Ray Dalio may not be a household name but in financial circles he’s a titan. He founded investment management firm Bridgewater Associates in 1975 which has now grown into the world’s largest hedge fund with approximately $154 billion in assets.1 But it’s Dalio’s unorthodox and creative approach to the markets and life that make our latest addition to the Masters of Finance list such an interesting story.
Dalio is not your typical hedge fund manager. Born in Queens, New York in 1949, his father was a jazz musician, playing saxophone in Manhattan night clubs, his mother, a homemaker.2 His introduction to the market came from the stock tips he received when caddying in Long Island. Dalio attended Long Island University, and then went on to receive an MBA from Harvard Business School before beginning his professional career, eventually founding Bridgewater Associates out of his apartment at age 26.3 He has reportedly also signed the Giving Pledge, planning to give away half of his net worth to charity, joining billionaires such as Bill Gates and Warren Buffett. Dalio spends his free time in the outdoors and even enjoys bow-hunting buffalo in Africa. These are some of the attributes that landed Ray Dalio on Time’s 100 most influential people list.4
Externally, Bridgewater has the reputation as being very client-oriented, even providing a daily newsletter to investors. This is in stark contrast to many hedge funds which can be very secretive. Internally, creativity and open-mindedness are tenets at Bridgewater Associates. They also go to great lengths to avoid groupthink, soliciting dissenting opinions whenever possible. If you plan on working at Bridgewater it would help if you were on the debate team in high school. When discussing an idea, Dalio will often take two people with extreme, opposing opinions and have them debate their case. Dalio then invites the whole company to watch. But not everyone’s ‘vote’ counts the same. Some employees are more “believable” than others and there is even an index assigned to employees to weight their vote. The index is made up of judgment, reasoning and past behavior.5
While this could lead to hurt feelings and crushed egos, this is at the heart of the Bridgewater culture-eliminating the ego-barrier, the desire to prove oneself right and others wrong, even in the face of evidence to the contrary.6 Dalio himself isn’t immune to criticism. After a meeting with a deep-pocketed potential investor, a Bridgewater client adviser sent a scathing email to Dalio giving him a ‘D’ on his presentation and complained he “rambled” for 50 minutes.”7 Dalio copied everyone in the company on the email so they could weigh in.
Dalio doesn’t fit the typical stereotype of a hedge fund manager. Along with Bill Gross, Dalio regularly practices transcendental meditation which he credits for much of his success in the markets. “Meditation more than anything in my life was the biggest ingredient of whatever success I’ve had” Dalio revealed in an interview at Georgetown University.8 Like the benefits of compounding returns in the markets, Dalio believes that meditation’s benefits accrue over time saying “the thing to convey is how it compounds.”9 While not required when working at Bridgewater, many employees voluntarily meet up to meditate. This unusual culture raises eyebrows and critics, sometimes disgruntled ex-employees, even say he runs a cult.10
Westport, Connecticut-based Bridgewater is considered a macro-fund, forecasting economic trends that have ramifications across many markets. Comprised almost exclusively of institutional money, roughly two-thirds is from pension funds money with the remainder being sovereign wealth funds and high net-worth families. Hedge funds typically charge investors the standard ‘2 and 20’ fee structure (2% of assets under management and 20% of profits). Bridgewater’s All-Weather Fund reportedly charges investors less.
The standard ‘2 and 20’ fee structure serves two purposes. First, when the fund manager commands twenty percent of profits (above a high water mark) he aligns his interests with fund investors. In other words, management has ‘skin in the game’, a motivating factor. Secondly, there is a tax advantage to the manager for deriving a portion of the income from capital gains, which are taxed at the lower 15% rate versus ordinary income.11
Bridgewater had a huge year in 2011, personally earning Dalio somewhere between $2 and $3 billion.12 These numbers may seem astronomical but with a fund this large, the fees can add up quickly. Last year, Dalio earned $500 million, due in no small part to his Major Markets fund which was up 10.6% net of fees.13 While industry critics surely feel that he is overpaid, hedge fund research firm LCH revealed that Bridgewater Associates has made more money for investors (in absolute dollars) than any other fund in history, ousting George Soros’s funds for the top spot.14 This has led some to ponder whether Ray Dalio is the greatest hedge fund manager of all-time.
A hedge fund the size of Bridgewater is disadvantaged trying to outperform market averages. That’s a good problem to have if you are a hedge fund manager. The reason the fund has grown so large is its long track record of outperformance. Bridgewater’s flagship ‘Pure Alpha’ Fund has returned 13% net of fees since inception in 1991.15 Pure Alpha has performed well in both up and down markets, returning 9.4% in 2008 amidst the subprime financial crisis LCH calculates Bridgewater’s Pure Alpha Fund as having generated $45 billion in net gains since inception.16
Bridgewater’s public equity portfolio is surprisingly basic, investing heavily in exchange traded funds. This is not surprising given one of the main benefits of ETFs is liquidity, the ability to convert the investment into cash. With assets totaling $154 billion, liquidity is paramount to meet redemptions. At the end of 2015, ETFs made up 87% of Bridgewater’s public equity portfolio and its two largest holdings alone, S&P Depository Receipts, SPY and the Vanguard International Index Fund, VWO comprise almost 60%.17
For Bridgewater’s All-Weather Fund, Dalio employs a controversial ‘risk-parity’ strategy that essentially attempts to control volatility. It allocates funds to a portfolio on a risk-weighted basis and actively shifting positions during market volatility, often through the use of leverage via derivatives. These ‘spread’ bets involve buying securities they believe are undervalued and shorting securities that are overvalued. The end goal is to reduce overall portfolio risk without sacrificing returns.
But according to the Wall Street Journal, Bridgewater’s Risk Parity strategy still lost 20% during the swoon in 2008, versus a 22% drop for a traditional 60/40% portfolio-the benefits weren’t that apparent.18 Further, equity markets experienced significant volatility last summer yet the All-Weather fund still lost seven percent for 2015, its second consecutive annual loss. But it should be noted that the All Weather fund has generated annualized net returns of 7.7% since its inception in 1996 and Dalio reportedly has a large amount of personal money in the fund.19
While risk-parity strategies comprise only around 20% of the $3 trillion of total hedge fund assets it’s becoming an increasingly popular strategy amid market volatility. Funds employing this strategy target mainly institutions as clients, often pension funds looking to weather market downturns. The Teacher Retirement System of Texas and the State of Wisconsin Investment Board have both embraced risk-parity models for their own funds. Some pension funds are getting impatient with this strategy, including the City of San Diego’s pension funds which reallocated back to more traditional investments.
There have also been rumblings that risk-parity strategy actually causes volatility in the markets. Some attest that risk-parity’s strategy of automatic selling based on changing market conditions exacerbates market moves, especially to the downside. Dalio defends the practice and counters that risk-parity helps dampen a volatile market by constant rebalancing (purchasing oversold securities while selling richer ones). It will be interesting to follow how pension consultants view the risk parity strategy going forward and see if there are any further shifts out of the strategy.