Episode 114: Bellmont Securities’ Michael Block

 

Full Transcript of the Podcast

Transcription of Episode 114 of the [i3] Podcast, Conversations with Institutional Investors

Wouter Klijn  00:15

Hello and welcome to the i3 podcast “Conversations with Institutional Investors”. My name is Wouter Klijn, and I’m the Director of Content for the Investment Innovation Institute. For more information about our educational forums for institutional investors, please visit our website at www.i3-invest.com There, you can also subscribe to our complimentary newsletter. I3 Insights in which we discuss investment strategy and asset allocation questions with asset owners from around the world. Now, as you all know, we love our disclaimers in this industry, so here’s ours. This recording is for educational purposes only. It does not constitute financial advice and is intended for institutional and wholesale investors only. Please enjoy the show.

Welcome to the I3 Podcast. I’m here today with Michael Block, who is the chief investment officer of Bellmont securities. Michael, welcome to the podcast.

Michael Block  01:25

Thanks, Wouter, thank you very much for having me.

Wouter Klijn  01:27

So I think you’re pretty well-known in the industry, but maybe just to set the scene a little bit, can you take us back throughout your career, and you have had a lot of different roles in both large institutional organizations, but I think you also have had teaching roles. Tell us a little bit about how it started.

Michael Block  02:05

A lot of people, when they see my CV, they think it looks very disjointed and very wacky, but there is a common theme, and that is that at all times, I’m just a nerd with a PC interested in investments

a long time ago, in a galaxy far far away, actually, in a country far far away, but even when I was in Australia. And just so you know, I was born in South Africa, from a very early age, I knew that I only wanted two things, which was to have lots of children and to work with investments, and this all started when I used to go and visit my father’s office, actually just a stone throw away from your office, Wouter in 19 to 31 Pitt Street, okay? And in the office next to his was a stockbroker, right? And this is before the internet, so they used to let me sit in the research room and look at documents, and I would pour through the chart books and the annual reports. And when I was by Mitford at 13 years old, in 75 I got a bit of money, and I bought some stocks. And the interesting thing is, I’ve never, ever been able to repeat that investment performance. Which stocks Did you buy? I bought four stocks, all of which were taken over. One was called Burley Hestia. Another one was Carlton United Breweries. Another one was called Collins and Leahy holdings. Little did I know that the rules that I was following were basically those that Benjamin Graham and Warren Buffett follow. Which was asset rich companies trading at a very low multiple and with a good dividend yield, and they were all taken over at huge premiums. I thought this game is easy, and then later on, I learned that it isn’t because voucher. If it was as easy as everyone would have you believe, I’d be in Monaco and I’d send you a postcard.

Wouter Klijn  03:40

Yes. And I don’t think you would recommend four stock portfolios today. Would you?

Michael Block  03:45

Actually? I might.

Wouter Klijn 

Oh, why is that?

Michael Block

Well, it all depends what you’re trying to do, but I do have a friend who does have a four stock portfolio, and I highly recommend that if it is part of a balanced portfolio, it’s okay. So for instance, if you have 80, 90% in the index, and you have a bit of money in a one, two or three or four stock portfolio, that makes lots of sense. Hello, miles. But you know, that’s why people, I think, make the mistake that, you know, we live in a world now with regulations that make people make investments that make no sense at all, and I’ll speak a little bit about that later. But as I said, you know, always knew I loved finance, so when you look at some of the jobs, they look crazy, but they were the same thing. So these include being the treasurer of the university. But guess what? I ran endowments. I ran, you know, I was learning about whether we all want to be like Yale and invest University endowments in an illiquid world with no constraints, pretty much how the future fund does it. Today, I went to work in Papua New Guinea, which was a super fund, but obviously very different rules and regulations, because in. Papua New Guinea, anything other than cold hard cash is like private equity, because, you know, as the largest pension fund in the country, we had no liquidity whatsoever. Then there was working at Bellmont securities. It’s pretty normal. It’s a wealth management firm, and our main value proposition is to make advisors more efficient by providing with great managed portfolios. But here are some of the weird ones. I worked as an analyst for the government, so yeah, I did some of the fancy law enforcement associated things, but at the end of the day, I was just looking at financial data and seeing is the money leaving Australia to go here, there, and how is money laundering take place, and how is drug trafficking being financed, things like that. But still, just looking at finance.

Wouter Klijn

That’s a different type of due diligence.

Michael Block

A whole different type of due diligence.

Wouter Klijn

You have any exciting cases in that?

Michael Block

Yes, I did. I had lots of things. Some of the fun ones, I can tell you, is I got to see and be involved in some high profile arrests. And my favorite one was once a bikey gang was raided by the National Crime authority, and I got to see the things they confiscated, which included drugs, money, guns, but most of all, a computer and a live alligator, really, lots of complicated things,

Wouter Klijn  06:29

yeah, how do you how do you transport that away from the crime scene?

Michael Block  06:34

Well, you don’t, but basically, I love that role. I loved working in all the jobs I’ve done because I’ve learned so many things that were important along the way. University learnt how to manage endowments. Papua New Guinea learnt a lot about frontier and developing markets. At WorkCover, learnt about insurance, accounting and all the regulations they’re in, like large and now, then two roles in Super learned about managing super funds and now in private wealth,

Wouter Klijn  07:07

Yeah, and I think your involvement with the university as well still shines through a little bit today, because I think you do a lot in sort of education for People coming into the industry, but also continue education for you know, everybody that has been in the market for a long time, and I saw also that you have a passion for finance and economic history, and look at how these trends have developed over time. There’s a little bit of a teacher in you.

Michael Block  07:40

Well, I’m sure there is. My mother was a teacher. Okay, my daughter is a teacher. Every woman I’ve loved has wanted to be in a caring profession, whether that be teaching social work University. My wife still works with universities, so I think that’s an interesting thing. So deep down, I think wanting to give back is a calling, and I’m very keen to do that. I know it sounds a bit cheesy, but whether that be helping young people, mentoring people, you know, the greatest accolade I can have is that people who I’ve worked with have now gone on to achieve in the outside world. These are people like Chris Drew at Rest, John Phokos at Coolabah, you know, makes me so proud that a they wanted to work with me more than one occasion. And secondly, you know, just what they’ve achieved, and they didn’t come from traditional backgrounds, right? You know, there are people like John Phokos started off life as a math teacher, so I’m totally open to thinking outside the box. And working at the University is an extension of that. We run a fund called the anchor fund and a course called student managed fund, which teaches students how to set up an endowment fund at the end. It actually involves live money, and it’s a practical course. I only wish that a course like that was available when I was studying, because it teaches so much different things, and I can make it sound a whole lot of different ways, but I have a lot of fun because I get to invite some of my friends to come and do guest lectures, not just Chris and John, but Jason Collins, who’s now The Australian head of Blackrock and so many others. Thank you to all of you. I’m sorry for not naming you all, but I really appreciate your generosity. And the students get to learn in a whole different way, and I hope what it will lead to is that our graduates will be preferred over other non practical courses that is already happening. Watch this space, and you’ll see that some of our graduates are getting some of the plum jobs. Then, of course, later on, I’ll say, Well, you know, I helped you out. Now, how about you give a donation to UTS? But it is working Wouter. I mean, UTS is now the most popular business. Course, in the country,

Wouter Klijn  10:00

that’s great. That’s great. That’s very good. So I thought the idea behind this podcast was to use that, that involvement with the anchor fund, to basically go over some of the investment principles and some of the lessons that you’ve learned during your career. So maybe with the anchor fund, can you explain a little bit, what was the background to that? How did it come into existence, and how do students get selected for this?

Michael Block  10:24

So first of all, it takes the 15 best and brightest students at UTS so it’s highly selective. It’s not unique in having a course like this, because Sydney has one. Anu has one. Hello, Jeff. He was a great professor. Warren was a great help to me. We worked together in the past, so we’ve known each other for a long time. But the idea is, what is unique about UTS, instead of just being a course that helps you how to pick stocks or do investment analysis, this helps you go from go to whoa in setting up an endowment fund, working out what your objectives are, how to set a strategic asset allocation, how to do all the paperwork, the compliance, what instruments you use, and at the end of the day, hoping to invest live money and getting to see what you do.

Wouter Klijn  11:13

So how much do these students know about investing when they come to the fund? Because I think one of the most powerful concepts in investing, I think, is compounding interest once you sort of understand that, you understand why you would invest for for a long period of time. But of course, there’s a whole bunch of other things that come with it, like mean reversion, just the asset allocation. How much do they know about investing?

Michael Block  11:37

They know a fair bit, but not everything. So remember, we’re selecting the very best students. UTS and a lot of them are doing a double degree, whether that be in engineering and finance or law and finance. So they all have a background in finance. They’re generally fantastic in modeling, investment analysis and coding. So compound interest, no problem. Mean reversion. They may not have heard of, and that’s one of the things that we try and teach about when mean reversion will occur. As you know, I’m a devotee of mean reversion. I think it’s a strategy that is time tested and will always work, to buy low, sell high. The only issue is, how do you know what low and high is? It’s a little bit like benchmarking. As you know, my favorite joke is Wouter we meet for a cup of coffee. You say How is Liz?, my wife and I say relative to what? So it’s a very difficult thing, but after having just written something just today about my magical roadmap with all the 45 years that I’ve learned, what does it tell you in an endowment fund at a university or even at Bellmont, we are able to implement these in a much better way. You may remember that Teik and you allowed me to run a series of presentations at Terrigal called “The Graveyard of Good Ideas”. There are some fantastic ideas out there that a super fund simply cannot do, or an investment fund simply cannot do because of regulations, benchmarking or other ideas. But they make sense. A very simple idea was, if I asked members in a super fund, would you be prepared to accept a lower return and having your downside protected, in other words, portfolio insurance of some sort. Most members say: “Yes, I would”. Nearly no super fund can ever implement it unless they’re, of course, they’re a defined benefit super fund or a non APRA regulated super fund. This is a shame. It’s a disconnection between the ultimate end user for whom you’re meant to be preparing the funds and what you do. So at Bellmont, we’re able to do these things.

Wouter Klijn  13:53

Yeah. Is that why you chose the endowment? Endowment model? Because in Australia, of course, the superannuation fund options are probably the most common form of investment. Fund endowment allows you to do a little bit more less constraints. Is that why?

Michael Block  14:11

Partly, so I’d love to portray it that I was at the top of my game, and every choice was mine, and Michael block decided to move into private wealth because of all the options available. But it’s not like that. Partly I’m the kiss of death, the last two super funds I’ve worked at have merged: Australian Catholic Super into Unisuper, and Mine with TWSuper to form Team Super. And as a result, I found myself in a world where super funds were consolidating. Not everybody wants a CIO like me. There were less jobs anyway, so partly it was Michael now has to look for a different path. And. And partly it was, believe it or not, I knew Bellmont because my ex wife is their compliance lawyer. Okay? And it’s always a good thing if your ex-wife gives you a reference, isn’t it? Anyway. And so Bellmont, I think we’re forward-thinking, and were willing to listen to some of the ideas that I have a very different from the rest of the world. And I’m sure when you know I outline my playbook, you’ll see why, because they certainly give better outcomes for the clients, but they may not give better outcomes for the BDMs or the platforms or otherwise. And there’s commercial interests at stake all the time,

Wouter Klijn  15:42

Yeah. So what are some of the key differences between your role at Bellmont, which is, you know, a private wealth role and sort of the institutional space where you spent most of your career?

Michael Block  15:51

Well, probably the two key differences are that Superannuation is highly regulated and you are constrained a super fund of the future will look massive and passive, and the your future, your super performance assessment, and the benchmarks that go with it are here to stay. And I understand why that occurred, but it really limits what you can do. I believe it’s a terrible piece of legislation in the way it’s implemented, not in what it’s trying to do at Bellmont. We do not have those constraints. We can recommend as long as it’s got an Australian unit trust and can be put on the platform. We can invest in it. The only problem is that the way that you do things is much more difficult and glacially slow. So let me give you a real live example. At Bellmont, we decided that we wanted to put some currency hedging on our global equities, something which in 2001 when I was at the University of New South Wales, was one of the greatest DAAs or tilts that I ever implemented at Bellmont. We had to do it in one way, but here’s how we do it. In a super fund, I’d ring up my friends at National Australia, bank, currency services. I’d say, Please change my hedge ratio, two bips, three seconds, done. In a wealth management firm, because of the way we were set up, I had to sell a large amount of bonds, wait until the money became available. Buy the ETF that was hedged global equities. Sell the AUT, the unit trust that was unhedged global equities, wait until the money became available anywhere between one and three weeks and then buy back the bonds. I had to do it that way because I couldn’t afford to be out of the equity market for two or three weeks. And obviously I’m so glad I did it that way, because just look at, you know, the 10 to 15% rise in stocks over that period. But really, to try and manage a portfolio in that way is very difficult. You know, when you’ve got a multi week lag between making a decision and implementing it, I think the advent of ETFs will get rid of that problem eventually, because now that we have a rump of ETFs in our portfolio, we can implement asset allocation and manage selection decisions on the same day. Because there’s a lot higher liquidity in that you don’t have the long settlement periods for those trades and often lower fees. So it’s a win win for everyone.

Wouter Klijn  18:40

So at the super fund you could do with quicker was that, because it’s easier to implement derivatives there, or

Michael Block  18:45

Absolutely, you know, if I want to sack a manager, if I want to do anything, my overlay manager, be it currency or derivatives, can implement it instantly, and then you don’t have to wait for the physical movement to catch up. So, for example, if you want to terminate a manager, you could short the index, and then as you sell the stocks, you could unwind the derivatives. So much cheaper, so much more efficient, so much quicker.

Wouter Klijn  19:09

Yeah. And is that simply a matter of scale that you can’t do that at Bellmont? Or

Michael Block  19:14

Not scale. It’s, it’s the limitations of the way you set up the portfolio in the first place. Once again, now that I’ve going to have some ETFs, it’ll be easier, it’ll be way better, but there are still limitations.

Wouter Klijn  19:26

So there’s sort of restrictions on the use of derivatives in that portfolio.

Michael Block  19:30

There are restrictions. But again, if it’s not allowed on the platform, you can’t use it,

Wouter Klijn  19:35

Are there any other substantial changes within the institutional space and Bellmont. And I’m thinking, particularly, you know, we’ve spoken in the past about, you know, peer risk. There’s obviously the your future, your super legislation. Is it easier to put together a strategy for a high net worth person?

Michael Block  19:55

The way I’d like you to think about it, Wouter I think, is that because you have different. Incentives, you have different methodologies and different ways of operating. So let’s go for an example. If you were to fail your future your super test, it is an existential threat, so every super fund has to make sure that that never occurs. It was implemented retrospectively. So 13 funds failed, nine disappeared. There will never, ever be a fund that ever fails ever again, because now they know the rules, they’ll just make sure they don’t have enough risk that that could ever occur.

In wealth management, we do not have, for the main part, a performance assessment. So a super fund, their shopping list goes, let’s make sure we never fail the benchmark, the performance assessment, YFYS benchmarks. That means, with a few bells and whistles, they have much more passive equities, little bit of low cost real assets, some private credit and some fixed interest later on, when we talk, I’ll say to you that I don’t think that’s a portfolio that makes sense for a 62 year old man like me with a decent size super balance. And as you know, I’ve written articles that say things like, now is the time to add alpha to your portfolio, open brackets, unless you’re a super fund, and I think that’s to the detriment of the funds. So super funds spend a lot of their time looking at those sorts of things.

You remember something you and I penned together a long time, which was called why my mother is a better CIO than me, and it goes something like this, if my mum doesn’t like Commonwealth Bank, and she shouldn’t right now, because it’s insanely expensive. She just sells it, putting aside the CGT consequences in Super land, we’re concerned about tracking error so no one sells Commonwealth Bank. In fact, as you’ve seen some high profile, funds have had to buy it back after underperforming for a long time. This is craziness, absolute craziness.

Other things, my mum looks at her after tax outcomes. Super funds are starting to do it, but nowhere near as advanced as wealth management. You know, the churn of managers, etc. And these things still happening in wealth management. We’re all aware that, you know, with an American mutual fund returning 10% the investors in it might only earn a four because they go in and out at the wrong times based on fear and greed and and being scared when the market’s falling, etc. So you put that all together, super funds care about YFYS, then they care about peer relativity, and nobody really ever cares about the absolute outcomes.

So let’s use a really silly example. If my favorite overlay manager came to me and said, Michael, would you like some portfolio insurance when I was at Australian Catholic super I’d say something like, Sure, Lachlan, that would be great. I’d love some tail risk insurance, if I had any tail risk. And he says, I’ve just looked at the portfolio, 60% equities, 20% real assets, 10% private credit. You’ve got a huge tail I said, No, I don’t, because if the market turns to custard, and Aussie super goes down close, plus goes down, and NGS goes down, and all the other peers that I’m compared against go down. If I go down with them, that’s totally okay. So until such time as one of them takes our portfolio insurance and I’m at risk of underperforming against them. No tail risk. Sorry. No sale.

Whereas in wealth management, I care dramatically, and it’s got major ramifications for the way we construct a portfolio. For example, you have interviewed many equity managers in super funds, one of my ex colleague, Susan Chau, who’s a fantastic Portfolio Manager, but her constraints mean that she would construct a portfolio very differently to me today, let’s have a look at the most obvious and easy ones. If there was an emerging market manager, and that manager has beaten the emerging market benchmark by 5% per annum for a super fund, that is fantastic, because emerging markets is in the index, and that represents an out performance against their benchmark. For me in wealthland, I have to ask myself the question, how has investing in emerging markets gone against investing in developed markets, and the answer is, for about a dozen years, pretty badly. So even if the manager added 5% per annum, they still might have underperformed the mag seven or the acwi or some other benchmark. So I have to now think of it from an asset allocation perspective. Do I or do I not hold emerging markets? Dollars and how, when would I take money out of an all companies World Index and to put it in AM? And the answer is maybe, maybe not, very different discussion.

Wouter Klijn  25:10

So when you look at sort of these type of problems, how do you then decide to bring it back to like basic concepts that you can then teach either at a university fund or, I think you’re developing educational modules for Bellmont as well. How do you take all of those dynamics and boil it down to a number of concepts that are clear and teachable?

Michael Block  25:34

Well, I don’t have many superpowers. I’m just a bespectacled, balding, 60 plus year old man. But I do have one superpower, I think, and I hope that that is that I can take a lot of jargon and everything I’ve learned in the last 45 years, and I can turn it into really easy to understand principles to invest by. Let’s call it the Michael Block Roadmap. And for the sake of this interview, let me just go through some of them, and we’ll see what it says. So number one, you should anchor yourself with a really good strategic asset allocation. It doesn’t matter, and I don’t want to get bogged down on whether asset allocation is 86% or 91% of the outcome. It’s a big part. It’s the most important part. So for the life of me, I do not understand why investment funds, super funds, wealth managers, don’t spend the same 80% of their time worried about SAA. They should, they will. But that’s what I do. So number one, work out the best asset allocation you can that is age appropriate for your clients,

Wouter Klijn  26:45

Is that also because most funds have relatively static options. I mean, they can vary a little bit between the bandwidths, but you can’t make a growth fund look like 70%…

Michael Block  26:57

I don’t believe so. Wouter I think that most super funds, the very large ones, you can divide them into two camps. They either believe in life cycle or they don’t. The ones that don’t believe in life cycle. Just want to put everybody into the one size fits all balance fund. Obviously that is lazy and stupid and just insane. Are you really telling me that whether equities are expensive or cheap, and whether you’re 25 or 62 everybody should be in the balance fund? No, never. So that’s that in the case of the life cycle funds, well, that’s a long way to achieving what you want to achieve. So I would say that, yes, my 33 year old daughter is running basically an all growth portfolio. I’m 62 with a much shorter investment horizon, still a long runway, but certainly not 100 or 120% equities.

A rough rule of thumb would be, take a number, we’ll just make it 120 for argument, or 130 so let’s make it 130 subtract my age, 62 from 130 and I should be 68% equities. It looks like basically an age based default, which is still very sensible, not perfect. I constantly have to say it’s not as good as getting a tailored portfolio or getting advice or intra fund advice, but for the 90 plus percent of disengaged default investors, it’s a whole lot better than just being in a balanced, good starting point, and we’ve done the modeling, but let’s return to my my shopping list of things You might like to consider.

Wouter Klijn:

What’s number two?

Michael Block:

Number two only move away from the SAA under extreme circumstances. Use the maxim when in doubt, leave it out. So if you don’t know, be at the SAA. I have a 45 year track record of making tilts or DAA changes, and only when they’re at extremes. There are a couple right now, for instance, right now, I think the Aussie dollar is worthy of being classed at a low ebb and outperforming against the US dollar. So maybe increase your hedge ratio. Maybe be a little bit underweight equities, because they’re very expensive. Just this week, global equities in every developed markets are now at all time highs. So I hasten to add, I believe in medium term tilting. I do not like TAA. TAA is what makes hedge funds and brokers rich. Some can do well at it, but not many. So it’s not my bag. So get your SAA, stay with it, accept your extremes. So most of the time in your SAA, then decide when you want to hire a passive or an active manager. It’s really simple for me, in those markets where active management has delivered returns. Are greater than their cost go for your life in those markets where it hasn’t when you know, for instance, in large, efficient, well-researched markets, be more passive. No one’s saying that a great global equity manager can’t win. It’s just harder.

So the shopping list would go something like this. Be passive in large cap global equities, or more passive, more like index, less risk, be more active in Aussie small cap equities, emerging market equities, global small cap equities, and be mixed in Australian fixed interest and Australian equities. One interesting thing is, I personally do not use a Global Fixed Interest sector. Once you hedge it all back into Aussie. It’s Aussie fixed interest. And right now at Bellmont, we’re winning handsomely by having brought all our fixed interest back to Australia. Because just last night, if you looked at all the worries about us rates spiking, we’re not going to have those worries here in Aussie. We’re still going to get another two or three rate cuts, and the chance of interest rates falling is much higher here. So now, Wouter, you’ve pretty much done it, so have a good SAA, only move when things are crazy at extremes, we can measure this three to five standard deviations away from the norm. Be more active where you’ve got a good chance of winning. Be less active where you don’t introduce some private markets, where appropriate. Right now, with all markets at extremes, I would certainly hold more cash, more credit, less equities, we can have a really interesting discussion about private equity and private credit. Do you fund them from equities? Do you fund them from defensive assets? I would be the odd man out, and I’d say that hybrids and private credit, I would fund out of equities, so therefore they are risk reducing and just just maybe water, you know, something like a 10% return in private credit might be better than what you’re going to get in equities over the next years, not just risk adjusted, but outright, but certainly risk adjusted

Wouter Klijn  32:15

On the second point. So you only make moves when you’re at the extremes. And I think we’ve spoken a little bit in the past about that basically means it’s only a handful of times that you make those type of decisions?

Michael Block  32:28

Absolutely right Wouter. Me and Howard Marks, one of my heroes, which we’ll talk about later. You know, Howard Marks is having a chat with his son one day, and he’s and he says, Son, you know what? I’ve got an almost 100% track record in all of my calls. And the kid goes, Yeah, Dad, that’s because you’ve made five calls in 20 years. Well, I’m taking them at about the same rate and some of the same calls.

Wouter Klijn  32:50

And is that sort of where the discussion around long term investing comes into play, that you can only make these calls if you really have a long time horizon,

Michael Block  33:01

Absolutely. So let’s use something that my analyst, who’s a very, very talented analyst called Daniel Deverich, and I were chatting about this morning, Commonwealth Bank. Both he and I think that the Commonwealth Bank share price is crazy high. It is the most expensive bank in the world. I think it’s a legitimate strategy to leave it out of your Australian equity portfolio. I’m pretty sure it’ll win over 20 years doing that. But if you hadn’t done that five years ago, you would have had a horrible time. Because, you know, I look at my children’s portfolio, which involves Commonwealth Bank, crypto and cash, they’re doing a whole lot better than me. The Commonwealth Bank, unexplainedly, to many people, you know is now, you know, 160 $170 crazy, crazy price. But do I have confidence that, over 10 or 20 years, that won’t succeed? And this goes back to mean reversion. Mean reversion is a wonderful science. Every single asset class in the history of mankind has mean reverted, bar one. And what do you think that one is about it?

Wouter Klijn

I know the answer, Australian residential.

Micheal Block

That’s the one Australian residential property. So let’s just put that aside as an anomaly. I have no doubt that the other major banks and Commonwealth Bank will converge. But now let’s let me tell you a sorry tale of people who’ve done convergence trades, Long Term Capital Management set in place a strategy that Royal Dutch Shell that was listed in two places, the prices would converge. They took the bet, they geared it as many times over. It didn’t converge. In fact, it widened. They became insolvent. They had to undo the trade, wind up the fund. Of course, ultimately, they were right, but that the lesson for that is that your time horizon is what matters.

So we can go to Lloyd, Lord Keynes and. Some of my favorite quotes. One is, the market can remain irrational longer than you can remain solvent. So if you think comm banks going to go back to normal in one year or two years, think again. The history of mean reversion can often take 20 years to work. You know, as a very wise man once said to me, it’s a bit like a broken stop. It’s a bit like a broken wristwatch. It’s only right twice every 24 hours. And so it is with mean reversion. And obviously the other part of the equation is, as Keynes said, in the long run, we’re all dead. You know, Jeremy Grantham, another one of my heroes we’re going to talk about, made the call to be underweight equities in 1999 of course, he was right. His research. He’s a man of science. He’s a great asset allocator, but by the time he was right, his assets under management had gone from 180 billion to about 35 billion. So it’s no good being right if you’ve got no clients. Yeah. So we have to think about that.

Wouter Klijn  35:58

So how can we apply that lesson to sort of today’s market, especially if we look at, you know, we talked about equity prices are expensive. We’ve seen last year the run up of the Magnificent Seven, very concentrated, very highly valued. Then Trump came in, tariffs were unleashed, and the market fell. But from the last time I looked, I think it’s already back up to where it was before the tariff war.

Michael Block  36:23

I absolutely can’t explain it. So let’s lead say that you know, if you want to base investing people’s life savings on the short-term, knee-jerk press releases of an orange person, and once again, I say about an orange colored person, not an orange man from Netherlands. But this is crazy stuff, but I think you’ve only got two options. You either say I’m going to try and use market sentiment behavioural economics and try and do something about it. That’s not my thing. I can’t do that. So what I would say is, I’ve been around a fair while. I’ve not seen everything like this happen all at the same time, but I’ve certainly seen it all individually, and I have total faith, if I just make sound, rational decisions, create robust portfolios that will navigate this volatility, that will be okay. So my position right now is, I thought equities were expensive six months ago. We are underweight equities. Tariffs have been introduced. Trump was elected. He can only introduce tariffs in the way that he can because they can be done by executive order. We’ll deal with some of the other things that might come, that might come later, that require Congress or other approvals. But by my reckoning, tariffs are unequivocally bad. So if I was underweight stocks six months ago and bad things have happened, I’m very happy to be underweight stocks today, and I still think stocks are too expensive, and you’d be better off taking some money out of stocks and putting it in, let’s say, some investment grade Australian credit, where you’ll make cash plus 200 with relative certainty, Wouter, this goes all the way back to my favorite poster.

Wouter Klijn

Ss that Jean-Claude Van Damme?

Michael Block  38:22

It is Jean Claude Van Damme, the Muscles from Brussels. And it says, Wrong Bet, yeah. And that is, do you want to bet on something that’s got a five or 10% chance of happening, namely, your active manager helping fix what might happen in a in an economic downturn or a market downturn? Or do you want to make cash plus 200 in investment grade credit, which has a 90 to 95% chance of success? I take the second one. Everything else, according to me, is wrong bet. I may add that That movie was only called wrong bet in Australia. It was actually called Lionheart, or other things in Europe.

Wouter Klijn

Oh, is that? So? I thought they were two different movies.

Michael Block

But you know, so again, I wish I could make this all complicated, and I could ask for huge amounts of money for doing strange and unusual and difficult things. If you came to me and said, Michael, what should I do? I’d say, let’s get you an age appropriate asset allocation. Then after that, let’s decide where you be active and where you be passive, or if you want to make any changes to that, and then we implement it through a series of ETFs and managed accounts or a UTS. And then, you know, you can go home and play with the children and and watch how that works out, because that’s been the best outcome.

Wouter Klijn  39:42

So to a degree. Do you think that we sometimes overthink investment strategies in this industry, and not, you know, not let it set and forget often enough?

Michael Block  39:55

I’d be even stronger than that. I think that the vast majority of large super funds are over engineered and over thought and are spending too much time doing stuff as you know, there’s a reason for this. It’s called an activity bias. People love to believe that if you’ve got more control and you’re doing more things, you’re adding value. It’s the reason why so many people go and play blackjack at a casino and lose more because they have this feeling of control, and it’s a good game to win. I work for the casino control authority. I can promise you that blackjack at a casino is a silly game to play. The casino’s edge is three to 4% five times bigger than in craps and three times bigger than baccara. It’s a terrible game to play. No one’s ever broken the bank. In blackjack in Australia, they play with eight packs. You can’t, can’t count.

So this whole activity bias, let me give you a really interesting stat. At certain super funds there, you can have member directed outcomes, where the clients can pick their own stocks and do stuff like that. The one super fund I have in mind that happens to be one of the best performing funds, the CIO there told me that very few members who were doing all of this activity had ever beaten their balance fund. You know who it is. Hello, Sam. Everyone knows who it is. He’s a fantastic CIO, but I think that there’s a lesson in that. And if we’ve all been to the same school, we’ve all done mean variance optimization, and we all get to the roughly the same long term. SAA, well, the only way you can differentiate yourself is to have different managers and things like that. I’m here to tell you, it mostly doesn’t work. Most stocks go up and down together. Most properties go up and down together. Asset allocation is the game to play. The last 12 years, you’ve either owned the mag seven or you haven’t. It’s a binary outcome. For those nerds out there, cross sectional volatility has been incredibly low, so there’s really been very little opportunity to add alpha. Hence, last year was the worst year on record for active management in global equities. So I think there is a good reason to be much more simple use an Occam’s Razor approach, as in, I’d rather be vaguely right than precisely wrong.

When you take my picture in a little while, you’ll see that, you know, I’m looking more Amish every day with this long beard

Wouter Klijn

and the hat

Michael Block

And the hat. And I think there’s something to it. You know, people ask me questions I’ve given some terrible answers, like, you know, why do so many people buy active strategies are not passive. And I said, Well, maybe one is because active managers buy better footy tickets, says Michael, who has just bought tickets to see Wrexham play Sydney FC later this year. But you you get the you get. The gist is, it all depends what you’re trying to achieve. And I’d be very critical that there are all sorts of commercial reasons why people do things that really science does not back up. You can look at SPIVA S&P Index versus active it has shown unequivocally that for the last 20 years, something like 90% of global equity managers underperform the index. That means it’s a hard, hard game,

Wouter Klijn  43:26

But this is also data that comes from an index provider.

Michael Block  43:30

No. There’s no biases. No. Actually the reverse, because if you allow for all of the managers that failed, you know, and survivorship bias, all sorts of other data. It’s actually much worse than that.

Wouter Klijn  43:43

So that discussion around simplifying things, what implication does that have for the definition of asset classes? Should you have a whole range of different asset classes and make it very granular, or should we stay at a higher level,

Michael Block  44:00

You’ve opened a horrible can of worms there, Wouter. Thank you so much. I apologize in advance to all my friends that run sub sector niche strategies. I’m afraid I’m a purist. I’m a purist when it comes to analyzing football, and I’m a purist when it comes to investment. For me, there are only two asset classes. There is equities and there is bonds. Everything else is some derivative of those.

And let me give you examples. If we look at property, all property listed property is is a form of lower risk, lower volatility, equities, they’re in equity benchmarks. You could just buy an equity manager, and they could put more money in them. That does not mean that I won’t allocate to some of them, but you know, if you’ve got lots of credit in your portfolio, it’s pseudo equity. So you shouldn’t ever be comparing a private credit strategy with bonds, you should be comparing it to a mix of bonds and equities, but certainly I’ll go through them very quickly. So I would always think about just equities and bonds. Sub sectors are exactly that. They are sub sectors. Global listed infrastructure, global listed property, is a sub sector of global equities, credit is a mix of bonds and equities. Infrastructure unlisted, is a mixture of inflation linked bonds.

And guess what? There once was a hugely over engineered strategy at QIC and Q super, where they replaced infrastructure and property with geared long term bonds. Brad Holzberger made a big thing that they are actually growth assets. It was a unique and revolutionary strategy, and was so fantastic because

Wouter Klijn

That’s the biggest parity idea.

Michael Block

It’s a little bit like risk parity, but risk parity is about risk. This was about: You can actually call those geared defensive assets growth assets. And guess what? Geared 30 year Aussie bonds performed very well compared to property and infrastructure, and did it for no fees and with total liquidity. Not so shabby.

Obviously, the bad side is Q super, over many 10 year periods, was number one for eight of them, and the very bottom for the other two. So it would certainly put them in a difficult position when they wanted to look at peer relativity. Oh, and guess what, when they suddenly become became open offer. Now they’ve merged with sun super obviously, but when they became open offer, they had to think about whether that strategy was still appropriate. And it’s not.

Wouter Klijn  46:49

No. It’s very different in your future, your super world. So when you look at that philosophy around asset classes, is that something that you bring into the course as well at UTS. Or do you stick with more a traditional, you know, asset classes.

Michael Block  47:07

For the sake of for the sake of education, we have a much wider range of asset classes. So we certainly have infrastructure, property, small cap equities, emerging market equities, they are mostly implemented by ETF, because practical considerations mean it’s hard for us to pick stocks overseas. And at the anchor fund, we teach investment analysis and making a pitch for an Australian stock, probably the one easiest thing and biggest thing that I do need to chat with you about is mean variance optimization. Nearly everybody believes in CAPM, Dr Markowitz, modern portfolio theory, and therefore that risk and return are highly positively correlated, almost linear. And therefore, if you take some capital market assumptions, you run them through a magic black box that gets the best mix of risk and return. We need say mean variance optimization. That is one way of doing it at UTS, we teach that that is nonsense. We actively discourage the use of mean variance optimization (MVO). Because it doesn’t work, is the short answer. So I would say to you that mean variance optimization is like driving a car down the highway, only looking in the rear view mirror and then waiting until you crash. Let me give you a concrete example. It’s 2007 equities have exhibited low price volatility, high returns. MVO says, buy lots 2009 equities have exhibited high volatility, horrible returns. MVO says, sell your equities. I in fact, listen to my hero, Jeremy Grantham, he said, 2009 you should invest. He wrote this fantastic paper called reinvesting when terrified. You know, I’ve mentioned it to you before, so I was a seller of equities in ‘[07 and a buyer in ‘09. Exactly the opposite of what MVO would tell you, yeah. Yeah. So we would supplement MVO with others, other methodologies, black Letterman, etc,

Wouter Klijn  49:27

Maybe Markovich knew this as well, because I think his own portfolio was 5050, split between equities…

Michael Block  49:33

Oh, that was, that was a totally different thing. That is a total misconception. Harry Markovitz was once asked, and he was a vain man, and he said, they said, What’s your portfolio? He said, 50% equities, 50% fixed interest might have even been cash. And then they said, why? He said, Listen, I just don’t want to be wrong. So if he was a fence sitter with splinters in his bottom, it was much easier to be 5050. I. A bunch of people have interpreted that as a theory. So this throwaway line has now become interpreted as minimum regret theory, or least regret theory, and people actually roll it out. Most Australian super funds are 50/50, hedged because of that. No, no, no. This was just, this was just Dr Markowitz his own vanity and wanting to not be wrong and willing to hedge his bets, and that’s why he was 5050 there is no reason at all why a 50/50 portfolio should have anything to do with investing.

Wouter Klijn  50:36

It does show that how behavioral elements come into investment decisions there.

Michael Block  50:41

Oh, absolutely. It happens all the time, and I have to give different recommendations to different clients. You know, there are some clients that will listen when I say to them, be more active here. Less active there. I don’t like this. I do like that this manager is good. There are other people who I could tell. So I’m blue in the face that it is a hard, hard game to invest in global large cap equities, but they still want to why? Who knows, but behavioural reasons? Certainly.

Wouter Klijn  51:12

Yeah, so you mentioned Jeremy Grantham, Keynes when you look sort of back off your career. Who are your heroes?

Michael Block  51:20

Well, let’s go through them one at a time. So Lord Keynes is the father of economics for me, and his quotes are the best, and I use them all the time, and he actually did a lot of very good research into some of what’s happening today. I think Jeremy Grantham is the best asset allocator of all time, and is a dour Yorkshireman and very honest, and has helped me so much in my career, personally. So I will always give time for GMO and anything they’re doing. I think Howard Marks is very good. He is one of the people that I listen to, as is Michael Kelly of PineBridge, which is one that other people might not have thought of.

And I think the greatest stock picker of all time is Peter Lynch. You may remember that one of your contributors, Daniel Grioli, and I did some research into because when Daniel said to me, who’s better, Lynch or Buffett, and I remember at Bellmont securities, we all come from a world where everyone reveres Buffett. I’m not saying Buffett is not great. Of course he is, and he’s retiring this year, but Peter Lynch is incredible. And there is no other outcome. There is no other belief you can have than his performance had to be genuine. Jensen’s alpha stock picking skill with so many others. There are ifs and buts, you know, there’s, I can show you so many other great investors, but there’s always a hint of maybe they’re a value investor, and value style worked. You know, if you found a fund that’s only invested in tech stocks for the last 10 years, we don’t know yet whether or not they’re a great investor. We’ll have to wait and see if, in a period when tech stocks don’t do so well, whether they’re able to change their spots.

Wouter Klijn  53:16

Yeah, I think you’ve mentioned thematic ETFs to sort of check whether active managers simply have a structural bias or whether they actually have skill in alpha.

Michael Block  53:27

Yeah, I think it’s a very useful tool. So again, going back to the graveyard of good ideas, smart beta was, was one of those, if you have a manager and all they ever do is make the value style return? Well, you can be pretty assured that an algorithm or a smart beta or a thematic ETF can replicate that return at a fraction of the cost. But I think all I’d say to you is this, if there’s a manager who portrays themselves as a growth Style Manager, if you measure them against an index that has roughly the same constraints as they do. Well, then at least you can have an idea of being able to compartmentalize how much of that manager’s return is beta, as in, just growth style, and how much is pure Jensen’s Alpha. That’s important to see what level of skill that manager has. It’s also important to see how much you should pay them for their outcomes. So it’s just one tool that I use to evaluate whether a manager is got genuine stock picking skill, whether they’re just a one trick pony.

Wouter Klijn  54:36

Yeah, so coming back to the question around heroes, did you ever get to meet Jeremy Grantham many times, because there is a phrase that you should never meet your heroes. Was it a good exchange?

Michael Block  54:47

Oh, wonderful exchange. The best thing I could ever tell you is I’m at the University of New South Wales, and Jeremy himself called me up and said, Listen, I think the markets are horribly overpriced and you should run away. I. And I said, well, then what should I invest in? And he said, inflation linked bonds. I said, Well, then, you know, send your rep to show me what you have to offer in ILBs. He said, You don’t understand, we don’t have any. You need to take your money out of GMO and give it to PIMCO. And that is the greatest act a fund manager can do is to say, I treat you as if it was my own money, and this is what I do, and that that integrity and that honesty is an incredible thing. And there’s less than five funds in my 50 years in the markets or thereabouts that have ever showed that. But no meeting Jeremy when he’s come to Australia has been wonderful. Sometimes I get star struck, but that’s actually more been sporting heroes, right? So other than the fact that my office now has a portrait of the greatest football player of all time, Johan Cruyff, in on my wall, but I’m also a nerd that has autographs from Jeremy Grantham and Burton Malkiel in my collection as well.

Wouter Klijn  56:05

Fair enough. Fair enough. Yeah, I’ve seen your office. It’s, it’s quite striking with the memorabilia,

Michael Block  56:10

Mostly Liverpool, yes, we’re the champions. Hello, Teik, thanks everyone. You’ll never walk alone. And Sydney roosters, yeah, aren’t doing that well, but I love them just the same.

Wouter Klijn  56:22

Maybe we finish up with coming back to the UTS anchor fund. What is next on that program? And have you already gotten any sort of results or a track record built up in that?

Michael Block  56:34

So there are a few things. What is next is our graduates achieve, and UTS goes from being the 88th ranked finance school and university in the world into the top 20 like Sydney and UNSW, and becomes the first choice for graduates. As I said, it’s already very popular. Certainly, we intend to widen the course, so we’re looking at doing things with the engineering and computer science in AI and things like that. And at the moment, it’s only a one semester course. Obviously, later on we might make it a two semester course, because really we’d like to make it available to more than 15 students per semester, or 30 students per annum. But that’s the plan, and certainly that will give me more opportunity to invite more than just, you know, 20 or 30 of my closest friends to come and give guest lectures at UTS.

Wouter Klijn  57:32

Yeah, I imagine it would be quite hard to condense 35 years of investing experience into one semester.

Michael Block  57:39

Well, haven’t we just done 35 years of investing knowledge into 35 minutes? So it is possible, but yes, you know it’s for me. It is an absolute honor that UTS allows me to do this. It’s something that other universities wouldn’t because I do not hold a PhD, so I would never be allowed to be a professor or a senior lecturer at Sydney University or UNSW, and so all I can say is I’m extraordinarily grateful to UTS to Lorenzo and Amir and and Karl, the dean of the business school there, for giving me this opportunity when so many others wouldn’t

Wouter Klijn  58:18

Fair enough. Well, Michael, thank you very much for coming to our offices and for doing this podcast. It’s much appreciated.

Michael Block  58:25

Baie Dankie, Wouter or Dank je well to you. Thank you so much. It has been such a ride to be involved with you and Teik from the beginning here at i3, and thank you very much for giving me this opportunity.

Wouter Klijn  58:55

Thank you for listening to the [i3] podcast. For more information, please visit our website at www.i3-invest.com That’s the letter i The number three. Invest.com and don’t forget to like, subscribe and review. Thank you very much.