openpolitics.com

How Ray Dalio built the world’s richest and strangest hedge fund.

 .. “I believe that the biggest problem that humanity faces is an ego sensitivity to finding out whether one is right or wrong and identifying what one’s strengths and weaknesses are.”

.. “Almost everything is like a machine,” he told me one day when he was rambling on, as he often does. “Nature is a machine. The family is a machine. The life cycle is like a machine.” His constant goal, he said, was to understand how the economic machine works.

.. “Bridgewater is a cult. It’s isolated, it has a charismatic leader and it has its own dogma.” The authors of the article noted that Dalio’s “emphasis on tearing down an individual’s ego hints at the so-called struggle groups of Maoism,” while his search for “human perfection devoid of emotion resembles the fantasy world in Ayn Rand’s ‘The Fountainhead.’”

.. In his Principles, Dalio declares that acknowledging errors, studying them, and learning from them is the key to success. He writes, “Pain + Reflection = Progress.” Bridgewater puts this equation into action by organizing lengthy assessment sessions, in which employees must discuss their mistakes.

.. One rule of radical transparency is that Bridgewater employees refrain from saying behind a person’s back anything that they wouldn’t say to his face.

.. “What Is a Jeweler?” It described a jeweller as basically an investor with a long position in gold and precious stones.

.. Dalio’s pitch, which hasn’t changed much over the years, was that by investing in a variety of other markets, such as U.S. and international bonds, and using leverage to bolster its exposure, Bridgewater could match or beat the stock market with less risk.

.. “You get the same return, but you get a heck of a lot of beneficial diversification, too.”

.. Worldwide, there are now some ten thousand hedge funds, which the government regulates only loosely. Together, they have about two trillion dollars under management.

Some hedge-fund managers, such as Steven A. Cohen, of S.A.C. Capital, and David Einhorn, of Greenlight Capital, are stock pickers, like Jones.

Others, such as James Simons, of Renaissance Technologies, are known as “quants.” They use computers to sift through market data, spot profitable opportunities, and place trades, all with minimal human intervention.

As a macro trader, Dalio is working in the tradition of George Soros and Julian Robertson, famous speculators who ranged across markets.

.. Almost a third comes from public pension funds, such as the Pennsylvania Public School Employees’ Retirement System; another third comes from corporate pension funds, such as those at Kodak and General Motors; a quarter comes from government-run sovereign wealth funds, such as the Government Investment Corporation of Singapore

.. “Given that I’m never sure, I don’t want to have any concentrated bets.”

.. Dalio is a consistent hitter of singles and doubles

.. these days many markets move in the same direction, which makes it hard to achieve real diversification.

.. “spread” bets, purchasing one security it considers undervalued and selling short another one it considers overvalued.

.. In any market that interests him, he identifies the buyers and sellers, estimates how much they are likely to demand and supply, and then looks at whether his findings are already reflected in the market price. If not, there may be money to be made.

.. Unless he and Jensen and Prince agree that a certain trade makes sense, the firm doesn’t make it.

.. The firm’s researchers also went through the public accounts of nearly all the major financial institutions in the world and constructed estimates of how much money they stood to lose from bad debts. The figure they came up with was eight hundred and thirty-nine billion dollars. Armed with this information, Dalio visited the Treasury Department in December, 2007, and met with some of Treasury Secretary Henry Paulson’s staff. Nobody took much notice of what he said, but he went on to the White House, where he presented his numbers to some senior economic staffers.

.. “Everybody else was talking about liquidity. Ray was talking about solvency.”

.. Summers went on, “He had a fully articulated way of looking at the economy. I’m not sure I would agree with all of it, but it seems to have been a very powerful analytical tool through this particular period.”

.. Dalio’s bearishness cost him in 2009. Despite the Fed’s actions and the Obama Administration’s stimulus package, Dalio predicted that the economic recovery would be weak. When growth rebounded faster than he expected and the Dow rose nineteen per cent, the Pure Alpha fund gained just four per cent.

.. an article in New York ridiculed Dalio’s Principles, saying that they read “as if Ayn Rand and Deepak Chopra had collaborated on a line of fortune cookies.”

.. It’s also the case that in the time I spent at the firm I saw senior people criticizing subordinates—but not the reverse.

.. “What we’re trying to have is a place where there are no ego barriers, no emotional reactions to mistakes. . . . If we could eliminate all those reactions, we’d learn so much faster.”

.. I have never seen a C.E.O. spend as much time developing his people as Ray.”

.. Another new member of Bridgewater’s management committee is James Comey, the firm’s top lawyer, who served as Deputy Attorney General in the Bush Administration between 2003 and 2005. “Most of my friends think I am having a midlife crisis,” Comey told me in a recent phone conversation, referring to his decision, last year, to leave Lockheed Martin and accept an offer from Dalio.

.. Comey said of Dalio, “He’s tough and he’s demanding and sometimes he talks too much, but, God, is he a smart bastard.”

.. “We learned that beyond having enough money to help secure the basics—quality relationships, health, stimulating ideas, etc.—having more money, while nice, wasn’t all that important.”

..

he regards it as self-evident that all social systems obey nature’s laws, and that individual participants get rewarded or punished according to how far they operate in harmony with those laws. He views the financial markets as simply another social system, which determines payoffs and punishments in a like manner. “You have to be accurate,” he says. “Otherwise, you are going to pay. Alpha is zero sum. In order to earn more than the market return, you have to take money from somebody else.”

.. Dalio is right, but somewhat self-serving. If hedge-fund managers are playing a zero-sum game, what is their social utility? And if, as many critics contend, there isn’t any, how can they justify their vast remuneration? When I put these questions to Dalio, he insisted that, through pension funds, Bridgewater’s investors include teachers and other public-sector workers, and that the firm created more value for its clients last year than Amazon, eBay, and Yahoo combined.

However, it is one thing to say that the most successful hedge-fund managers earn the riches they reap. It is quite another to suggest that the entire industry serves a social purpose. But that is Dalio’s contention. “In aggregate, it really contributes a lot to the efficiency of capital allocation, and capital allocation is very important,” he said.

.. Like many successful financiers, Dalio justifies capitalism and his place in it as a Darwinian process, in which the over-all logic of the system is sometimes hidden.

Of course, this view conveniently ignores the argument that hedge funds, through their herd behavior, have contributed to speculative bubbles, in tech stocks, oil, and other commodities.

.. “There is a basis for the argument that hedge funds add economic value,” Andrew Lo, an economist at M.I.T. who runs his own hedge fund, says. “At the same time, they create systemic risks that have to be weighed against those positives.”

.. In 2008, hedge funds had hundreds of billions of dollars on deposit at investment banks, which acted as their brokers and counterparties on many trades. When the Wall Street firms got into trouble, a number of other hedge funds demanded their money back immediately. These demands amounted to a virtual run on the banks and helped to bring down Bear Stearns and Lehman Brothers. Dalio acknowledged to me that Bridgewater was one of the funds that pulled a lot of money out of Lehman

.. Fifteen years ago on Wall Street, remuneration packages of five or ten million dollars a year were rare. Today, C.E.O.s and star traders routinely demand vastly higher sums to keep up with their counterparts at hedge funds.

.. some of the very brightest science and mathematics graduates to the industry. Can it really be in America’s interest to have so much of its young talent playing a zero-sum game?

.. “We are still in a deleveraging period,” he said. “We will be in a deleveraging period for ten years or more.”

.. Dalio believes that some heavily indebted countries, including the United States, will eventually opt for printing money as a way to deal with their debts, which will lead to a collapse in their currency and in their bond markets. “There hasn’t been a case in history where they haven’t eventually printed money and devalued their currency,”

.. Other developed countries, particularly those tied to the euro and thus to the European Central Bank, don’t have the option of printing money and are destined to undergo “classic depressions,” Dalio said