Inside the world's biggest hedge fund
Bridgewater founder Ray Dalio's intense focus on principles helps him make money in good times and bad. Now he's bracing for some very tough times indeed.
(Fortune Magazine) -- Is the current downturn merely a severe slump, or are we facing a second coming of the Great Depression? That's the question everyone is asking these days. But Ray Dalio, founder of Bridgewater Associates and manager of what is now the world's biggest hedge fund, has been preparing to answer it for eight years.
In 2001 he had his investment team build a "depression gauge" into the firm's computer system, line by line in the code, to adjust the portfolio's strategy and risk profile if the economy ever entered a massive deleveraging period - the kind of multiyear process that ricocheted through the world economy in the 1930s and that has eviscerated markets periodically through the ages.
On Sept. 30 of last year, just a couple of weeks after the failure of Lehman Brothers, Dalio logged into his system and saw that the computer had flipped the switch. Bridgewater's black box is now operating on high alert.
Yet even as he is preparing his clients to hunker down for something different and more challenging than a typical recession, Dalio still expects his fund to thrive. Because his approach doesn't depend on the direction of any particular market, he explains matter-of-factly, there is no reason that he shouldn't continue to find as many good investment opportunities as he always has. Considering what he sees coming, that's a pretty bold statement.
In normal times we might be writing about Ray Dalio, 59, simply because he's one of the world's most successful investors. Since starting Bridgewater Associates out of an extra bedroom in his Upper East Side Manhattan apartment in 1975, Dalio (pronounced Dally-o) has built the firm into a powerhouse managing some $80 billion. With a personal fortune estimated at more than $4 billion, he ranks as one of the wealthiest residents even in money-soaked Greenwich, Conn.
More impressively, for the past 18 years his flagship hedge fund, Pure Alpha, which now holds more than $38 billion, has averaged an annual return of 15% before fees - gliding through the Asian flu of the 1990s, the dotcom implosion, the terrorist attacks of Sept. 11, 2001, and the current worldwide financial crisis without ever suffering an annual loss greater than 2%. Last year, when 70% of hedge funds lost money and the average fund fell 18%, Pure Alpha generated a gross return of 14%.
But these are not normal times. And what makes Dalio compelling is not just his track record but the way he goes about making money, and the rigorous analysis he applies to understanding markets, organizations, the economy, and life.
Does Dalio think of himself as one of the world's great investors? "No," he says, shaking his head, visibly agitated. "First of all, I don't know what the definition is of 'one of the great investors.' It's a totally irrelevant question. I have the fear of messing up. And that fear drives me to ask, 'Well, could this thing happen? Could that thing happen? If it happened in Japan, how do I know it won't happen to me?'"
Dalio describes himself as a "hyperrealist," in the sense that he is driven to understand the processes that govern the way the world really works, without bringing subjective value judgments into the equation. "I think the thing that makes him different is an intolerance for the inadequate answer," says Bob Prince, 50, Bridgewater's co-chief investment officer, who's been with the firm since 1986. "He'll just keep peeling back layer after layer to get at the essential truth."
In every activity in his life - from managing his firm to stalking a wart hog on a bow-hunting trip - Dalio believes in applying a carefully thought-out process to get the results he wants. That's especially true in making investment decisions. "I'm very big on having clarified principles," he says. "I don't believe in being reactive. You can't do that in the markets effectively. I can't. I need perspective. I need a game plan." To develop one, he stress-tests strategies through computer simulation across time and around the world to make sure that they're "timeless and universal." It's all about cautious - and highly educated - wagering on probabilities.
During the long boom, many hedge fund managers earned billions on big leveraged bets that stocks would rise; later, a handful made fortunes by anticipating the bust. That not Dalio's style. (In fact, he hates being called a hedge fund manager.) For one thing, he doesn't magnify his bets with a lot of borrowed money - his leverage ratio is about 4 to 1, far less than other investors have used.
Like fellow quant-minded managers D.E. Shaw or Jim Simons of Renaissance Technologies, Dalio translates his insights into algorithms and then has a powerful computer system scour dozens of markets around the world looking for mispriced assets and other opportunities. Rather than focusing only on stocks and searching for Peter Lynch's proverbial "10-bagger," Dalio and his computers concentrate heavily on the currency and fixed-income markets, grinding out consistent singles, doubles, and occasional triples. That approach, as we've seen, can be very rewarding.
Bridgewater's main office is an unobtrusive, three-story stone and glass building that sits on 22 acres of heavily wooded land in Westport, Conn., some 20 miles up the coast from Greenwich. The firm has added space in three other buildings around the area as the explosive growth in its assets under management - averaging more than 40% annually for the past 10 years - has necessitated a similar investment in new employees and technological capacity. Since 2000 its headcount has grown from just under 100 to about 800, with more than 100 people in its client services division alone.
Unlike a typical hedge fund, Bridgewater does not manage money for wealthy individuals. Rather, it works only with large institutions like pension funds and sovereign wealth funds. Right now the firm has 270 clients, about half in the U.S. and half overseas. Like a standard hedge fund, it charges a management fee of 2% of assets and 20% of profits.
But its relationship with its investors consists of much more than taking a cut of their money. Bridgewater's army of analysts provides clients with a stream of research. "I love their daily economic report," says Loews Corp. CEO Jim Tisch. "For me it's a must-read." And the analysts are always on call to perform custom jobs or offer a portfolio critique - even of allocations to other hedge funds. "I view them more as a partner than a vendor," says John Lane, the director of Eastman Kodak's $7.5 billion pension portfolio, which has had money with the firm since the late 1980s. "We don't make a major change here in strategy without calling Bridgewater to get their view."
The money-management industry has been battered by scandal and failures lately, but Lane has complete confidence in Bridgewater. "Of all the investment firms we work with," he says, "they're the most trusted." Asked head-on about the trust issue, Dalio points out that outside custodians hold customers' money and that his institutional clients aggressively audit Bridgewater's operations.