Aravind Sithamparapillai is a Financial Planner with Ironwood Wealth Management Group. Since becoming a licensed advisor in late 2020 Aravind has been on a mission to learn as much as he can (including listening to every episode of the Rational Reminder podcast + Money Scope)
He’s best known for:
- Raising his hand to ask one too many skeptical questions in an industry presentation
- Being an extrovert and being genuinely excited to network and meet people in the industry
- Geeking out on some technical planning topic earning the nickname “nerdavind” to some of his closest financial planning colleagues.
This combination has resulted in achieving 1st place on the February CFP® Exam as well as being awarded the FP Canada Emerging Leader’s Award for Exemplary Leadership and Innovation in the Financial Planning Profession. In his personal life he is a father to two boys and a girl, married to Mikayla who is better liked on Twitter than he is, and never seems to get enough sleep.
What happens when alternative investments shift from niche products to the industry’s go-to value proposition? In this episode, we’re joined by financial planner and self-described “pathological nerd” Aravind Sithamparapillai for a rigorous exploration of private markets, product due diligence, advisor incentives, and the narratives driving the surging popularity of alts. Aravind has become known in advisor circles for asking the uncomfortable questions at conferences—the ones that expose gaps in explanations, shaky assumptions, and in some cases, outright contradictions. In this conversation, he shares the stories and analytical frameworks behind his deep dives into mortgage funds, private credit, private real estate, IRR-based marketing, vintage stacking, stale pricing, operational risk, and why even large professional allocators get burned. We explore how advisors are selling alts, how funds are pitching them, what due diligence actually requires, how expected returns can be decomposed, and why illiquidity and “low correlation” benefits rarely play out in practice. Aravind also explains how some funds maintain stable NAVs through “extend and pretend,” how gating works, why audited financials aren’t a safety blanket, and why even top-tier firms miss red flags.
Key Points From This Episode:
(0:00:38) Aravind’s introduction and reputation for deep, “pathological” research
(0:02:23) Why alts have become embedded in Toronto’s planning culture
(0:03:38) Client pressure, advisor FOMO, and the belief that 60/40 is “broken”
(0:05:31) Aravind’s personal path into indexing, factors, and Dimensional
(0:10:46) Why he started digging into alts: curiosity, client conversations, and advisor narratives
(0:13:47) The “conference meme”: why he asks questions others avoid
(16:58) The role of intellectual honesty vs. industry narratives
(20:19) The pivotal 2023 mortgage fund story: duration, turnover, and a major contradiction
(22:51) “Extend and pretend”: how stable NAVs can be manufactured
(28:59) What “gating” actually means and why it matters
(31:48) Marketing tactics: cherry-picked start dates and chart crimes
(32:47) IRR manipulation, vintage stacking, and anchoring bias
(36:35) Why comparing gross private credit returns to net equity returns is misleading
(39:18) The problem with “low correlation” as a selling point
(41:00) Why rebalancing with illiquid assets often fails in practice
(44:58) How Aravind builds expected return estimates for alts
(47:07) Private real estate: why expected returns often land near public market levels
(48:48) A case study: apparent outperformance disappears once you match the right benchmark
(51:43) The idiosyncratic risk of overweighting single-sector, single-region REITs
(55:12) Why most advisors don’t truly understand the all-in fees
(58:00) What real due diligence should include (and why it’s so hard)
(1:00:35) Should advisors trust third-party due diligence providers?
(1:02:58) How much comfort should investors take from audited financials?
(1:05:02) Why valuation levels (1–3) matter and why most private funds use Level 3 inputs
(1:06:00) The overall conclusion: markets work, but alts require extraordinary scrutiny
Read The Transcript:
Ben Felix: This is the Rational Reminder Podcast, a weekly reality check on sensible investing and financial decision-making from two Canadians. We're hosted by me, Benjamin Felix, Chief Investment Officer and Cameron Passmore, Chief Executive Officer at PWL Capital.
Cameron Passmore: Welcome to episode 386 and Ben, we welcome a special guest this week.
Ben Felix: Yeah, today we're joined by Aravind Sithamparapillai and I have said your name on the podcast before, so people may remember. I pronounced it perfectly, I believe, this time and last time. You can correct me if I'm wrong.
Was my pronunciation good?
Aravind Sithamparapillai: You nailed it, except it's Sithamparapill-ay, not pill-ai. Everyone misses that.
Ben Felix: I was close. Aravind is a fellow financial planner here in Canada. He is one of the biggest nerds that I know and he has a like almost pathological nerdiness where he digs into stuff to the point where it's like, man, he just digs into stuff deeper than most people I've ever met.
He's done some really interesting work on alternative investments and he did a presentation on this topic at the IAFP conference, the Institute of Advanced Financial Planners conference this year. We thought we'd have him on to have a similar discussion covering kind of the same rough outline of what you talked about at the conference. You and I, Aravind, we wrote one public post together where you had done some work on the true cost of contributing to CPP.
We coauthored some stuff on that. This is not the first time we've nerded out together. You will be coming on Money Scope as well to talk about some other nerdiness.
Speaking of nerdiness. On a pension plan for healthcare professionals here in Canada. Anyway, that's enough of an introduction.
We'll jump into the questions in a sec, but Cameron, do you have anything?
Cameron Passmore: I just think it's fun to have you here, Aravind. The timing is interesting because as you guys know, I spent a lot of time talking to a lot of people kind of all over the industry and have traveled a lot across Canada and the US this fall. This topic of alts, as you guys know, our focus is and our beliefs, we share deeply.
I know you agree, Aravind. Planning matters and markets work. Markets do a good job of delivering good returns.
We believe that most people muck it up by trying to beat the markets. So many conversations with so many people in this industry are all about alts.
Aravind Sithamparapillai: That's wild.
Cameron Passmore: You're in the Toronto area. I was in Toronto this week with Ben and it sounds like, this is after talking to a number of people, alts are part of the financial planning culture in Toronto. You can't just do, God forbid, do indexing and believe that markets work.
Our true value prop is the ability to bring alts to you because 60-40 is broken, right?
Ben Felix: It's very common.
Aravind Sithamparapillai: I hear it a lot too.
Cameron Passmore: Well, you're living it, I assume. Is that true?
Aravind Sithamparapillai: Yeah. I would say not a day goes by that I interact with a planner or another advisor who is allocating to alts or thinking about allocating to alts. Even in some financial planner forums that I'm in, other people are asking, everyone around me is doing it.
Or I just saw this, someone presented this brochure about this and we'll talk about an example of a private real estate fund and it seems to be doing better than the public version. How do I think about this? From that perspective, I agree.
Financial planning is paramount, but the other side to that coin is the investments guide where you're allocating, what your goals are, how much you can save for. If you're not really thinking about that properly or you don't have a framework to approach that, then it runs the risk in some ways of blowing up the financial plan, in my opinion.
Ben Felix: I had a conversation with somebody this week as well that was really interesting. Someone that knows our space really, really well. They don't work in it, but they're intimately familiar with it.
They asked me if we're using private equity or private assets and other alternatives. When I said no, they were surprised. They were surprised because their view is that people have to, or people are using those products and those asset classes to be competitive.
It's like basically selling clients what they want to remain competitive. I was like, no, we tend to attract people that just don't want that stuff just by the way that we do our marketing and attract people. It was an interesting commentary because I think for a lot of advisors out there, and I've talked to some who have said this, that is true, where they feel like they have to offer something spicy in order to attract business.
Cameron Passmore: But in our case, Ben, there's so many people that are looking for that lower cost, probably diversified markets work philosophy that they're finding us based on the profile that we happen to have in the marketplace. When it's bank dominated, higher MER, higher expense ratio type products. That can give us lots of opportunity.
Maybe it's a different, if you're going out trying to hunt for people, we have to have a value prop that is different, indexing might win those. We have people seeking us out. We have lots of people seeking us out now.
Aravind Sithamparapillai: It's funny you would say that. Although before we get into the weeds, I got to say, just it's an honor being here. I know Dan's not on this one, but I think back in 2009, 2010, when I started investing, I found Canadian couch potato pretty quickly.
So I joked that Dan Bortolotti was my gateway drug into indexing, but then coming up in my prior life before becoming an advisor, I was listening to The Rational Reminder. So you guys are kind of my gateway drug into factory investing, but also like what advice can look like. So this is very much a huge honor.
Ben Felix: Awesome.
Aravind Sithamparapillai: I will say one thing too, like I agree with you, on people who are finding you. The reason I've kind of looked at it the other way. And so like, how do I tackle this is because exactly that, like by the nature of social media, by the nature of algorithms and the way things are dominated, you're going to have people who are naturally looking for technical advice, sort of a basic understanding of indexing, and they stumble across you like I did.
But when I think about that whole other world, the goal that we all share is that there's so much more that can be done on the advice side. There's so much more in terms of wealth that Canadians can benefit from. The people that probably stand to gain the most because of how far from where we are, they are.
They're also the ones like not seeing the social media posts, not seeing the podcast, that kind of thing.
Cameron Passmore: Couldn't agree more. They don't even know we exist.
Aravind Sithamparapillai: A hundred percent.
Cameron Passmore: They don't even know as a category we exist. But then you step into this category and you've got everything in terms of skill sets and backgrounds and investment philosophy and you post about this very frequently, but all the things that you see in your day-to-day roaming around the industry. I saw your post, I think it was today on LinkedIn talking about it.
Aravind Sithamparapillai: I said this at IFP. Someone asked me about this and I said, honestly, I saw my clients, like some of my best, biggest clients. Someone's going to show up on your doorstep one day and they're going to tell you Aravind is lazy or the way Aravind is doing things, there's a better way to do things.
I've heard other advisors say, oh, we get you access to different investments. If that's not the value proposition, then doing this work at least gives me an edge because my clients know that I've done enough homework to tell them why not. That helps create walls, not just around me and my clients, but my clients when they're in those positions.
Ben Felix: You're building a practice, trying to attract clients. Do you find that you're coming up against people who are demanding this or wanting this or not willing to work with you because you're not offering alternative asset classes?
Aravind Sithamparapillai: The question has come up a couple of times for sure. What is interesting though is as the tide turns and when you talk about gating and when you talk about some of the other things that are happening in the news, what I'm also seeing is people who are getting burned are now realizing it. One's been twice shy.
One or two conversations I'm having are actually where the pendulum is swinging the other way and people are saying, oh, this happened to me or my family, my parents, me, whatever the case is. This isn't all it's cracked up to be. One, I would say as the pendulum shifts, being on the forefront of talking about this, explaining it in a way that they understand can probably help, but I have totally come across or people have booked with me based on a conference I've spoken at or whatever the case and then they are a little bit surprised or disappointed.
Earlier in my days, I think like two years into the business, I had someone who had a review with me. We did an intro fit call, then they came back for the plan review and they had gone to a bank and a bank had showed them all these different funds that they were going to invest in and it's going to be so exciting and amazing. And then I couldn't even get to the plan.
They were like, I just want to know what you're going to invest in. And it was like, done. They probably not a fit on my side, but they hands down were like, oh, I'm not interested then because I really want to invest in all this stuff that's going to be amazing and make me a lot of money and all of those things.
To some degree, that was kind of the beginning of the, okay, if they don't understand, I got to figure out how to attack this problem in a way.
Ben Felix: We've had that too. I mean, I said earlier that we attract people that don't want that stuff, but we have definitely come up against cases where somebody did want that and we were just like, well, it's not what we do. This is why we don't think you should do that.
And like your example just now, they've said, well, this other guy's offering me whatever, 60% in private equity and I want that. You want that, there's not much we can do for you. We do a bunch of questions loosely based on the talk that you did at IFP.
I want to jump into that. We've kind of touched on it, but just to set the stage for the discussion, can you describe what your investment philosophy is and the philosophy that you use with your clients?
Aravind Sithamparapillai: I'm a big factor enthusiast as well. Now I will say that a lot of that came from having listened to the rational reminder for a very long time before becoming an advisor, but having studied indexing and then hearing sort of the theoretical underpinnings, it made a lot of sense. Now, I do use DFA.
I think a lot of people will then ask, okay, well, there are other ways to do this. And so I would say that it's important to understand that it is a market's work. Indexing generally works.
And then some of these extra factors or theoretical premiums potentially make a lot of sense combined with thoughtful execution, like the tax efficiency components that you both have talked about on the podcast before. And so it's really understanding all of that in a wrapper and then saying, okay, holistically, does it make sense? But for a client who is very purely market indexing based, I don't have an issue with that because we're already 80% of the way to what you need to be able to get planning returns.
But if you ask me what I hold, and I did write a sub stack post on this where I shared my own personal portfolio, and you can see that it is almost 98% DFA.
Ben Felix: The theoretical piece is big. And then the execution, of course, is huge. You and I were nerding out and Cameron and I did on a recent podcast episode too about the capital gains refund mechanism and how efficient that makes mutual funds in the way that Dimensional uses it in particular in Canada.
Cameron Passmore: So Aravind, what got you interested into digging into alternative investments?
Aravind Sithamparapillai: I think twofold. First, we spoke about when someone or a couple of people say to you, hey, I don't know if I want to work with you, because this feels very simple or very lazy. And I kind of know in my head that I've done some of this work.
And then you see other advisors all around you. And it's funny, if you spend enough time in this space, you realize that they're all kind of pitching the same alternative funds. Like the same fund shows up at a bunch of different advisors books, or in a bunch of different dealership conferences, or fund co-conferences.
So all of a sudden you start realizing, oh, wait, it's not that different. Like what this guy over here is saying, this advisor over here is saying. So I was like, okay, my gut is that probably people aren't doing the work, but you can't really stand out there and say, oh no, my way is better.
And then have no proof or no ability to challenge it. And so having asked a few questions of other advisors, I realized I wasn't actually getting answers around how they do due diligence, what goes into the due diligence process. And so for me, this started to raise the light bulb of, oh, I think everybody is kind of doing it because everybody else is doing it to some degree.
So if I can go a different angle and at least do enough work so that when clients come to me and say, why aren't you allocating to these? And I can say, here's as far as I got, and here's all the red flags. Has this other person shared with you the risk, the reward, the potential?
And then they say, no. Then at least I have done enough work to sort of plant those seeds of doubt or uncertainty in what everybody is claiming is a bulletproof process.
Cameron Passmore: So I'm curious because you're probably closer to this than we are. Are the alts part of their value proposition or do they view kind of the investment solution in a box like we might? It just happens to be a different box.
Aravind Sithamparapillai: I think there's both. So I have met and recently having gone to a lot more conferences this year than ever before, I have met a ton of advisors across the spectrum. So the same level that Ben and I or you and I, Cameron, geek out about planning, I've been in conferences where advisors are coming to me and we're talking about a very, deep cross-border nuances, complexities, et cetera.
But they also have in their investment mandates and allocation of a higher percentage to alts. I would say that that is less common. And what I see a lot more of is people who are like investment sort of experts, or they claim to be investment experts first and access to alts or a unique, different idea of investing is part of that value proposition that they're sharing with clients.
Ben Felix: Among our group of friends, Aravind, there's this meme that we share, that's a picture of you at a conference with your hand up. Because you sit in the front row and when there's someone presenting on whatever, their alternative fund or whatever it is, you put your hand up and we joke about how they must just be like, at this point, now that they know the tough questions you ask, people must be kind of shaking when you put your hand up. Why do you think you ask questions that other people just don't?
Aravind Sithamparapillai: First, I feel like we should get that and put this in the video, because I want to see this meme.
Ben Felix: We will.
Aravind Sithamparapillai: Look, if I had to be honest, and I think this applies not just to investment methodology, this is applied to the way I've approached planning, even the way I approach sort of the discussion around hoop. And Ben has seen me ask these questions or the taxation of mutual funds. It's to be honest, it's like, perhaps I have a reputation now for asking one too many questions, but if I see something that doesn't check out, or it doesn't make sense, or maybe I just don't understand, I can't not want to know the answer.
Ben will distract me sometimes with a question. I'll be working on something. I'll be like, great.
There goes an hour because Ben asked this question. But that's the thing, is it always came from sort of this curiosity of, like, I don't know the answer. And being in this industry, like when I found this industry, this was a second career.
Both of you already know that about me. I'd always been on the search for like, what is it that I can be sort of this top 1% or like the thing that I can do really well and enjoy? And so now that I found it, a lot of those questions kind of stem from curiosity.
So when someone says something, like, you know, it's not correlated, or the duration is super low, which we'll talk about, because the question and this reputation kind of came back from a 2023 presentation at IAFP. It started with me just asking a question, thinking everybody else knew the answer. Like, that's what always happened in the first four to five years of this career, is I assumed everybody else knew the answer.
And I would just ask, thinking that it was going to be like a very easy, like, oh, yeah, this is the textbook answer. You just don't know this yet. And then they would give me sort of this runaround answer or wishy-washy answer.
And then I'd say, wait, no, I don't understand. Can you explain it again? Or can you explain it differently to me?
And then people started getting annoyed with me. And then I realized, oh, oh, wait, it's because they don't necessarily know how to explain it, or they don't know the answer. And then that's when I started to realize that a lot of the narratives and a lot of these pieces that are kind of discussed at a surface level, those second and third order levels of thinking that I'm trying to get down to so I can make sense of the whole logic, people aren't doing.
So it honestly just started with curiosity or just a desire to figure out finance in some degrees, like math. Yes, you can't predict the markets, but discounted cash flows have a valuation theory and a formula. So to me, it was just like, oh, there's a formula I don't understand.
So someone teach me this formula. And then I realized that's not actually what's happening.
Ben Felix: I would say that the people you are asking those tough questions to who didn't have the answers started to get annoyed, but the other financial planners, the other people that were at the conference, hearing you ask those questions, they liked your questions enough that they invited you to give this talk at the conference in a later year.
Aravind Sithamparapillai: I mean, that's what happened. A handful of people, actually a fund co-manager, like a fund manager also came up. And it was funny because that fund manager said to me, it's funny because we're not allowed.
There's like an unspoken code across the fund managers. No one's going to dunk on anybody else's presentation or tell you where somebody else's bodies are buried. But he was like, it was kind of fun watching you pick up on something that so many other people haven't or wouldn't or whatever the case is.
And to Ben's point, a lot of people did come up and say, well, how did you put that together? Or how did you know? Or it was so cool because I wouldn't have known what to ask.
Cameron Passmore: Is this ultimately why you were committing so much time to this space was really not aligned with our shared investment philosophy?
Aravind Sithamparapillai: Yeah, like twofold. One, it was just like a desire to understand, candidly, Cameron. So I love indexing.
I love factors. But I also do find that in general, there's a lot of people who are like, it works. And that's it.
I don't have to sort of think through the nuances of indexing or factors. It's kind of like that IQ meme, like on the low IQ side, there's everyone who's like, oh, I just index. And then in the middle, it's like the overthinker who's like, well, you know, you got to do this.
And the PE ratio is here. And then over here, you got the Jedi who's also like, I just index. Like when Ben and I talk, it's like the Jedi saying, I just index.
But you also know why you're indexing, what you're thinking about, the nuances, how you're explaining it to clients. And so I would say across the industry, there's probably sort of that range. And so for me, yeah, it doesn't necessarily align.
But I couldn't just turn my brain off and say, hey, it doesn't work. In general, it doesn't work because some podcasts say it or the academic evidence says it. I had to still understand at a deeper level, like what are the numbers and how do they connect together?
That kind of play out to like why it doesn't work. And so probably a waste of time. But to some degree, it's worked out for me just in terms of having fun.
And I would also say that anybody who studies this space, you get a better understanding of businesses and how they operate. Reasons business owners might sell. If private equity is going to buy a business or something like that, you start to get a little bit more of an appreciation for people on both sides of the table, what's happening in the industry.
And to some degree, I would say that that probably plays back into how we all run our business as well.
Ben Felix: I don't think it's been a waste of time. I mean, you're here talking about it on this podcast and you have been invited to speak about it at other conferences. So I wouldn't call it a waste of time.
And it's important work, man. Like it's hard. You say, okay, I want to understand the formula, the equation that explains how this product works.
And you start digging into it, trying to understand that. And it's really hard because it's not made easy to understand in the way that they do their marketing for sure, which I would even go as far as saying is often misleading. But even in their reporting and their financial statements, you can't just sit down and read through that and be like, oh yeah, okay, I get this product now.
It's really not that easy.
Aravind Sithamparapillai: No. I remember actually someone on a due diligence committee, I was asking them some questions about one of the funds and they were like, hey, if you've gotten through the financial statements, you should probably go back and check the legal structure. And then they had shown me how there's this piece owns this piece, this piece owns this piece.
And then they had kind of highlighted where they saw some gaps in the legal reporting structure. And I was like, hadn't even thought about that operational piece and the risks associated with that. So there's just so many layers to thinking through it that the default answer I have in a lot of cases is you're kind of like an individual advisor or an individual planner allocating.
Do you have the capacity? Is that your core strength to be able to allocate intelligently?
Ben Felix: Even then, man, there are examples and I think we have a question about this later, but there are examples of funds and of firms who have said that their expertise is in identifying good alts managers who have put stuff that blew up in other products. I don't even know if that just applies to individual advisors. This stuff is objectively hard to understand and there's a lot of, a ton of idiosyncratic risk.
How has your nerdiness on this topic filtered through to the advice that you give to your clients? We understand that you use dimensional and you believe in indexing slash factor investing, but have there been cases where you might have otherwise allocated to something based on it being marketed to you or your firm, but you decided not to because of your nerdiness?
Aravind Sithamparapillai: So this is a great time to kind of bring up the 2023 story. So we're at IFP. Anybody who hears this or remembers this will know, because this is sort of the first time.
This is like one of the first times I've been in a conference, like a investor conference, because I came into the industry during 2020, like during COVID. So people didn't really know me other than my online persona. And so there was a private MIC, a mortgage investment corporation for anyone who doesn't know the lingo.
Mortgage investment corporations, think of them as like a private debt fund. They're lending to people who can't get a mortgage at a bank at a higher rate so that they can buy some property. And so what ended up happening in that presentation is we're in late 2023.
So for anybody who can remember that period of time, we had just gone through ultra low interest rates in 2020, 2021, 2022 interest rates start taking up. By mid 2023, the Bank of Canada overnight rate had gone up four or even 5%. So the reason I bring this up is, again, from like a theoretical underpinnings perspective, if you think about credit risk, it's always going to be some premium above like a risk free rate.
When they had shown when this MIC showed their 22, 23, and then forecasted 24, 25 returns, they had only shown over that period of time that the forecasted return was going to increase by about a percent. So it would have been consistently like six or 7% the entire time. And so now 6% looks great back in 2020, 2021, when mortgages are sub 2%.
But now that mortgages are hitting 5, 6% at a bank level, the question in my head, if you think about credit, and you say, okay, so these are borrowers that can't get mortgages at 5% at the bank. So shouldn't there be like a commensurate extra risk rate on top? And so I put my hand up and I said, I don't understand what happened.
Why is the rate not going up? And then the fund company said, Oh, well, it's because the mortgages haven't turned over yet. And so if you have a five-year mortgage, you lock in that five-year mortgage at five or 6%, then you won't renew into that higher rate for five years.
So in my head, I was like, okay, I mean, I guess because you would think that maybe there would be like some percentage of them renewing every single year. So you would see these ticks. But I guess anyone who's watching the video will see like my face looks kind of doubtful.
And it's that thing of like, Oh, I guess that's the right answer. But I don't know, but I'll believe it. And then somebody else in the audience puts up their hand.
And then they asked a question about the stability of the fund because the actual unit price doesn't move. It's just the interest is distributed. So the unit price would stay at $10 consistently.
And so they asked about, well, how do you maintain such a stable NAV? And then the presenter, I think kind of forgot what I asked and slipped back into sort of sales mode. And then turned to that person and said, Oh, it's because our loans are super stable.
And they're super short duration, super short term. In fact, the average duration of our fund right now is under two years. So then my head should back up.
And so this is where everyone laughed because that presenter saw my angle up and then mumbled accidentally, Oh, no, into the mic. So a bunch of people in the audience heard that presenter say, Oh, no. And so for anyone who doesn't know what we mean by duration, duration is this idea that if you have like a pool of loans, so a bond fund or something like that, which Ben, I know you and Dan just talked about duration and bond funds in a prior episode.
If your duration is under two years, then what they're essentially saying is we actually expect this whole portfolio of mortgages to basically all renew in two years. So that means that when your forecasted return over 24 and 25 is basically the same, but you expect the whole thing by 25 to have flipped over into these new higher rate mortgages. Something is off there.
It doesn't quite make sense. So my hand went up. And so I asked the question and I said, I don't, I said, this is the thing.
I wasn't trying to catch them in a lie or just want to understand. Yeah. I just, I didn't get it.
So I put my hand up and I said, I don't understand if the duration is under two years, but you just told me like the mortgages haven't turned over. I don't quite understand how this works or why we're not seeing those increases. And so what they admitted then on stage was that they had been extending the loan at the same terms.
They hadn't been renewing any of the loans to current owners at higher rates. So I pinned them down afterwards, again, out of curiosity to say, I don't like, why would you not? And so what came out was the areas they were lending to the geography and the buildings that were being purchased had fallen by more than 30% at that point in time.
And so they loan at a loan to value of 70%. So what that means is if a building was a million dollars, they would lend you 700,000, you put up 300,000 of capital. The building value falls more than 30%.
That building is now worth less than 700,000, which means if the owner can't make the payments and they default and you seize that building, you still don't have enough value in the building to sell and get your entire loan back. So here's what gets interesting, Karen, because of that stability of the nav piece. So what happens is everyone thinks that a default, you know, automatically is a triggerable event, so on and so forth.
And that's true. But if there is no default, if you extend, so this is the term I learned in the industry, extend and pretend. If you extend the loan at the same rate, and don't increase it, because if you increase it, you know, this business owner, this person who's already kind of struggling will likely not be able to pay that higher interest rate.
So if you just leave it at the same rate, you know, under the hood that the property has fallen more than 30%. But you just keep making the payments. It's a non marketable event.
Nothing has changed. So you don't have to restrike the nav. Now, on the other hand, if you increase the rate, and then they default, and you seize the building, you have a triggerable event, which then requires you to mark down your nav because the value of the building is not enough to pay back the loan.
So by extending and quote unquote, pretending, you can pretend that your nav is stable, and everything is fine, and let things go on as they will. So that blew my mind, I would say sort of like the first like, oh, wow, what is on stage and what is said is not necessarily always going to be the whole story. Also, to my original point about the formula, I now understand like a framework for thinking about real estate and real estate lending, and then term risk and credit risk and how all those pieces come together.
So what then happens is as 2024, almost a year later, a fund shows up at our office. And most of our office knows how I think about things. But in general, sometimes I'll sit in these meetings to kind of take a look or understand.
And so it was a mortgage fund, specifically lending to real estate lending to real estate owners and operators. And so what was interesting is I'm sitting there and in general, I'm, you know, kind of listening, but I'm not going to allocate. So why spend too, too much time.
And then the fund salesperson says, Oh, and our loans are all ultra short duration. So that's one of the ways that we keep the fund stable, and we keep it safe, and we try to make sure. And so I hear that, and my mind goes all the way back to the 2023 presentation where someone told me that the loans are ultra short duration.
So then I pulled up the marketing literature. So now we're So now we've had enough time where if I look at the duration, and I see the interest rates, in theory, I should see that these rates are climbing over time. The rates were not.
And so I asked the question, why are the rates not going up commensurate with these interest rate increases? You know, a couple people around the table were like, well, maybe they're trying to be conservative in their assessments or whatnot. And I was like, I just want to hear what he has to say.
This is my thesis, though. And I said, here's what I saw from another fund. Can you corroborate?
Can you say why the rate is not increased? And the fund salesperson kind of laughed awkwardly and said, you know, it makes a lot of sense when you say it like that. But the answer is, I don't actually know I can get back to you.
And he never got back to me. So people around the table are like, wow, that's great. This makes a lot of sense.
We probably shouldn't do anything with this. And nothing happened to that fund for almost a whole year. And then this year, earlier this year, that fund gated. So you can still be right.
Ben Felix: Hold on, hold on. You got to tell the listeners what gated means.
Aravind Sithamparapillai: For anyone who understands mutual funds or ETFs, they're fairly liquid. You know, in a mutual fund, you sell the fund back to the fund company, essentially, and then you receive your cash. And there is a one or two day transaction period, and then you receive your money.
In the case of alternatives, or what are often called OM or offering memorandum products, where there's a whole bunch of extra legalese, disclaimers, things that they can do that don't sit inside of the typical landscape. One of them is they can arbitrarily decide to essentially lock or prevent you from redeeming your units for your cash. So that sounds nefarious on the surface, I think it's important that everyone remember that alts are often things like you're investing in private debt, where you've secured a five year loan or private real estate.
So now you have a bunch of big buildings that you can't just fire sale, private equity, if you have a business, a large private business that you now aren't selling for a few years, because you're in the middle of a turnaround. You know, in the olden days, you didn't get your money back as a pension fund or something like that you gave it to them with the knowing that they were going to only give you that money after they sell it in five years. So now with a lot of the public or retail versions available where they say, hey, we offer monthly or quarterly redemptions, they still have provisions where if there are too many redemptions or some issues, they can essentially reserve the right to lock or gate the fund.
And so in this case, that fund specifically then gated. Now we don't know whether it's gating for good reasons, maybe there are some things that they're doing that are appropriate or whatnot. But to me, that was a sign of two things.
One kind of dodged a bullet, again, based on, you know, taking one lesson from credit, and really a lesson that we learned from the basics of your CSC or the wealth management essentials. And now applying sort of the same factor framework, understanding credit risk, and applying in the private world, but also that you could be right about something, and then still look wrong for a whole year, because nothing happened to that fund. It's seven-ish, eight-ish percent rate of return still persists, which sounds great for a private debt fund relative to public bonds.
So you could be right, and then still have everyone think that you're crazy for a very long time before the fund gates or the crows come home to roost.
Cameron Passmore: Gated sounds so much nicer than locked, doesn't it?
Arvind Sithamparapillai: Yeah, or just arbitrarily not handing you your money back.
Cameron Passmore: Okay, so Aravind, I want you to take us kind of give us a front row seat. Ben and I don't get a lot of pitches, if any, in the offices, but I know many firms have kind of a parade of people pitching alts. You talk about the different ways that they market their funds?
Aravind Sithamparapillai: So I think the first, and maybe like the most, like, hey, there's no data integrity, but it's still a chart crime, is you'll see a lot of illiquid alts often pick a start date right before some public equity crisis. So you'll see like a lot of funds, and they'll start in like 08 or 07. So then you have equities take a sharp dip.
And then you have the illiquid alt kind of cruising along at a steady pace. So it looks like it's outperforming over a certain period of time. The data is all correct.
They're posting whatever their stated returns are, but they've picked a start date, such that you kind of hit the worst, you start with a 50% drawdown. So you're basically giving the fund a head start, in some sense. And so that doesn't necessarily give you a clear picture of the risk and reward of equities versus an alt.
I can talk about a few others. But any questions about that? Or anything to clarify for the listeners?
Ben Felix: Oh, makes sense. What else is there?
Aravind Sithamparapillai: IRR, I think is a standard one. So you all have talked about this on the podcast before. After hearing, I think Ben talk about how early returns and IRRs can skew later performance.
I actually went and played with like, what happens if I had like an amazing IRR in the first couple of years from like a fund distributing and then sort of playing it down the line. And I had to know, it blew my mind.
Ben Felix: I did the same thing when I read about that, obviously.
Aravind Sithamparapillai: This is why we get along. But what's crazy is knowing that, and then you see a lot of fund marketing, and they'll sort of advertise since inception IRRs. And so I realized, then you start to read some of the fine print related to those IRRs.
And you realize a couple of different things are stacking up in those IRRs. First is sometimes they're aggregating IRRs across vintages. So it's not even necessarily the same fund.
It's like, hey, you know, based on these three vintages. And so I showed a case study where, or not a case study, like I created like a fake example of you could have three vintages where you had one IRR that was insane, like 30 something percent. And then they use that as marketing for the next vintage.
And even though the vintages subsequently have worse and worse returns, your since inception IRR after three vintages were the last one, I think delivered an IRR of 5%. Your since inception return was still 16. So you can now take a since inception return going back 10, 15 years of 16% with the fine print saying, you know, spread across three or four vintages.
And now you can market that and say, like, look, we have these awesome returns. And we know that past performance doesn't necessarily indicate future. But you have to know that under the hood.
And I think Ben has already talked on the podcast about the academic literature around anchoring and the fact that IRRs still kind of create an anchor bias for advisors and investors. So that's IRR. The other one that I find fascinating, but has happened a few times, is using benchmarks of alternative asset classes to say, hey, look, they're equivalent or better than other public market returns, without baking in what the actual fees and net fee return would be.
So I saw a firm put up a private credit benchmark against the S&P 500. And it was just gross returns. It was in a webinar, I couldn't, it was one of those pre recorded webinars.
I was watching it because this large firm is, you know, available to the retail public. And so I had a couple of my clients who are active on social media, so on and so forth, and kind of just asked me about this, which is why I watched the webinar. So we have private credit and S&P 500 average returns over the last 15-20 years of like nine ish percent without going the extra step and saying, well, you can buy the S&P 500 for single digit basis points.
The fund that this company went on to then pitch has a 1.5% fee and a 15% performance fee above a hurdle of 5%. For anyone who doesn't know what hurdle basically to say, hey, the first 5%, we won't take a performance fee on. But after that 5%, if we outperform, we're going to take 15% on that.
And this is at tail end of 22, beginning of 23, where you could buy T-bills for basically 5%. So again, when you think about the whole idea of credit risk, and we're just going to lend to people who can't borrow already at 5%, you're not really earning performance fees, you're just getting a fee on the additional risk that you're taking to some degree, but none of that is disclosed. So again, to the average person comparing benchmark to benchmark, it kind of looks great.
And it looks like you're getting this correlation benefit or non-correlation benefit because some years the S&P 500 is going to do well, some years private credit is going to do well. But once you take out those fees, all of a sudden, your nine and nine don't look so similar anymore.
Ben Felix: It's crazy, man. And it's not as easy as like, there's so much data for public funds now that everyone kind of gets it that most funds have underperformed. And you can go and find a really easy to understand report showing that to be true, or an academic paper, like it's just the information is out there.
But for private funds is not the same. There's a few papers looking at it. We had Mamdouh Medhat from Dimensional on recently, he's got a paper looking at private fund returns.
And he basically shows that if you benchmark against a risk appropriate public asset, the public market equivalence, like the outperformance relative to that public benchmark, they tend to be really small if they exist at all net of fees. But that information is not out there for everybody to see. So everything you're saying, I agree with it.
But I think it's really hard for the average advisor or retail investor to go and find information to say, what are the base rates for this asset class? Should I expect this thing to outperform on average? I think usually the answer is no.
But anyway, we can talk more about that. Anything else to say on this one?
Aravind Sithamparapillai: The only thing I would say is it's work to even understand the benchmarks. That's the other piece.
Ben Felix: Right.
Aravind Sithamparapillai: Even in understanding that piece and when I wrote, because Ben, I think I had sent this to you, because you had asked me for this report, because someone else had asked your team for it. And to then say, okay, so this is private credit, but what element of private credit? Because even private credit as an asset class, there's so much happening there.
There's maybe people who need a mortgage, but can't get it from the bank. Then there's mezzanine debt, which is like, hey, you don't have asset backed debt, you don't have any real estate to secure. So this is going to be even worse from a risk perspective, because we can't seize anything.
And then what's the actual credit rating of the borrower? So as you look at private credit, there's just so much in that space of what are you actually benchmarking to? And then you have to look at the firm that's doing the benchmarking, because none of this information is so readily, easily available, that it's proprietary data to some degree.
I remember speaking to that benchmarking firm, because they were at FutureProof, and telling them that I saw their benchmark being used in this webinar. And it was great that they released it for people like me to read and study. And they're like, yeah, that firm actually never licensed that benchmark from us.
So we have to have a conversation with them about it. They'd already known about it by this point, because public webinar and everything like that. To that point, it's so difficult to know what you're getting into.
And I would say, it's probably not worth most advisors time, unless you're kind of crazy, like me, and you do it out of curiosity. But to get to the same thing at the end of the day, which is like, markets generally work. Do we really want to incur taxable events or pay higher fees for an uncertain future return?
In most cases, most clients don't want that level of detail that I've done.
Ben Felix: What do you think about the low correlation argument for private assets?
Aravind Sithamparapillai: A couple things. Let's start with the assumption that low correlation is a benefit, and it does actually exist. Even if it did, you have to manage it somehow.
You can't just hold the asset. You can't just hold two different equities and non-correlated private debt in their individual constituents and then just let them grow. Part of the non-correlation benefit comes from rebalancing, selling whatever is done well and is a larger share of your portfolio, and then buying into the thing that's relatively lower.
Can you do that with a lot of the restrictions, or if a fund happens to be gated, or if you're trying to do it on a very quick timing basis when they have maybe a six-month, a quarterly, or an annual redemption process? COVID is a great example. 2022 is a great example.
Public markets are down, and we have an opportunity to rebalance, to quote-unquote take advantage of this non-correlation benefit, which in 2022, I saw so many posts on LinkedIn and online about, oh, this is why you should hold non-correlated assets, so on and so forth. Then the question becomes, cool, were you able to sell? Could you sell in a timely manner to get the cash to then rebalance back into volatile markets?
That incurs two problems. That's the timing, and then there's behavior, because at the end of the day, you're now making an active decision, and you're telling your clients, hey, we're going to sell this thing that's done really well to buy into falling markets, which everybody hates, and it's so tough to pull the trigger on. You're doing that, and that's at the retail level, where it's liquid in, quasi-liquid out.
One of the arguments that will then get posed is, yeah, but if you're doing it at an institutional level, so if you're managing it on a per-deal basis or direct with those larger tickets so you can strip out some of the fees, well, then you're dealing with what are called capital calls. For anyone who doesn't know what a capital call is, they don't take all your money at once. When they say it's a minimum of a million or a minimum of 10 million to invest in the fund, what they're saying is, we're going to do 10 deals at a million dollars each.
We're not taking all 10 million from you at once. When we find a good deal, then we're going to get that million from you. Now you have another element of project management around, how do I keep this cash?
What do I do with it in the meantime? If they're going to take it over six months or over a year, how do I invest it appropriately? When they call it, where am I pulling it from?
So on and so forth. Even if the non-correlation benefit is there, and then you make a commitment to then allocate to some of these funds, how are you managing the timing of your portfolio such that you can actually take advantage of this diversification benefit? And so that's if the non-correlation benefit is there.
I would also say, and you talked about this literally on the last podcast episode, around the fact that a lot of it is some type of stale dated pricing, or really once you take out the smoothing of returns, the underlying assets or the underlying industry, sector, geography, whatever the case is, there's a lot more correlation there than you expect.
Cameron Passmore: So before investing in alts, Aravind, how important is it to come up with some sort of expected return?
Aravind Sithamparapillai: I think it's paramount because you have to understand, what is it adding to your portfolio? So if you believe there's a non-correlation benefit, I mean, that's great, but non-correlation at the cost of or at the price of what?
Because as an example, we talk about cash and bonds as somewhat being like a diversifier or a non-correlation benefit to equities. But we also accept that to some degree, we're reducing the long-term expected return and we're pricing that in for projections. So in order to say that there is a benefit, the benefit to me has to be, well, commensurate with these risks, illiquidity or whatever the case is, I'm getting a better return or maybe similar return, but non-correlation benefit or lower risk or whatever the case is.
But again, if you can't actually derive an expected return for this asset class that you're investing in, then you have really no way to actually gauge or assess whether it's adding anything of value to your portfolio or if it's adding another benefit, net of return, what is the cost to your overall expected return of your portfolio? And from a financial planner perspective, I raised this point at the conference too, because from a financial planning perspective, forward-looking projections and assumptions, like Ben having sat on FPCanada for I don't know how many years now, helping them make those asset class assumption guidelines, we use those because we're trying to do two things. One, we're trying not to under or we're trying not to overestimate returns and then leave clients in a position where they don't have enough money to achieve all of their goals.
But in line with finding and funding a good life is, you've talked about many times on the podcast, if you're understating returns, so if you're using standard FPCanada assumptions, and then you're saying, hey, but I'm going to allocate to these other illiquid asset classes because they're going to provide a higher return, or they're going to provide a non-correlation benefit, which then from a rebalancing volatility perspective, you'll have a better long-term return. If you're understating your returns, then are you depriving your clients of the ability to truly spend more during years where it might benefit them?
And so that applies to act management, that applies to alts, etc. If there is a portfolio benefit that meaningfully improves returns, well, then shouldn't that be part of your expected return assumption that you're baking into your financial plans for your clients?
Ben Felix: When you've looked at these things in the past, how have you approached estimating the expected returns of them?
Aravind Sithamparapillai: It's tough. I will say that you have to think about every asset class individually based on what is the asset, how does it grow, so on and so forth. The way I broke it down, and I don't know if this is in a textbook anywhere, but trying to come up with a formula that I could use, what I said is we can start with the gross return of the asset class, because in general, you can either derive it, figure out a discounted cash flow, the fund company might have some models around that.
So start with the gross return of the asset class, add in the impact of leverage. So both scaling up whatever that extra return would be based on maybe borrowing and buying at a two to one ratio, deduct the cost of interest, and then deduct other fees and performance fees. And then you can add in an adjustment if you feel it's in your skill set for sort of manager efficiency operations, alpha, whatever the case is.
And to me, that way, if we break these pieces out, even if we don't necessarily know like the manager alpha, or whatever, like we don't have that long standing relationship. And when you figure out these pieces, which everyone can generally kind of agree helps us paint a picture of the asset class and what we're going to get out of this fund, you potentially detracts or whatever the case is, what are we starting with here that justifies investing in this. So that's kind of the framework that I've now started to approach a lot of these with is how do I just strip it out piece by piece and starting with that gross asset class, and then adding in all of these pieces actually helps turn it from this big chaotic mess into something where you can isolate and look at each piece and sort of test out the assumptions a little bit more rigorously.
I can walk through Ben, if you want, I have that case study that I shared at IFP of looking at private real estate as that example, based on a fund that I had sort of reviewed at the time.
Ben Felix: No, I think the way you explained it is good. I think going through numerical examples probably too much for all of our audio listeners.
Cameron Passmore: Touche. But I'm curious, you've looked at some, how did their, the private fund expected returns, net of fees compared to public markets?
Aravind Sithamparapillai: I mean, they ended up at roughly the same spot. So one private real estate fund basically borrows at two to one. So for every dollar you put in, they're going to borrow a dollar, take $2 and invest in real estate.
When you net out the expected return of real estate right now, you can use any sort of like public benchmarks or real estate broker firms or whatnot to talk about where you see apartment buildings, etc. And then scale it up, account for interest, and then account for management fee and performance fees, you kind of end up in that like 80% range. So now I'm looking at a private real estate fund and saying, the expected return, maybe is 8%.
You know, you got to be somewhat conservative, because we know we're not precise with these assumptions. What don't I know? Because have I studied this enough to really know that every single fee I've accounted for, because there are many, and I know there's a question later, there's many different levels of fees that you can incur.
And have I got this right, that 8%, which relative to a full equity portfolio right now, is six and a half, seven ish, maybe. So all of a sudden, this 1% premium, but 1% doesn't really feel like a very big premium for all of the uncertainty and then the extra illiquidity, the risk of gating all of those pieces. You know, in my mind, we're basically kind of back to a public equity style public markets portfolio in terms of expected rate of return for the risk, not just in up and down volatility, but all of the other operational pieces that we haven't thought about.
Ben Felix: Can you talk about the one example where the private fund had outperformed a public REIT index, but when you looked at the component of the public fund that was actually comparable to the private fund that they performed was similar?
Aravind Sithamparapillai: Yeah. Someone had posted in a financial planner forum and one of our mutual friends had tagged me in the forum because he knew that I had actually studied this private REIT specifically. And so it was a Midwestern residential REIT.
Specifying Midwestern residential private REIT is important because the person who had asked the question said, hey, they're comparing this private REIT to one of the standard low cost, it might have been Vanguard, I can't remember for sure, but they've been comparing it to one of the standard low cost REIT ETFs. If we start and we look, well, the REIT ETFs have a variety of geographies, and sectors. So we're talking industrial, office, residential, storage, etc, etc, etc.
And across the country, whereas this single private REIT is just Midwestern. So we're talking like Alberta, that kind of thing. It's not really fair to take that and then compare it to this broad diversified behemoth.
Now inside of that REIT, though, there weren't many, but there was a single public REIT that had similar exposure, mostly Midwestern, all residential, they had some other geographies too. And so when you actually compare it, so the reason that this planner had brought this question up is in general, that REIT ETF had declined over the last couple of years, whereas this Midwestern REIT had been going up. And so their question was, is it really good?
Is there something shady here? What's the question? When you peel it back, and you looked at that single Midwestern residential REIT inside the ETF, it had also been positive over that period of time.
And so when you compare those two, you realize all of a sudden, oh, REITs as a whole, sure, gone down. But this Midwestern residential area seems to be very geography specific, it's doing all right. Now, that private REIT, they get outperformed by a couple percentage points per year.
But when you look at that general trend, all of a sudden, you're back to this is actually performing very much in line with a public equivalent. So now I'd have to get really deep into the granular details of how are they pricing? What do they buy it at?
What's the strategy to understand some of the nuances to say, is one actually legitimately better than the other?
Ben Felix: This has come up for us recently too, where a lot of those private funds are comparable to one REIT inside of a REIT index, like the example that you just gave. But then it becomes, it's like taking a stock in the S&P 500 that has outperformed the index and being like, oh, well, this is a good company. But it's one company, you're adding a whole bunch of idiosyncratic risk.
One individual REIT has a ton of single company risk, just like a stock would, even if it has a bunch of properties underlying it. And it's just hard to look at a diversified benchmark and compare it to a single holding. And you can find ones that have done well for sure.
But like you just explained, do you go and pick it apart and figure out, did it do well because it's a well-managed private REIT, or because it happens to be in this area, this sector, whatever, that has done well recently?
Aravind Sithamparapillai: Exactly. Now, do you want me to dive into the sort of like, this was the context of where I said, hey, if this outperforms, maybe if this outperforms, do we want to actually allocate to it? Because I think it's an appropriate time to take this and carry the story further.
So to that point, I kind of look at it as, okay, fine. Looking at a private REIT like that is to me no different than saying, okay, I'm going to roll up my sleeves and do like a DCF and a deep dive on a single company in the S&P 500, or Canadian stock market, whatever the case is, for the purposes of stock picking. You now have to actually know what you're doing to assess this as a single individual business.
In this case, there's a modest outperformance. So let's assume that we want to replace this public version of the Midwestern residential REIT with the private version. The question becomes, what percentage are you allocating?
If you generally kind of believe in efficient markets, or you generally kind of believe that market cap waiting to some degree across industries, etc. works, then REITs, specifically Canadian REITs, I think accounts for like 2% of the world. I think it's like some small percent of Canada, I think REITs in like most portfolios account for like two or 3% of the world.
And so Canada has a 30% weight in the portfolio means that if you want your Canada REIT waiting to be somewhat similar, you're not going 30% times two or point six. But the Midwestern piece, that tiny little sliver, depending on the benchmark you use, is as low as like point one 5% of the portfolio, or point two nine, again, depending on the two benchmarks that I reviewed in Canada. So I'm going to go through all this work, maybe have like a 1%, 2% outperformance relative to the appropriate public version.
And I'm going to put a quarter of a percent in my portfolio. And then I'm going to rinse and repeat this over and over and over again across a whole series of privates. To me, like the juice isn't necessarily worth the squeeze, then at least not at a small individual level.
And that's assuming that I got all of this analysis right, in the first place, and then accounted for illiquidity, taxation impact, like with CGRM and mutual funds, you're now deciding, hey, like some of the tax benefits that we get from keeping everything sort of all together, I'm choosing to unwind that and make a more expensive process, a bigger, more involved thought process. So the outperformance like really better be worth all of that extra work that we're going to put into allocating to the portfolio.
Ben Felix: I would give an inverse perspective on that too. I agree with everything that you just said. But the other way to think about that is that if you're putting enough in your portfolio for it to be worth it, like you're giving a 10% allocation to this one REIT, you're dramatically overweighting in this case, Midwestern Canadian real estate in your portfolio. Why?
Aravind Sithamparapillai: Exactly. That's the piece. If you say, because I've seen people who've held this and they're talking about having like 5% allocations.
What exactly is the thesis? Is it Canada? Is it real estate?
Residential? Midwestern residential? Where was your overweight perspective across all of those allocation decisions to get down to the point that you decided that this was what you were going to add 5% or 10% to?
When you ask that question, most people's faces just kind of look at you like, I have no idea how to answer that question.
Ben Felix: All those subcategories you just went through, each one of those has its own significant amount of idiosyncratic risk.
Aravind Sithamparapillai: Exactly.
Ben Felix: On fees, how well do you think people understand the total all in fees that funds are charging in this space?
Aravind Sithamparapillai: The reality is I don't know if anyone outside of the fund providers really truly understands it. I've read them and sometimes I'm still like, wait, I think I missed one as I go through the list. I would say most advisors, to be honest, I don't think they are.
Because if they were, then this whole expected return, net-of-fee return discussion wouldn't be so groundbreaking. Even as I presented it at IAFP, I had people coming up to me and saying, that's an amazing framework. The way you thought about that is amazing, which is great.
But if you think about the fact that if you knew fees and you knew your expected asset class return, it would be pretty easy to derive an expected return. My guess would be the most or not, I might be getting into trouble by saying that, but that would be my initial assumption or my initial hypothesis.
Ben Felix: It is interesting though, right? You did what to you is the basic level of due diligence to understand the equation or the formula as you described it earlier. How does this thing work?
Then you present that to a group of your peers and everyone's like, wow, this is groundbreaking work. But you're like, isn't everyone doing this?
Aravind Sithamparapillai: In fairness to IAFP, from a planning perspective, this probably isn't. And even for your firm, I would say your advisors who are working with clients at the ground level, you have an investment committee, you've got Ben, the CIO, who's reading academic papers left, right, and center. So the reality is, there has been a bit of a choice to segment out the duties and responsibilities.
So it may very well be that the investment committee has a framework or a process for this, and it hasn't necessarily made its way all the way down to the planner level. But the point that I would sort of push back on planners is, unless you're like explicitly advice only with no sort of referrals to other firms or whatever the case is, you're just kind of there sort of like reviewing, maybe generally talking about asset classes, getting paid a fee and then walking off into the sunset. Even if you're outsourcing to a third party, or you have like a referral arrangement to a firm, you're kind of implicitly endorsing what's happening.
And if you're managing an ongoing relationship, you kind of bear that client relationship when things work or when things don't work. If you're creating asset class assumptions, or you're saying, hey, based on a projected rate of X percent, you can or cannot hit your goals, you have to save more, or you can save less. All of that to me means that as planners, even if we're not directly managing the investments, if we're kind of adjacently touching it, then we have a responsibility to understand some of these pieces, which is also why I can't let it go to some degree.
Ben Felix: Which should be, and it is, people should be following the regulation, know your product, you should know your product. There's a difference between what you're doing and I think what often gets done or what would pass as know your product, due diligence.
Cameron Passmore: So what boxes need to be checked as part of that due diligence process for advisors that do want to use these kinds of products?
Aravind Sithamparapillai: At a base level, do you understand the asset class and can you derive and expect a return? Do you understand some of the operational mechanics that are going to go into dealing with all of this? That just touches upon its application in the portfolio.
But I had attended a due diligence session at a conference in the US. They had two CIOs of like large multi-billion dollar firms that are almost exclusively private asset firms or allocate very heavily. And they were talking about not just how you have to look at the asset class returns and like sort of the pure financial piece.
But when you're making allocation decisions to managers, again, just like investing in a business, there are all of the other operational pieces. So they talked about things like, does the firm have like a good AML process or anti-money laundering? Do they have operational controls?
Do they have cash controls? Do they have director's E&O insurance? Are they following all of the required rules around reporting on a regular basis?
And what kind of tech stack do they have for communicating with their investors, communicating with the constituent funds, so on and so forth. And that made me realize, as easy or as surface level as it sounds, it made me realize like I've never thought in any of this, my default has been open up a financial statement, read numbers. So I've never really thought about all of the other applications.
But that's usually where, to some degree, that is where like things blow up. Cash controls, fraud, etc. It all happens there.
It doesn't necessarily happen in the financial statements. Additionally, they talked about background checks and this one blew my mind. So these are firms that are, again, multi-billion.
They have tons of pitches. And they said that for the people that make it to that shortlist, so somewhere between 10 and 30 a year, they'll do a background check on the fund managers. So hire an investigator, so on and so forth.
And they said that pretty consistently, there's something in like one to three fund managers passed, whether it's a bankruptcy, whether it's another fund that blew up, whether it's allegations of even like harassment, sexual assault, things like that. So their sort of ending point on that was when someone tells you like, oh, like all of our checks have never turned up anything, or they're not necessarily forthcoming about who they're hiring, who they're firing, or not hiring and why, it's there. You have to look for it. So that was also really eye-opening.
Ben Felix: I mentioned this earlier, but that all sounds hard. There are some firms that specialize in either creating funds or outsourcing due diligence on alternatives. Do you think that is enough for an advisor or a financial planner to just say, well, no, they did the work. I don't have to understand this.
Aravind Sithamparapillai: This is a tough one because it's also really arrogant for any of us to say, hey, like I refuse to trust the watchers. Like it is in some sense, I would say arrogant for me to say, well, I'm doing a good enough job saying it's in the too hard pile. And therefore, I'm not going to trust a firm who says this is our specialty, this is our expertise.
But I think there's two pieces. Actually, I would say there's three probably right now at this point in where the trend has gone that people should be aware of. The first is that we've seen funds with issues.
We've seen private investments blow up at all levels of third-party firms. We had FTX, which was owned by pensions as an example. And the legal structures and all of those pieces, the fact that they were trading and was it working, was it not?
Like it wasn't assessed properly. And we only found that out after the fact. So from the top down, we can see that there are firms who their job is to do that, and they haven't necessarily done that.
And the second is in Canada, specifically, the regulation between Canada and US is so different. I think the OMs for a lot of funds that I've seen in Canada, so the offering memorandum, which is the financial statement, plus all the legal disclosures, it's maybe 60 to 100 pages. But there was one fund that I stumbled across once, and they're cross-listed.
So you could buy in the US or Canada. And so to save on fees, time, whatever, they basically just added the Canadian addendum to the US piece, so they could just distribute one document. And what's crazy is it's like 400 pages, because the US version and all of the regulations and the disclosures are like, hey, when we charge a fee, this is how the fee gets paid.
If the fund does this, if it goes up, this is how the fee gets docked. If the fund goes down, this is how the fee gets docked. So that also made me realize that the level of detail and disclosure is so different.
So what level are we assessing at? And then third and finally, I think a lot of firms are inundated. The demand is there, like Cameron, you said, in Toronto.
So now imagine that you have more and more dollars chasing a hypothetically exclusive asset class. And so if you want to grow, you want to collect those fees, you want to shove those dollars somewhere, you either have to loosen the restrictions on who you're allocating to or the deals you're partaking in, or turn away dollars. And that's a really tough place to be.
Cameron Passmore: How much comfort do you think audited financial statements should give investors in these private funds?
Aravind Sithamparapillai: We've seen the big four, we've seen auditing firms get sued for private funds that have blown up. And that's not to say that, no, you can't trust auditors, but I think you have to take the statements for what they are, like a starting point. You know, not only have they been sued for maybe not catching controls or maybe the reporting hasn't been tight, but for anyone who's looked at sort of the underlying assets of a lot of these illiquid funds, there's like a, in terms of what they call like the fair market value assessments, there's a level criteria, level one, two, three.
So a level one is when they say, hey, this is like a publicly traded equity. There's like a current daily value for it. So this would be like when you review Berkshire's investment statements and you see Apple on there or whatever the case is.
There's a public price, you can directly link the public price. So you can kind of get a fair value for it. Level two and level three are basically decreasing levels of transparency or further remove links from a true public market proxy.
So level two, remember to search correctly is, you know, there's recent reportable transactions or something like that. So you can get a rough gauge, kind of like how we would look at real estate. And, you know, if your realtor says, hey, you know this, you have a three bedroom house, the three bedroom house down the street sold for X.
So we can roughly ascertain that. And level three is that there are one or more inputs that can't actually be fully directly verified from the accounting firm. So then you're relying on like a discounted cashflow or a valuation assumption or something like that to draw what that value is.
So in that respect, you also have to understand that there are assumptions being drawn into the financial statements. And those are all now backwards looking. The question is not just about, can we trust the financial statements?
It's what do the financial statements actually tell us in terms of today's price relative to the future? So you then still have to go back to, if I believe what I see in the financial statements and if the fees line up to what I see being docked, okay, I still have to determine whether this is the right price, whether the expected return is appropriate, so on and so forth.
Ben Felix: That's all the questions we had. I think that was a great discussion. As we've been talking about, it's a space that's hard to understand.
It's hard to look at. And then a lot of people just aren't looking at it. But the problem is they aren't looking at it and they're still allocating it.
Aravind Sithamparapillai: I think that's the challenge. I do want to be clear about one thing. There are likely, there are probably very good firms doing very good due diligence and there are likely good alternative funds out there.
I know you guys have talked about it. Like the fund that's doing well doesn't want your money. The fund that wants your money, you probably should be wary of.
But it's like, can you do the work? Can you do the due diligence? Can you look at performance fees?
I think the one quick example from a number standpoint is I looked at three hypothetical case studies where the average return of the 10 deals would be 10% on a 20% performance fee. But then I started spacing out the variance or the spread in return. So everybody achieved 10%.
A bunch achieved 20, like five achieved 20 and five achieved 10. Five achieved 100% or whatever the number would be. And then five went to zero.
And so what people don't realize is performance fees are one interesting example where they take the fee on the winners. They don't rebate the fee on the losers. And so as you spread that variance out, those big, big winners, you can actually take so much of a fee from those big winners that you end up as the investor net negative because you've lost money here.
And then you gave away so much in performance fees. And I know that on the podcast episode you just had, they talked about Venture Cap being one of those where there's a lot of those where you see this big variance with a lot of the funds actually being net losses. And so to me, that made so much sense when you started thinking about, oh, well, Venture Cap is, one becomes the unicorn that becomes XYZ tech company.
The rest go to zero. Oh, great. If the rest go to zero and I get to take a 20% or 30% performance fee on that, I can now start to see how investors lose.
And so how do you ask those questions? How do you determine how the fees are being paid? I think most people can.
I think some can, but it's really finding the funds and what is your due diligence process for doing it. And I think for most people, that's going to be far too difficult to do properly.
Ben Felix: Yeah, the performance fee thing. We talked to Zahi Ben David about that when he was on a while ago. He has a paper looking at hedge fund fees for that.
I don't remember the exact numbers, but directionally it was like, it goes from a little bit less than two and 20 as the sort of contractual fee to something like a little less than two and 50 as like actual fee that most people are paying because of what you described, because you don't get credit for losses, but you pay the full performance fee when you have big winners.
Aravind Sithamparapillai: I think it might have been Cliff Asten. I heard him on a podcast and he said, there's no investment that has such a great return that it can beat a high enough fee or something like that. Basically, there's a fee high enough that it can turn an amazing investment into a terrible investment.
Ben Felix: Right. Well, it's like that. We also talked to Ludovic Falopu about this, about how basically private equity managers have added a ton of value before fees, but the managers have mopped up all the value for themselves and there's been very little, if any, left for investors.
Aravind Sithamparapillai: You know what? I think, Ben, you and I were talking about this, right? You got to assume to some degree that you don't necessarily know all the pieces in the equation.
And so that's what I come back to is I'm just here on sort of like a mission to ask the questions and try to figure it out. But I would say where I've defaulted to is more and more, the more I study it, the more I'm like, so far, there doesn't seem to be an efficient way to allocate in a transparent method that gives me reassurance that I'm not blowing up my client's money by doing this. And so to that degree, I care.
I invest my client's money the way I invest my own. And so if I can't necessarily look that fund and say, I think I'm going to incrementally gain something by adding it to the portfolio, net of all the work, fees and risk, it doesn't make sense to me.
Ben Felix: And to your point earlier, it's worth reiterating. It doesn't mean that there aren't good private funds out there, that there are bots, there are smart people running them. It's just a matter of doing the work to identifying them and having a degree of confidence in what you're allocating to, understanding what you're allocating to.
That's the disconnect we're talking about. It doesn't mean that there aren't, there isn't good stuff out there. It's just, can you find it?
Is it worth trying to find it? How much of a difference is it actually going to make when you adjust for the risks that you're taking? All that kind of stuff.
Aravind Sithamparapillai: I would add one piece too, and this comes back to Cameron's point at the beginning. As planning focused people, what you have to ask is the papers that you've done on dynamic corporate compensation, that to some degree has been groundbreaking in terms of giving a framework for thinking about corporate compensation. So for everyone who says, oh, we're awesome at due diligence, allocating the alts, doing all that stuff.
And don't worry, we got the planning on lock too. Well, if that was the case and they would have produced a paper, a dynamic corporate compensation, or as we're talking about with MoneyScope, studying pensions and studying who. So as much as I want to say like, yeah, everybody can do everything.
Like I see it in practice. So as the client or as the end investor, what matters to you? Potential, theoretical, half a percent or 1% out performance? And what is it coming at the cost of taxes, planning?
Ben Felix: Man, it comes back to something that we've said so many times in the podcast. You've got to focus on the things that you can control. Adding value through optimal corporate compensation or we've been doing some work recently with corporations on asset location.
And those are things that like, they'll much more reliably add value than picking the best private fund.
Aravind Sithamparapillai: Totally.
Cameron Passmore: But for so many practices, financial planning is a throwaway, right?
Aravind Sithamparapillai: True.
Cameron Passmore: It's a cost center either to generate sales or to close business in so many cases. Sell insurance policies.
Ben Felix: We talked about this, Cameron. We do planning so hard for lack of a better way to describe it, that it's probably detrimental to us as a business. We could be a much more profitable business if we didn't plan so hard.
But we, like Ervin said earlier, we can't help ourselves.
Cameron Passmore: But it's the right thing to do, right? People are relying on you and the stuff matters. 100%.
And in so many places that, in the industry, you talk to the different people and there's no planners on the team or it goes into central planning. Some person at some desk that just goes into a pipe and kind of comes out the other side. That's not a real planner.
We know the person.
Ben Felix: Or you're just getting a financial planning projection and that's the end of the so-called planning.
Aravind Sithamparapillai: I think a lot of financial planning, you could kind of double up retirement projection in place of financial plan because a lot of what I do see is that. I'm not saying that's necessarily a bad thing if that's what you as the client or you as the investor want. But most of the time, they're showing up and saying, tell me I can spend X in retirement or tell me I'm going to have this amount of money when I retire.
And that's super important. But then once you start talking about inflation, taxation, the types of clients that we all work with who aren't just focused on will I have enough to retire, but how do I set my kids or my grandkids up? Or if I have a business, if I have a corporation, am I managing this corporation properly or am I paying far too much in taxes?
That is far more all-encompassing when you start thinking about the legal implications, the tax implications. So to Cameron's point, sending it away to a central place to input some numbers and some projections doesn't necessarily help hit on all of those other personal, emotional goals they may have. I think industry is changing.
I think people are waking up to it. But to that point, those people that are starting to realize what they want are so far removed from where we are today that finding out how to bridge that gap is something that I still remain obsessed with.
Ben Felix: Getting the end client to know this is what is right as opposed to the shiny thing that promises a 20% IRR, even though that means nothing, that is hard to communicate. It's really interesting to think about the point that you're making, I think, which is that really good planning is hard. It's objectively hard.
Due diligence on alternative investments is objectively hard. But the place where we can much more reliably add value is the really good planning. If you have limited resources and limited time, you probably can't do both really well.
So where should we focus our time? And that's basically why we end up where we are.
Aravind Sithamparapillai: Kitsis said recently, or not recently, he was at this conference in the summer I went to, and he was speaking to next-gen advisors. And one of the questions was like, how do I find the right firm? So on and so forth.
How do I find a fit if I care about planning? And he said something that I think is really interesting that really hits home on what we're wrapping to here, which is, is like, I kind of see a bifurcation in the market eventually. You'll have a small sleeve of firms who are they'll come up with like a niche idea for investing or some very specific investment solution, you know, pursuing our performance, so on and so forth.
And then you'll have sort of the broad majority in some type of vanilla index or index like diversified, et cetera. And they're going to focus on really good planning and however they can execute or add value or differentiation there. Now he was saying that as advice for next-gen advisors, like think about where you want to end up.
If you care about planning, then you should be asking questions that help you ascertain both sides of what they're doing there to figure out where they're allocating those resources. Because if you're at a firm that is spending a lot of time on the investment side, they're probably not spending a lot of time on the planning side from interviewing back as opposed to just blindly finding a job. That was his advice.
But it also made me realize, and Cameron, I know you've been talking about this for the last year or two, like the landscape is changing, being at the forefront of planning, explaining that markets work as people wake up to that, being at the forefront of that curve, I think is a really cool place to be as people wake up to what they're not getting.
Ben Felix: All right, man, this has been a great discussion. We appreciate you coming on. It's great to hang out and chat.
Aravind Sithamparapillai: It's an honor. Thank you.
Ben Felix: Great to see you, Ervin.
Disclaimer:
Aravind Sithamparapillai is an Investment Advisor with Aligned Capital Partners Inc. (“ACPI”). The opinions expressed are those of the author and not necessarily those of ACPI. This material is provided for general information and the opinions expressed and information provided herein are subject to change without notice. Every effort has been made to compile this material from reliable sources however no warranty can be made as to its accuracy or completeness. Before acting on the information presented, please seek professional financial advice based on your personal circumstances. ACPI is a full-service investment dealer and a member of the Canadian Investor Protection Fund (“CIPF”) and the Canadian Investment Regulatory Organization (“CIRO”). Investment services are provided through ACPI or Ironwood Securities of Aligned Capital Partners Inc, an approved trade name of ACPI. Only investment-related products and services are offered through ACPI/ Ironwood Securities of Aligned Capital Partners Inc. and covered by the CIPF. Financial planning and insurance services are provided through Ironwood Wealth Management Group. Ironwood Wealth Management Group is an independent company separate and distinct from ACPI/ Ironwood Securities of Aligned Capital Partners Inc.
Disclosure:
Portfolio management and brokerage services in Canada are offered exclusively by PWL Capital, Inc. (“PWL Capital”) which is regulated by the Canadian Investment Regulatory Organization (CIRO) and is a member of the Canadian Investor Protection Fund (CIPF). Investment advisory services in the United States of America are offered exclusively by OneDigital Investment Advisors LLC (“OneDigital”). OneDigital and PWL Capital are affiliated entities, however, each company has financial responsibility for only its own products and services.
Nothing herein constitutes an offer or solicitation to buy or sell any security. This communication is distributed for informational purposes only; the information contained herein has been derived from sources believed to be accurate, but no guarantee as to its accuracy or completeness can be made. Furthermore, nothing herein should be construed as investment, tax or legal advice and/or used to make any investment decisions. Different types of investments and investment strategies have varying degrees of risk and are not suitable for all investors. You should consult with a professional adviser to see how the information contained herein may apply to your individual circumstances. All market indices discussed are unmanaged, do not incur management fees, and cannot be invested in directly. All investing involves risk of loss and nothing herein should be construed as a guarantee of any specific outcome or profit. Past performance is not indicative of or a guarantee of future results. All statements and opinions presented herein are those of the individual hosts and/or guests, are current only as of this communication’s original publication date and are subject to change without notice. Neither OneDigital nor PWL Capital has any obligation to provide revised statements and/or opinions in the event of changed circumstances.
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