Bridgewater Associates – global macro investing style hedge fund based on economic trends, such as inflation, currency exchange rates, and U.S. gross domestic product.
Hedge fund Bridgewater Associates was founded by Ray Dalio, Bridgewater began as an institutional investment advisory service, graduated to institutional investing and pioneered the risk parity investment approach in 1996.
In 1981 the company moved its headquarters from New York City to Westport, Connecticut and currently engages 1,200 employees. It embraces a corporate culture that encourages transparency and the elimination of the decisionmaking hierarchy and in 2011 was the world’s largest hedge fund company with US$122 billion in assets under management
Bridgewater manages approximately $169 billion in global investments for a wide array of institutional clients, including foreign governments and central banks, corporate and public pension funds, university endowments and charitable foundations. Approximately 1,500 people work at Bridgewater, which is based in Westport, Connecticut.
Founded in 1975 out of a two-bedroom apartment, Bridgewater remains an independent, employee-run organization. Throughout its 40-year history, Bridgewater has been recognized as a top-performing manager and an industry innovator. Bridgewater was one of the few firms to have positive performance during the 2008 financial crisis. The firm has received over 50 industry awards and various recognitions in the past 10 years; including awards for industry innovation, performance, quality of research, client service and client satisfaction, quality of operations and operational infrastructure. Additionally, in 2014 Bridgewater received industry recognitions for: Best in Institutional Portfolio Management, Best in Risk Budgeting, Top Workplaces, Best Client Service, Investment Company of the Year, Overall Excellence, and multiple awards for Innovation and Performance. Its clients and employees routinely give Bridgewater top satisfaction ratings in annual surveys.
Bridgewater’s unique results are a product of its unique culture. Truth and excellence are valued above all else. In order to be excellent we need to know what’s true, especially those things that we would rather not be true, so that we can decide how best to deal with them. We want logic and reason to be the basis for making decisions. It is through this striving to be excellent by being radically truthful and transparent that we build meaningful work and meaningful relationships.
Bridgewater Associates has a variety of principles that lend to its success. It is a firm that values utter transparency, even when mistakes are made. As long as ownership is taken for the error and the reason behind the mistake learned from, the firm is accepting. Hedge fund tries to keep everyone in sync, always questioning whether a premise is correct and does it make sense. This is how the firm manages itself and how it manages its investments.
Bridgewater Associates, operating out of a 22 acre Westport, Connecticut campus and staffed with an army of over 1200 employees. Hedge fund was founded by Ray Dalio out of his apartment in Manhattan in 1975 to provide consulting services to corporate clients. Initially, the firm advised corporations on how to manage their currency and commodity-exposure risks. Soon thereafter, as Dalio’s expertise in describing complex financial problems and insightful solutions in simple terms (e.g. his paper on a jeweler being described as a business long in gold that needs to hedge against his gold inventory) developed and shined through his institutional client’s boards, he started providing macroeconomic advise to giant corporations such as McDonalds and Nabisco, and also government agencies.
In the eighties, the firm began to regularly publish its insight in a newsletter entitled Daily Observations. This was a paid subscription and till today is sought after and read by major corporate C-level decision makers, influential investors such as pension funds, and central bankers and policy makers all across the world.
Bridgewater’s first mandate to manage money came when their client World Bank entrusted them in 1987 with a 5 million dollar investment to be managed in fixed income. This trend from merely advising on asset management to actually handling the client’s account was followed by two more of their clients, Kodak and Loews, who wanted them to manage their currency exposure in 1990.
The first three clients set a trend that they follow till today — they accept and manage institutional money only, unlike many hedge funds that rely on asset growth from high networth families. Most notably, they guide a lot of pension (both public and corporate) fund money, not only in the sense of being one of the many managers chosen by them, but offering strategic and tactical advise at the highest level of asset allocation. Out of the 270 clients they have today, although many are US-based (mostly public pensions funds and corporate pension plans), a quarter of assets come from foreign government sovereign wealth funds. Needless to mention, the category of their clients vindicates their management abilities.
So far they had created a semblance of hedge fund offerings for their clients on an ad hoc basis. But in 1991, seeing asset management as a natural extension of their advisory services, they officially offered their fund Pure Alpha as a platform to all their clients and prospects.
While alpha is simply a measure of an investment’s excess return over its benchmark, the Pure Alpha fund seeks to outperform the collective returns of the markets it engages in while taking on lower risk. Portable alpha and alpha overlay, as made famous by Ray Dalio, are the central principles of the Pure Alpha fund which seeks to disengage alpha from beta.
In theory, portable alpha has a zero beta or market risk. This is achieved by hedging the portfolio holdings by using derivatives (futures options, or swaps). For instance, if a manager holds the S&P 500 index, he can hedge his position by selling futures on the S&P 500 index, thereby eliminating any beta. Of course, there is a cost associated with the derivative trade and that would eat into the returns. The idea behind the Pure Alpha fund is to reduce beta and then create alpha through active management. Without the active management, this would be a zero-sum game.
Adding the alpha overlay strategy, the fund invests in a diversity of asset classes ranging from foreign bonds to inflation-indexed bonds to currencies to commodities to global equity markets. So it diversifies the sources of alpha itself. Also, the fund fortifies against risk by optimizing the mix of assets classes in such a manner that there is a low level of correlation among them. To execute this dual complex strategy involves constantly analyzing fifteen or more asset classes and simultaneously placing forty or more trades in each asset class.
Since its founding, the Pure Alpha Fund has only lost money in three years (never more than 2%) and averaged a 15% compounded gain net of fees. The fund remained relatively stable through the downturn of the early 2000s (implosion of internet bubble and 9/11) and in the financial crisis of 2008 returned 14% gross. In 2009, however, the fund returned 3%, trailing the equity markets.
In 1996, Bridgewater introduced its second investment vehicle: the All Weather fund. As the name implies the fund is engineered to produce high risk adjusted returns regardless of the current market conditions. This fund was initially started as a personal trust fund for Ray Dalio as he wanted a vehicle that did not rely on alpha generation by active management (since he could not choose the managers for his family after his death). So while the Pure Alpha fund seeks to separate and optimize alpha, the All Weather fund does the same for beta.
The central tenet of the All Weather fund is risk parity. While the concept of risk parity has been around for a while, Bridgewater was the first to offer a product based on it. Today risk parity has become somewhat of a buzzword in institutional investing circles and many similar offerings are cropping up with differences in what they mean by risk parity.
Ray Dalio’s initial approach to risk parity was simply to look at the problem of a traditionally balanced asset allocation fund – say, 60% equities and 40% bonds. While on the surface this traditional allocation seems balanced, the reality is that it highly imbalanced from a risk perspective – 90% of the risk comes from equities and only 10% from the bonds. Hence, these traditional portfolios are far from being truly balanced and in reality rely heavily on equities to achieve their targeted return, thereby highly subject to the volatility (beta) of equities (which defeats the purpose of being balanced to begin with).
Ray Dalio’s solucion: leverage the bond (or any other low beta component of the portfolio) allocation enough so that the associated risk or beta for each asset class matches the asset allocation of the portfolio. By levering the low beta asset and (if needed) de-levering the high beta asset, a portfolio can achieve a 60% equity beta and 40% bond beta. Back testing this formula gives a 3% plus return advantage over the traditional portfolio while reducing volatility. The reason most balanced fund managers do not follow this simple strategy is because they confuse leverage with risk.
Akin to the Pure Alpha fund, the All Weather fund further diversifies itself beyond simple equity and bonds by investing in commodities, global debt, currencies and derivatives. Unlike the Pure Alpha fund, which charges the traditional 2-20 to its clients, the Al Weather fund has very low charges as the strategy depends on matching the returns of the markets it invests in.
Since its inception, the All Weather fund has returned 9.5% (net of fees) which is 50% above most institutional balanced portfolios. Further, it has done so by assuming 25% less risk by deploying the risk parity strategy. It is worth noting that while the fund has indeed abided by its risk parity strategy, it has deviated from Ray Dalio’s original idea that the allocation would remain the same. Under more active stewardship of co-CIO Robert Prince, the fund went into a safe mode with no allocation to equities after the collapse of Lehman Brothers.
In mid-2011, Bridgewater launched a new fund titled Pure Alpha Major Markets that is spearheaded by the co-CEO Jensen. Since the original Pure Alpha fund is closed to new investors, this fund was mainly created to accommodate new commitments of over 7 billion dollars. The fund also seeks to have more liquidity by investing in major markets only.
Investment Philosophy:As already described, Bridgewater applied innovative quantitative strategies to manage money under its two global macro flagship funds. Besides separation of alpha and beta, resulting in alpha portability/overlay and risk parity through systematic diversification in all asset classes, the firm continuously pioneered or enhanced many other strategies: global bond overlay program, advising US Treasury on creation of inflation-indexed bonds, super-long duration bonds for liability management, currency overlay program, and others.
Most recently, Ray Dalio contextualized the subprime-led financial crisis as the “D-process” – deleveraging and deflation – and distinguished it from a traditional recession, thereby recommending investors strategize differently than they would in a regular downturn.
All the innovation and constant tweaking of strategies by their army of analysts are first and foremost guided by Ray Dalio’s meta-philosophy as described in his book “Principles” (available for free on their website). The book has three parts and a fourth one that has yet to be written. Part 1 lays down the significance of espousing principles in general (regardless of whether they are in agreement with his or not). Part 2 expands on his fundamental principles that guide everything he undertakes in his life. Part 3 shows how he applies these principles at Bridgewater. The yet unwritten Part 4 is going to be about his investment principles.
Principles laid out, in reality the general principles described in the book truly lay out what guides his investment strategies. These basic (yet hard to practice) principles are:
(1) Setting one’s own goals.
(2)Using independent thinking to generate ideas on how to achieve the goals.
(3) Stress-testing the ideas against the smartest brains to find out where they are wrong
(4) Cautiously guarding against letting any over-confidence creep in through the ideas and reminding oneself of the virtue of “not knowing”
(5) Awareness and acknowledgment of reality as the ideas are executed, experiencing the results of the decision and constantly reflecting upon the process and how to better it.
Now, translating this into investment parlance:
(1) Establishing desired returns.
(2) Creating a strategy to achieve the returns with the lowest risk possible.
(3) Back-testing and detailed analysis and challenging of the strategy.
(4) Deploying the strategy with diversification, spreading the bets because one does “not know” what will actually happen in the future.
5) Readiness to acknowledge the strategy is not working because of the current realities of markets and tweaking it accordingly.
The third part is decision-making rules from this five step process that are applied by all employees regardless of their rank in the firm. The decision making tools have actually been incorporated in the firm’s proprietary software so that there are numerous check points before a strategy or tactic is executed. Also, true to the fourth principle of challenging one’s investment thesis against the best of the best, at Bridgewater all employees are encouraged to challenge anyone’s ideas without regards to their seniority. In essence the book has become the cornerstone of how to continuously generate improvement and innovation in money management at Dalio’s hedge fund.
Read more about hedge fund manager Ray Dalio