, tax return preparation and filing. It's a state planning. It even includes the drafting of foundational state planning documents, like wills and trusts and health care directives, and really everything and anything that touches our clients' financial lives and their balance sheets, as we've really tried to internalize those resources to create a unified team to really help our clients really navigate the complexity of the US financial system and really do everything in our power to help them really amplify and really simplify their financial lives as much as possible.

Cameron Passmore: That's really impressive, Don. In total, how much capital does Mercer Advisors manage for your clients?

Don Calcagni: At the moment, we currently provide fiduciary oversight and management to approximately 63 billion dollars for somewhere around 35,000 families across the United States. We have almost 1,200 employees working out of about 100 offices, so we are relatively local to most markets. We do think that's important to be close to our clients to engage with them directly. Zoom is great. In this post-COVID world, Zoom has become normalized, but we also think it's really great to still really connect with our clients at a very human, at a very personal level.

Ben Felix: How does your firm approach portfolio construction?

Don Calcagni: It always begins with philosophy. David Booth once famously said that the most important thing when it comes to investment philosophy is you better have one. I think it really begins there. What does it mean to be a fiduciary? When I took this job about 10 years ago, Ben, I spent a lot of time reflecting on what exactly does it mean to me personally to be a fiduciary? The only way that I know how to answer that is to incorporate the absolute best scientific thinking available into our investment process, and to do that in a way that's very practical.

We are managing money for humans. We're not managing money for robots, or for the Yale endowment, right? We're managing money for real families. I think it begins there, having an investment philosophy that makes sense, that's practical, that's scientifically grounded. I think the second order of operations here, Ben, is with respect to investment governance. Who makes decisions with respect to the investment portfolios? We have an investment committee that's currently over 50 members across eight underlying subcommittees. We put a lot of thought into how we govern that investment's committee. It's very structured. We maintain minutes. We take votes. There's no Supreme Court appointments on our investment committee. The whole intent is to turn it over with a certain cadence over time so that we're getting fresh ideas and fresh input.

An important feature of our investment committee, for example, is no senior executives other than myself are actually permitted to even serve on the investment committee. That's because our senior executives have a fiduciary duty to our shareholders. We want our investment committee to be autonomous from the management structure of the organization. Two-thirds of our committee members are advisors. Many of them are CFAs, like yourselves. Many of them have MBAs from some really amazing business schools. Almost all of them are certified financial planners.

I think it begins with those two things, with respect to portfolio construction. That's maybe a roundabout way of getting to the more tangible answer to your question. I think it begins there. If you get those things wrong, I would argue everything else I'm about to tell you, candidly would be meaningless.

At a more tangible level, when we think about portfolio construction at Mercer Advisors, it always begins with a financial plan. The financial plan informs what the client's asset allocation should look like. Again, I would argue, if you don't have that in place, I would argue, you don't know how to invest. You have to first know what success looks like and define it, so that you know what it looks like when you achieve it. Once the financial plan is in place, then it fundamentally becomes about diversifying across and within global asset classes.

We do embrace different variations of modern portfolio theory at Mercer. We are factor-based investors within asset classes. We use factors to tilt the portfolio towards things, like value and momentum and profitability inside of our portfolios. We generally take a core-satellite approach. We do believe markets are pretty efficient and you should think long and hard before you depart from a market-cap-weighted index and just be very judicious when you are making those decisions. Most Mercer portfolios you'll find will have some core equity component, surrounded by a blend of different factor tilts.

I use the word tilts very specifically because we still want to own some of those “growthier” stocks in the portfolio. We just want to underweight them a little bit and tilt the portfolio towards these academically identified and supported different factor exposures that we want in the portfolio. We do embrace using very low-cost solutions, index funds, factor-based funds, and separately managed accounts that own individual securities. We do rebalance regularly. We are generally not market timers, by any stretch of the imagination. We really fundamentally seek to build portfolios that real people can hold on to through good markets and bad.

Ben Felix: Wow.

Cameron Passmore: Pretty good answer, I would say, Ben, and just a pinch and common with us.

Ben Felix: Oh, my goodness. I was going to say like –

Don Calcagni: Just a little.

Ben Felix: That sounds like something we would have said if we were as good at speaking as you are.

Don Calcagni: Well, I've been listening to you guys for about four years now, so I've learned from you.

Cameron Passmore: It's funny. Don, tell us about the Building Better Portfolio Summit.

Don Calcagni: This is really the highlight of my job. This is one of my favourite parts of the job is really working in close partnership with some of the greatest minds in finance. Just to back up for a moment, what I was saying earlier, what does it mean to be a fiduciary, to embrace the best scientific thinking available in the marketplace? Before you can embrace it, you have to seek it. You have to invite it into your office, as you need to ask the best minds in the business to grade your work.

What I love about Mercer is it's a very intellectually curious bunch. It's also a very humble bunch. We are not afraid to have others grade our work. About two years ago, our president, Daniel Gourvitch and I were having a conversation and we came up with this idea, why don't we invite our top five, or six asset managers to come to our offices in Denver, Colorado for a couple of days to meet with our investment committee members, and why don't we give them all of our strategies, all of our model portfolios, tickers, weights, the whole nine yards, and then ask them to come spend two days with us and grade our work?

Cameron Passmore: Together.

Don Calcagni: Together.

Cameron Passmore: They're all together.

Don Calcagni: They're together. We actually have a dinner, which is even better. I mean, can you imagine some of our dear friends from Dimensional and AQR and Avantis all together? It's an interesting bunch, and it's really a lot of brain power. But we send them prompts ahead of time. Part of that is to help guide the conversation. You get some really smart people in a room, plus you throw a few academics in for good measure, and you can go in a lot of different directions. We learned, Cam, that we need to send these prompts, these questions, which help guide the discussion.

What we do with those prompts is tell them exactly, what's on the minds of our investment committee members. What are the issues we're struggling with that we really feel we need some advice on? That helps to guide the discussion. We ask them to send us a pre-read two weeks before the actual two-day on-site. That way, our team has had time to digest feedback from these asset managers, as well as to get some feedback from some of the academic consultants that we work with. Then we all get together and it's basically the Hunger Games for two days, right? We talk about things like, what are the best value metrics and how many value metrics do you need to express a value factor in a portfolio, and some really fun stuff

Cameron Passmore: Must be fascinating.

Ben Felix: Yeah, that sounds like a blast.

Don Calcagni: We actually call it “Nerd Fest” internally.

Ben Felix: That's accurate.

Don Calcagni: It's so humbling. It's so humbling to have folks actually grade your work. We've learned quite a bit from it.

Ben Felix: I can only imagine. You mentioned some of the asset managers that have people present, but who's actually coming? Is it names that listeners would know?

Don Calcagni: Yeah. I mean, I think our listeners would likely know many of the names. It's Vanguard, it's Dimensional and Blackrock and Avantis and AQR and firms like that. We've certainly invited others over the past couple of years. Our intent is to invite still other asset managers. What we try to do is we try to identify those asset managers that we think are most relevant to the prompts, to the agenda topics that we are trying to explore. We try to identify asset managers that we perceive have a particular expertise in a given area.

I think what you'll find is there's a lot of overlap from summit to summit. We hold these every six months. So, you'll see a lot of the same names. What does change a little bit is the academics who tend to join us. We had Professor Robert Novy-Marx join us last time. We had Toby Moskowitz from AQR/Yale join us, and we've had Savina and Marlena from Dimensional and Gerard and Eduardo and others over the years come join us.

The intent is to continue to broaden it, to continue to invite others. I just interviewed a professor from Penn State University earlier this week that we're considering inviting as a consultant for our next event, which will be in January.

Ben Felix: Did you by chance listen to our episode with Andrew Chen?

Don Calcagni: Andrew Chen. Refresh my memory. I don't remember that one.

Ben Felix: He's the one that says, basically, after costs, there are no more factor premiums out of sample. That could be an interesting person to throw into the mix in a room like that.

Don Calcagni: Where's he at? I'll definitely look him up.

Ben Felix: He's a Federal Reserve Board, but he's published in all of the top journals. He's not with an academic institution, but he's in those circles.

Don Calcagni: That's a scary argument that I think many of our committee members will probably actually end up agreeing with. There's actually a Fama-Miller Research Center paper, where I think Fama and French actually went back and looked at the value premium post publication of the 1993 paper, right? That was a little scary. I think the conclusion was, there wasn't statistically enough evidence to reject the null, but at the end of the day, it was a little scary.

Ben Felix: Yeah. I remember that paper. Yeah. They said, there wasn't enough evidence to say that the out of sample premium was different from the in-sample premium.

Don Calcagni: You just said it so much better than I could have.

Ben Felix: Yeah. Anyway, I love stuff like that that challenges the basic assumptions that we have. You mentioned the prompts. What are the prompts, or some examples of the prompts that these people get?

Don Calcagni: Yeah. We typically give them three. The first two tend to be very specific questions. Usually, there's multiple parts. For example, the first summit we held, we asked them to give us advice on how many value metrics. One, what are the best value metrics to use, price to book equity, or price to forward cash flows, or whatever? Then we were asking questions around, well, how many value metrics would you need to express a certain factor theme in a portfolio?

What was great about that is Dimensional has one view on that. Avantis has another view, BlackRock has a view, where they try to use multiple value metrics to express a value factor theme in a portfolio. Some of those questions are very, very specific. An additional question was, for example, around trying to capture the momentum premium. What is the right rebalancing frequency in order to really do that? AQR rebalances monthly, BlackRock at the time was rebalancing once every six months. They've since shortened it to every three months.

Trying to get into the weeds on how we should think about which factors to include in a portfolio, how best to go about hiring managers and looking at their methodology for how they're trying to express those factor themes in a portfolio.

The third prompt is always very open-ended. That's where we invite the managers to educate us about anything that we have failed to ask about, something that we just don't know about. It's meant to be very open-ended to give them some airtime to come in and pitch us on anything that's top of mind for them, whatever they're working on. Oftentimes, managers want to come to these meetings and naturally share what they're researching, what they're working on. That way, it's a very fruitful meeting for everybody.

Cameron Passmore: Can you share some of your main takeaways from your most recent summit?

Don Calcagni: The most recent summit focused on governance. One of the things we were trying to understand, Cam, was how do some of these very large, global, very sophisticated asset managers, who decides? How do they make decisions? Who's on their investment committees? What does that appointment tenure look like? At the end of the day, we wanted to understand who decides.

We invited a range of managers. That was very insightful. You can see that there are, without mentioning names, you can see where the business philosophies of certain asset managers tend to permeate how their investment committees operate. For example, there's some managers that are clearly more product manufacturing type organizations, where they're constantly pushing out new products to the marketplace. They also tend to have a high retirement rate for a lot of those products, right? Then you have other organizations that are significantly more purist in their belief systems around their investment philosophy.

It's just fascinating to see how those different business management philosophies tend to manifest themselves in the governance structures that these organizations have in place. You can also still see that there's personality dependency in many organizations, which is something that, at least for me personally, and I think many of our investment committee members would agree, is that that's something we're very concerned about, right? We'd like to make sure that there's a very academic, free marketplace for ideas within our asset managers. That's something at Mercer we try to manage. Our investment committee as a voting investment committee member. I have one vote as a member. The idea is to create this free marketplace.

The takeaway for me, Cam, back to your question, was it just really interesting to me to see the divergence in how very large global asset managers are governed. It was a little bit of an eye opener. Again, I'm not saying it's good, or necessarily bad. It was just interesting to see that there's a big difference in how many of the big brands are actually operated internally.

Ben Felix: That is really interesting. I guess, not surprising when you think about it, but it is really, really interesting to hear that observation.

Cameron Passmore: Does it get highlighted, Don, by the fact that they're together, so you really see the contrast in real-time?

Don Calcagni: I think that's part of it. Now, just to go back to the summit Cam, and maybe I wasn't clear on this, is we will have a dinner together with all the managers. But then, we have private breakout sessions with each manager. We felt that we had to do that in order to have the asset manager speak freely, right? Cause a lot of times they feel like, they have their own special cooking and they don't want the others to listen in. Then we do have a very popular social dinner, where we all get together and we're all breaking bread and continuing to discuss the day's topics.

Cameron Passmore: That sounds a little easier to manage. Okay. Now I get it.

Don Calcagni: Yeah. Yeah.

Ben Felix: Did any of the attendees, just thinking about the most recent summit, did anyone raise points that surprised you?

Don Calcagni: Certainly. Like I said, it's been educational. What I would say is, I mean, if you think of the managers and the faculty that we generally invite to our events, they probably agree on 90%, but they fiercely disagree on that 10%. Some of the things that have surprised us, many of the managers will take our portfolios and then compare them to proprietary databases of other advisor portfolios, right? If you think of Vanguard, or BlackRock, BlackRock, for example, owns Aladdin. Aladdin has something 22,000 advisor portfolios in Aladdin.

One of the things that really struck me at the last event was how many advisor portfolios, one still use very actively managed mutual funds in the portfolios. I thought that by 2024, that that had gone the way of the dinosaurs.

Cameron Passmore: You're funny.

Don Calcagni: I know.

Cameron Passmore: That’s such a quaint idea, Don.

Don Calcagni: Part of me says, this stuff is so obvious. Why would you pay 80 basis points for a US large-cap value?

Cameron Passmore: Oh, you're so charming.

Don Calcagni: Doesn’t make sense to me. The was the first. The second, which follows from the first is how expensive the average advisor's portfolio operating costs are. According to Aladdin, the average advisor portfolio in the United States has an internal operating expense of 46 basis points. Ours is about 11 and a half. Now, that's partly because of our design, our portfolio construction. It's also partly because of the managers we've selected. That was always a little surprising. For me, that also calls in the question to some degree, really the validity of the comparison, right? Because I want to see how we're doing really vis a vis, perhaps, what I would consider to be peer organizations in terms of how they're designing index-based, or factor-based portfolios for clients. Cam, to your question, I think that was an interesting observation.

We also learned a great deal. Full transparency, one of the things we learned is we could be more aggressive in pursuing factor premia in our small-cap and non-US allocations. Perhaps, those really aren't the best places to pursue a core component. Given our investors, our US citizens, they have that natural home country bias. Maybe that's the place where we should pursue our factor premia a bit more aggressively. I think as the literature shows, the factor premia are higher in those markets than in the United States, certainly then in US large cap. That's something our committee's been revisiting and taking a look at, what does that actually look like? How would we really go about implementing that, so on and so forth?

Ben Felix: Yeah, that's really interesting. You mentioned disagreement. What are some of the most extreme points of disagreement that you see with participants?

Don Calcagni: There's the tangible ones. Then there's the ones that are a little less tangible. I always think the ones that are less tangible are a little bit more interesting. I'll give you examples of both. The less tangible one that I think's interesting is that you can see that there's a tug of war between, I mean, these are all quants, right? These are folks you guys know, right? There's this tug of war between our over-precision biases, where we want to carry things out 10 decimal points, and what's practical. You can see that even among the asset managers, this tug of war between, gee, we have an investment thesis and there's data that strongly supports both in-sample and out-of-sample certain factor exposures. You have some firms that are very purist in wanting to pursue those.

You have other organizations where they'll look at that and say, “Yeah, that's great. We think it's fine to tilt towards those, but you should still really diversify as broadly as possible, right? Because you're managing money for humans, not robots.” I think that's always interesting. There's a lot of disagreement there around how precise, or how aggressive to get when implementing an investment thesis in a portfolio.

At a more tangible level, we see lots of disagreement around how many factors to include in portfolios, even disagreement around what are legitimate factors and what are not, right? Lots of debate, as you would imagine, Ben, around the momentum factor. Does it exist? Does it not exist? I think we all agree it exists, whether or not it's capturable or not is where we all have lots of debate. Minimum volatility. Is that some derivative of the value factor, or is it something different that's providing some legitimate diversification exposure? Lots of debate there.

But then, even within something as widely acceptable as value, how to measure it, right? Avantis has one view on goodwill. Other organizations have a different view on whether or not to add or exclude goodwill from book equity, whether to look at the cash flow statement, whether to look at the income statement or the balance sheet. Lots of debate. I don't know that at the end of the day, whether that advances, or changes how we think about portfolio design. I mean, these are fun debates. I certainly am excited to engage those. But I think you see a lot of debate around things like that.

Tons of debate here in the United States around how heavy should our home country bias be. One thing that surprised me is we're just slightly north of ACWE in terms of our US home country bias. Just a tad. Maybe three to 400 basis points. Which I found out was very low.

Cameron Passmore: Yeah, it's not easy, I'm sure either.

Don Calcagni: It was not easy. Compared to our peer group, 80%, 90%. There's many firms in our peer group that are 100% US that don't invest outside the United States. Back to your earlier question, that was a huge shocker for me.

Cameron Passmore: Can you talk about the topics that all the participants did agree on?

Don Calcagni: I think there's definitely agreement on methodology, taking a very systematic approach to how we think about analyzing the data. I think that's very different from many, for example, traditional active managers. Just by virtue of taking a very systematic approach, looking at large sets of data, analyzing the data in-sample and out-of-sample. I think methodologically, there's a lot of agreement. I think they all agree that you want to build broadly diversified portfolios. You want to diversify within and across major global asset classes, which I think there's lots of debate there.

I also think that among our asset managers, there's a humility that they recognize that they don't do what you do. They don't do what Mercer Advisors does, right? They understand that we're working with humans and that by definition, that requires us to think through how best to go about implementing portfolios. They're often asking us, they would be asking you, Cam, Ben, what do we need to do to help you have the products, the tools you need to build real investment solutions that clients can hold on to? I think there's an agreement that what we do is similar, but different. We play very different roles in this broader supply chain that involves providing fiduciary financial advice to end consumers.

Ben Felix: How do the takeaways from the summit actually make it into client portfolios?

Don Calcagni: We have a process. It always begins first with follow-up research, right? Just because a manager has made a recommendation, or shared some research with us, naturally, we're going to take that information, share it with others, get their input, do our own research. We then discuss and debate sometimes quite fiercely as an investment policy committee, what we call an investment policy subcommittee. If an idea has merit, then we will make a motion and we will take a vote. If the investment policy committee, for example, were to say, “Hey, we want to invest in XYZ factor exposure and add that to our asset allocation strategies.” If the investment policy committee approves that, then it then subsequently goes to our manager selection subcommittee. That's a totally separate group of individuals.

At that point, then the mandate is let's source and identify and then approve, whomever we think the best manager is to harvest that specific asset class or factor mandate. Once that happens, it gets handed off to the investment team, which is separate from the investment committee. The investment team then will actually map out the operational implementation. All the block trading across the different custodians, we negotiate with the manager. If there's a negotiation to be had, we'll negotiate with the manager. We typically work with the capital markets desks at the managers. They'll direct us to the authorized participants, where they're seeing the most activity. Then we'll typically go directly to the APs and either bust, or manufacture shares.

Ben Felix: Wow. That's incredible. Quite a process.

Don Calcagni: It's pretty involved. But it is a process and you have to have that process, right? I mean, you guys know in this business, you got to be careful. If you don't know what to stand for, you're going to fall for anything. I think having a process, a lot of checks and balances in the process, I like to think, ensures that we make the best decisions possible for our clients.

Cameron Passmore: Speaking of decisions, Mercer Advisors recently launched an alternative program. How was that decision made?

Don Calcagni: Yeah. I think you have to go back to our investment philosophy. It's interesting. Lots of debate around this one, right? Because there's private markets. I've listened to your guys' podcasts on private markets, as well as many others. I've had no lack of advice from our public markets managers on private markets. I think, for us, it goes back to really Markowitz's 1952 paper on portfolio choice, right? We believe that there is value in diversifying across asset classes. Private markets, we believe are legitimately their own asset classes.

Intuitively, we look at private markets as adding value from a diversification perspective. I think, there's always been this desire. When I first started in his business in the late 90s, I was with the multifamily office in Philadelphia that specialized in private equity. That was really my first exposure to the asset class. I think empirically, when you look at the Preqin data, or the Burgess data, I think objectively, we know that the median returns on private investment funds generally are a lot higher than what we observe in public markets.

Now, there's lots of debate around identifying systematically. What are the different drivers of persistence and manager returns? Are manager returns even persistent? Steve Kaplan in Chicago has written on this quite extensively. I know there's lots of debate around that. What I would say is in private markets, though, by definition, trying to analyze returns on private market funds using the same quality of data that we use in public markets is never going to happen. We have massive survivorship bias in private markets, and it's not even transparent. Some of the very best private equity managers I know are extremely secretive about their returns. Their investors are secretive.

I think, trying to meet the same standards of quantitative evidence that we use in public markets, I just don't think is achievable. What do you do with that as an allocator like us? I think you have to rely on theory. I think you have to rely on the anecdotes that populate your lived experience. I think you have to rely on your network. I am a huge believer in Fama's efficient markets hypotheses, in all the different forms. If you think about the different forms that separate weak from semi-strong and strong, it's really the ubiquity of information. If you think about private markets, what really is driving value, creating value in private markets, it's that information is very hard to come by. It's not widely available. I think ironically, if you embrace the efficient markets hypothesis, it logically follows that there's value in private markets.

Having worked with high-net-worth and ultra-high-net-worth investors for the past nearly 30 years of my career, there are absolutely very attractive opportunities in private markets. From there, you combine that with over the past 10 years, have been receiving lots of requests from our clients around doing more in private markets, whether it be real estate, whether it be credit, certainly post-GFC. We've seen the rise of private credit, but private equity and venture. It's a combination of investment philosophy and client demand. Then combining that, I think, with a very obvious observation, and that is our clients don't require full intraday liquidity.

If you believe that there's a liquidity or an illiquidity premium, then it would logically follow that it would make some sense to pursue higher expected returns and broader diversification through allocating to private investments. Cam, I don’t know if that answers your question, but that's how I think about it. I always go back to, well, what's the theoretical rationale for why we would do this?

Cameron Passmore: Do all clients get an allocation to alternatives?

Don Calcagni: They certainly do not. I mean, certainly just at a very high level in the United States, we have very strict regulatory requirements that even governs who's permitted to invest in private investments. Qualified purchaser, what we call a qualified purchaser in the United States, for a natural person is 5 million dollars or more in investable assets, 25 million dollars or more for a non-natural person. Certainly, no. It's not something that we even make available to all of our investors, but it is always available to our ultra-high net worth and high net worth investors. It's really a function of liquidity. It's a function of risk tolerance. It's a function of how comfortable is the client with investing in fundamentally less liquid investments, right?

I mean, these are very long-term investments. At least 10 years for private equity. Oftentimes, it's 12 to 15. These aren't investments for the faint of heart. These are very long-lived investments for balance sheets, for families that can really forgo the liquidity. We do believe, and we've seen it empirically, that there are higher expected returns available there. Then, Cam, back to your question like, how did we arrive at the decision? Well, for the longest time, actually accessing the asset class has been virtually impossible. Fees remain high. Minimums are high for the best managers. It's a very complex asset class, right? With subscription documents and dealing with capital calls, and then manager selection, right? The dispersion of manager returns is so wide that if you don't know what you're doing, you really should not invest in the asset class.

Fast forward to how we made this decision. We actually acquired a firm from the San Francisco Bay Area that had a nearly 30-year track record investing in private investments. In fact, the firm was set up as the multifamily office for two very successful venture capitalists in the Bay Area. This was a team that when we did our due diligence, it was clear that these folks have actually identified very systematically, what are the drivers of persistent outperformance within private investments, within private investment funds?

By bringing that team in-house, our view was, okay, now we can actually help clients select the very best managers. We then subsequently set up our own fund-to-fund structures. Now, why is that important? It's important because it gave us control, gave us the ability to negotiate significantly lower fees for our clients. With our fund-to-fund structures, for example, we don't charge a management fee on those. There's no carry, there's no performance fee. Then we actually capped the internal operating expenses on the fund-to-fund structures at 19 basis points. We drove down. Because now what we're doing, rather than having 100 investors with small checks going to Carlyle or KKK, it's one investor showing up with a 25-million-dollar check. That allows us to negotiate our own side letters, our own fee arrangements, and to push down expenses.

Because we're not charging a management fee on top of our advisory fee, it really allows those savings now to follow the bottom line for the client. We get better diversification, better manager selection. We can bring down the fees and we can bring down the minimums. At the end of the day, this creates a better investment experience for the client. At least in our view, the alpha that exists there in those private investments should then now naturally go entirely to the investor.

Ben Felix: Yeah, it makes a ton of sense. I really like the way that you guys have built that out with a fund-to-fund structure that doesn't have the typical egregious fees that you might get in a fund-to-fund. Your clients are getting the benefit of the fund-of-fund, which is scale and lower costs at the manager level, but they're not paying ridiculously high fund fees. I mean, it just seems like the way to do it, if you have the scale to do it like you guys do.

Don Calcagni: I'm pretty cynical. Coming from Philadelphia, I'm pretty cynical. Most fund-to-fund schemes are just compensation schemes for GPs. Our view was, hey, if we can completely remove that layer of lard that's in the middle, now we're just delivering a great service to our clients, right? Okay, we want to invest in this asset class. How do we do it in a cost-efficient way? How do we do it in a diversified way that makes it simple, that makes the asset class accessible for our client?

Ben Felix: Yeah. Makes a ton of sense. All right, Don, what parting advice do you have for the average investor who doesn't have direct access to the type of people who attend Building Better Portfolios?

Don Calcagni: This is my favourite question because this is how you change people's lives, right? To be fair, not everybody can afford, Ben, or Cam, or Don, or Mercer Advisors. I think it comes back to three things, Ben, three things that I believe very passionately. Number one is you have to have a plan. There's lots of great tools online. Build a plan. The financial plan that you build for yourself should inform what your asset allocation needs to look like. That is the most important step in the investment process is determining, what is that right mix of investments between stocks and bonds and real estate and perhaps, other asset classes? I would definitely start with the plan.

Second is I would learn to manage the biggest risk in your portfolio, and that's us. That's the humans, right? The biggest risk in any portfolio is none of the investments. It's the investor. Managing our emotions by focusing on what we can control and really ignoring the rest. Ignoring politics. Here we are in the United States amidst a very tight presidential election. Ignore all that. Keep that out of your portfolio.

Then the final parting words of advice would be to invest in as much of the market as possible, using very low-cost index funds, or factor-based funds. Try to avoid picking individual stocks. Try to avoid sector ETFs. Own the market and stay as broadly diversified as possible. If you do those three things, 99% of us are going to be just fine.

Ben Felix: Yup. I would say, that is rock-solid advice.

Don Calcagni: Well, thank you.

Ben Felix: Awesome. Well, thanks a lot, Don. We really appreciate you coming to the podcast. This was a great conversation.

Don Calcagni: Ben, Cam, thank you so much. It's been great to be here.

Cameron Passmore: Great to see you. Thanks, Don.

Don Calcagni: Thanks, gentlemen.

***

Ben Felix: All right. I hope you found that conversation with Don interesting. I know I definitely enjoyed it. Now, we’re in the after-show.

Mark McGrath: Or the three people who are listening.

Ben Felix: Three people. People love that joke. Then they always joke like, “Oh, we're up to eight people now.”

Mark McGrath: Yeah. Cameron really likes telling that joke, I think.

Ben Felix: Yeah. Mark, you wanted to talk about the RBC options trading incident, which is just incredible.

Mark McGrath: Yeah. This news came out. When are we recording this on what? Thursday, the 10th. This would have been maybe a week ago, sometime in the past week. There was an investor who was an RBC client of some kind. I think he was a self-directed investor at a certain point, but then he was working with an advisor at some point as well. He turned, I think something like $88,000 into 415 million dollars, allegedly. He's now suing the bank for losing it all.

Ben Felix: Can we just pause for a second? $88,000 to 415 million dollars.

Mark McGrath: Yeah, yeah, yeah.

Ben Felix: It was over the course of a couple of years.

Mark McGrath: Yeah, a couple of years. I mean, annualized. It's lottery tickets, right? The way he did it was with short, I assume. He was trading options on Tesla stock. I assume he was trading very short-dated call options, which is making a bet that by a certain date, the stock price is going to go up. Implied there is that there's a lot of leverage in those financial instruments. You have to get the direction right. If you do, you're amplifying your gains by, in his case, thousands and thousands of times. He was able to pull this off, I guess, repeatedly for a couple of years and turn it into, like you said.

Ben Felix: It says, he was using put and call options. I don't know if he's looking –

Mark McGrath: Oh, interesting.

Ben Felix: Bets on both directions, but he crushed it. It's absolutely incredible. The numbers are, it’s staggering, really.

Mark McGrath: Half a billion. He was on his way to being a billionaire. How many billionaires are there in Canada? Just not that many. He was supposed to be –

Ben Felix: He’s a carpenter. He's a carpenter in Sooke, British Columbia. Yeah.

Mark McGrath: Unbelievable, that he was able to do it. Then he lost it all, 415 million dollars, poof, presumably using the same strategies. They just moved against him, right? I tell people this. I tell clients this. I've written about this a little bit, but the behaviours that lead you to gaining 415 million dollars on an $88,000 position are the exact same behaviours that are very likely to lead you to blow up your entire account like this.

I've got a friend who did this with NFTs. Do you remember NFTs? That was the thing. Monkey JPGs. He was doing it with basketball cards or something like that, digital basketball cards.

Ben Felix: NBA Top Shot.

Mark McGrath: That's right. Top Shot. Yeah. He went from effectively zero to nearly 10 million. This is a guy who never, never had money. Last I heard, he is filing for bankruptcy. Literally, the exact same thing. Went to 10 million, took nothing off the table, went for another home run and lost it all.

Ben Felix: Yeah. This guy is suing RBC, saying that the RBC advisors failed to understand and support his evolving wishes to essentially retire by liquidating his Tesla options and moving the wealth into secure investments that would generate passive income. I mean, this case as the details come out, or if they come out, is going to be absolutely fascinating to see what conversations were actually had and what advice was provided.

Dan Bortolotti: I mean, it's impossible for us to know the details, of course. I mean, maybe they will be made public during this hearing. This is really what it always comes down to is, is this a question of an investor whose greed got the best of him and now he's looking for someone to blame? Or is it truly terrible advice that he received, right? I mean, I think it's very easy for someone to say when they're engaged in speculative investing. I don't even want to call it investing. Let's just call it speculation. And to see returns like that and then say, “Well, I was going to stop once I got to X number of dollars.” If you didn't stop at 415, million or whatever it was, what would you have considered enough? We never really know.

I feel like that, and again, I don't want to comment on this specific case, because I don't know any of the details of this gentleman, or what went on. But there is a tendency, I think, for investors in general, to keep pushing as long as it's working. Then when it turns around, blame somebody else for not telling you that you should have got out when you did.

Mark McGrath: It's just that, right? I mean, you take credit for taking it from 80,000 to 400. It's your fault that you got there, but it's their fault that you went back to zero. If you're suing them, in my opinion, it should be for the original 88. Then the whole thing was their fault, right? The gains were their responsibility as well. Now, I don't know when the advisor actually entered the relationship. In this case, it's impossible to say. To your point, Dan, people like to take credit for their wins and blame others for their losses.

Dan Bortolotti: The attribution error, as they call it, right?

Mark McGrath: Right. Yeah.

Dan Bortolotti: The good luck is, well, there's no good luck. That was skill. But the bad was bad luck.

Mark McGrath: It was bad luck, right? I think it was Warren Buffett that said, don't try to get rich twice. I don't know if it was Buffett. I think it was. All good investing quotes are usually Buffett’s, so I'm just going to attribute it to him.

Dan Bortolotti: The first billion is the hardest.

Mark McGrath: Something like that, right? Yeah. He was almost there, too. 415 million. Just a couple more days of those compound returns, he would have been there.

Dan Bortolotti: Wild stuff. We'll see what happens.

Mark McGrath: Yeah. This is not the type of investment strategy that it's not repeatable. This is pure lottery ticket, pure luck-based. Ben, I think you read some papers that show that when people see these types of returns, they tend to increase risk in their own portfolios. I'm sure that people reading this going, “Oh, I could do this. It is possible. Let me try.” Please, don't.

Ben Felix: Yeah. There's an experimental paper where they take people, they let them have two trading sessions. After the first trading session, they expose some people to the results of the top people from the previous session. Then the other group does not get exposed to that. They find that people get exposed to the results of the most successful traders in the next trading session, take way more risk and are less satisfied with their own results in the second session. We live in social media. We literally do. You see the stuff like this. I mean, this story is a little bit different, because he lost it all. But you see stuff like Roaring Kitty, or I mean, I'm sure there are other people on Twitter who are posting big wins all the time that I'm not paying attention to.

People see that, and I think it does have that effect on people. If you look at options specifically, you look at the retail options market, people are not making money. The ton of studies on this. They're losing money a lot.

Dan Bortolotti: But they're not sharing their stories. Yeah.

Ben Felix: Yeah. That's right, Dan. Those people are not the one sharing their stories.

Dan Bortolotti: Right. I mean, I think crypto is another great example of that. We all know of stories of people who made astronomical returns doing it. But there's got to be a whole lot of people who lost. It doesn't have to be enormous sums, right? Just a lot of people who entered the market and lost whatever they invested, even if it was just a small amount. The sheer number of losers must exceed the number of winners by some order of magnitude.

Mark McGrath: What usually does with these types of things, right? If you look at all the really, really successful funds, the average investor loses money because they pile in after the stellar performance. It becomes famous after the performance happens and gets publicized. That's when the average person jumps in. You look at Cathie Woods funds and very famous portfolio managers. There was a Bitcoin article from, I don’t remember what magazine, and it was a couple years old now. It said something like, 78% or 80% of people who have ever purchased Bitcoin had actually lost money at the time for that exact reason. I don't know what the stat is now. It's probably a bit different, because Bitcoin was down quite a bit at that point and has come back up. Just further elucidates your point then.

Ben Felix: Yeah. Well, people have the tendency to buy after something's gone up in price and sell after it's gone down. I mean, that behaviour does not go away in any asset class. I did also want to mention that episode 325, where Mark was sick and Dan, you and I just talked through a bunch of comments that we got on episode 323, and some stuff from the Globe and Mail, too. It was like, it was a hit. People loved it. People there were like, we asked for feedback on the format, feedback was universally positive and the download numbers were great.

One of the suggestions from the Rational Reminder community was that we should do a comment episode like that once every five weeks, or something like that. One comment was really interesting. Somebody said that the Rational Reminder community is full of really good discussion, but most people, most listeners are not in the Rational Reminder community, and so those discussions just don't get seen or heard. It's a good way for us to surface some of the thoughtful stuff that comes out of the community and other places that people comment on our stuff online.

Dan Bortolotti: It was such an approachable topic, too. It's something that virtually everybody has some – well, anybody who lives anywhere has first-end experience with one of those two things. Maybe a little bit, even though your analysis, Ben, very thorough and a little academic, the decision that each of us makes is much more personal. Everybody had something to say about it. Some of the comments were very wise, I thought, and quite diverse. You had people saying that their personal experiences were the exact opposite of other listeners. It was a really nice way, I think, of getting a cross-section of opinion.

Ben Felix: Yeah, so definitely want to do more of those in the future. I like that. Like we mentioned in that episode, it was way less prep time than a typical episode. Reviews, Mark, you want to take one?

Mark McGrath: Sure. The Swagly in the US says, “Great. Keep it up. Found on YouTube first with just Ben, but really love the show. I learned a lot and new perspectives gained from listening to the show. Like, the recent episode responding to comments.” There you go.

Ben Felix: Nice. I'll read the next one. Then maybe Dan, you can do the listener mail. HPFanMD in Canada says, “Best podcast. I found this podcast in 2023 and have gone back to listen to most episodes since it started. This has truly revolutionized by financial knowledge. I'm often being consulted by friends and family for what I know about different financial topics. Cameron and Ben are truly spectacular.” They must not have listened to the more recent episodes and they didn't mention you guys. “Cameron and Ben are truly spectacular speakers. I have so many positive things to say, and I'm constantly recommending the podcast to my friends. But I can never stop laughing when Cameron says, ‘Have you seen this show, or read this book?’ And Ben's answer almost every time, ‘Nope.’ Makes me laugh every time. Keep up the spectacular work.”

Mark McGrath: Pretty much a comedy podcast at this point, ain’t it?

Ben Felix: I guess so.

Dan Bortolotti: Yeah. Let's share an email, speaking on that same theme about episode 325. This is a email that we received from a listener. Says, “My partner and I have accumulated a portfolio of 4.2 million dollars in 25 years. Very early in our careers, we contemplated trying to save for a down payment, but the housing market made that impractical. We quickly realized that we'd like the ease and the freedom of renting and very much dislike the costs and labour of home maintenance. We also value financial independence and the freedom to change jobs, or take breaks in between. While we have never moved cities for a job, it was always an option due to the mobility of being renters. We were also able to take the career risk of changing jobs frequently for ever-increasing salaries. As renters, we could keep fixed costs low and invest the savings difference, instead of throwing money away on things.”

This was one of the things that we asked people to reach out on about because we talked about this idea of labour mobility and how it can be facilitated by renting, rather than purchasing. Here's a great example of somebody who took advantage of that. Also, not specifically uprooting in order to move. This idea was always having that flexibility available to you and just leading to not only financial success but also just a more contented lifestyle.

Ben Felix: Yup. I can read the end, too. They sent that renting story, renting success story, but then, they also say at the end, “Finally, thank you for the great podcast. I've been a listener from the beginning and really appreciate how Rational Reminder and PWL Capital team take the time to listen, educate, and inform. I was happy to see Dan join as a co-host recently. Along with Rational Reminder, the Canadian Couch Potato Podcast was one of the best sources of Canadian financial content early on in my personal financial education. The team is changing people's lives for the better, mine included. If I hadn't learned about evidence-based investing in 2018, our portfolio and financial lives would look very different today.” Very nice.

Dan Bortolotti: Yeah. Kind words. Thank you.

Ben Felix: Yup. All right, so then last thing is the meetup. We did have the Ottawa Rational Reminder meetup. Mark did not come.

Mark McGrath: Why not, Ben? You cancelled me. That's fine. Let's be clear with this.

Ben Felix: You’re still on, but they cancelled. Okay.

Mark McGrath: Ben, I don’t know if you heard, I started calling Ben, Business Class Ben, because on the way back from Future Proof, I think he had a business class ticket. For those of you who don't know, Ben, how tall are you?

Ben Felix: I am 6'10".

Mark McGrath: So, 6’10". Flying economy for Ben must be just the worst.

Dan Bortolotti: Yeah. Yeah.

Mark McGrath: It's very obvious to me that if he can get an upgraded ticket of some kind and some more space, then that's the humane thing to do. He flew back from Future Proof Business Class, so I started calling him Business Class Ben. Then I was supposed to fly out to Ottawa for the meetup. At the last minute, Ben was like, “You don't need to go.” I was like, “Oh, cool. You get to fly business class and then you get to tell me that I'm not even allowed to take an economy flight.”

Dan Bortolotti: Well, how do you think he can afford to fly business class?

Mark McGrath: Precisely.

Ben Felix: Okay. I did that, because that specific ticket, it was an extra $50 to upgrade to business class. I was like, “Okay. That's worth it to be able to not suffer.” Yes. But I don't usually fly business class. Anyway, I did not cancel you, Mark. Mark said, “I'm really sick. I don't think that I should come.” I said, “Okay, Mark. If you're sick, you probably shouldn't come. That's a good idea.” Then that turned into me cancelling you. I don't know how.

Mark McGrath: I don't think that's how it happened.

Ben Felix: I'm just trying to be nice. Anyway, the meetup was very successful. I estimate, there are probably around 70 people. We were at Beyond the Pale, which is a brewery in Ottawa. Probably around 70 people came through throughout the course of the evening. There were a ton of listeners, just normal people, if we can call them normal, they're all pretty nerdy in a good way. Then there were a bunch of financial advisors that came, because it was actually a conference that overlapped, a financial planning conference that overlapped with the meetup. A bunch of people that I know from there came, then a bunch of PWL people came, my parents came. It was wild. Real party.

Mark McGrath: That's great.

Dan Bortolotti: Some people who never listened to the podcast, but just figured it was a brewery, so why not?

Ben Felix: Actually, there was one person that didn't know we had the meetup, but was a podcast listener.

Mark McGrath: Oh, really?

Dan Bortolotti: Oh, that's odd coincidence.

Ben Felix: They were sitting there like, “What's going on?” Yeah, that was interesting. One guy came from Seattle, which is incredible for the meetup.

Mark McGrath: Specifically for the meetup, from Seattle?

Ben Felix: Yeah. I guess, he's had some family who's going to visit in Boston on the trip, too. Yeah, he came primarily for the meetup.

Mark McGrath: Amazing.

Ben Felix: Dan Solon was there. He travelled from far, too. They're always fun. We'll have to do another one in Toronto, Dan.

Dan Bortolotti: Yeah, that would be great.

Mark McGrath: Need a West Coast one at some point, too.

Ben Felix: Yeah, that's true. Some people did say we got to do one on Vancouver, which is probably true. Maybe next year.

Mark McGrath: Sure.

Dan Bortolotti: World tour next year.

Ben Felix: Yeah. I don't know. Only if we can do a business class, I guess.

Dan Bortolotti: I was going to say. At least bulkhead seating.

Mark McGrath: I'll be hitchhiking. Ben will be in first class.

Ben Felix: I usually do bulkhead seating. It's a little bit more expensive, but not business class expensive.

Dan Bortolotti: Have you ever flown – well, I'm sure you have, regular economy class with your 6’10” frame, your knees must be under your nose.

Ben Felix: This summer, I decided at the last minute that I was going to go to BC. My parents and sister were going for a big anniversary event at my high school, that both my sister and I and my dad all went to. I wasn't going to go, but then I got the last-minute FOMO and decided to go. I booked the ticket three days before I was flying. It wasn't crazy expensive, but I couldn't get a bulkhead seat or even a business-class seat. I was in just regular economy in a middle seat. My knees are jammed into the food tray in front of me. Yeah. No, it's not fun. It was a four-hour flight or whatever.

Dan Bortolotti: Oh, man.

Ben Felix: I felt bad for the people next to me. My shoulders are spilling over. My knees are spilling over. I was like, “I'm sorry, guys. Nothing I can do.”

Mark McGrath: The lavatories on the airplane is supposed to be – you must avoid them. You can’t.

Ben Felix: I don’t. I don’t do it.

Mark McGrath: Doesn’t work.

Ben Felix: I just plan ahead –

Mark McGrath: It doesn’t make any sense.

Ben Felix: - to not have to do that. Yeah. All right, I think that's all we got for the episode. Hopefully, people enjoyed it and we'll be back next week.

Dan Bortolotti: See you then.

Mark McGrath: Great. Thanks. See you.

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