In our second installment of “Lessons from Hedge Fund Market Wizards“, we’ll offer up some trading and macroeconomic insights pulled from Jack Schwager’s interview with Ray Dalio of Bridgewater Associates.
You've probably heard of Ray Dalio if you have even a cursory knowledge of the hedge fund industry (or the Forbes billionaires list), so let's get right to it. These notes will fill in the rest of the story.
1). Dalio is the founder and former CEO (now "mentor") of Bridgewater Associates, a fund that has returned more money ($50 billion) for investors than any hedge fund in history.
2). Bridgewater still manages to achieve excellent returns on a huge base of capital and has done so over a long period of time. It is among the few hedge funds with a 20-year track record.
3). Dalio believes that mistakes are a good thing, as they provide an opportunity for learning. If he could figure out what he (or someone else) was doing wrong, he could use that as a lesson and learn to be more effective.
4). His life's philosophy and management concepts are set down in a 111 page document called, Principles, which drives the firm's culture and daily operations. Identifying and learning from mistakes is a key theme. It also advocates "radical transparency" within the firm; meetings are taped and employees are encouraged to criticize each other openly.
5). "The type of thinking that is necessary to succeed in the markets is entirely different from the type of thinking required to succeed in school". Ray notes that school education emphasizes instructions, rote learning, and regurgitation. It also teaches students that "mistakes are bad", instead of teaching the importance of learning from mistakes.
6). If you are involved in the markets, you must learn to deal with what you don't know. Anyone involved in markets knows you can never be absolutely confident. You can't approach trading by saying, "I know I'm right on this one." Dalio likes to put his ideas in front of other people so they can shoot them down and tell him where he may be wrong.
7). "The markets teach you that you have to be an independent thinker. And any time you are an independent thinker, there is a reasonable chance you are going to be wrong."
8). Ray learned in his early working years that currency depreciation and money printing are good for stocks. He was surprised to see US stocks rise after Nixon closed the gold exchange window in 1971 (effectively ending the gold standard). The lesson was reinforced when the Fed eased massively in 1982 during the Latin American debt crisis. Stocks rallied, and of course, this marked the beginning of an 18-year bull market.
9). From these earlier experiences, Dalio learned not to trust what policy makers say. He has learned these lessons repeatedly over the years (much like our previous "Market Wizard", Colm O'Shea).
10). Dalio vividly recalls a time when he was nearly ruined trading pork bellies in the early 1970s. He was long at a time when bellies were trading limit down every day. He didn't know when the losses would end, and every morning he'd hear the price board click down 200 points (the daily limit) and stay there. The experience taught him the importance of risk management - "I never wanted to experience that pain again".
11). "In trading you have to be defensive and aggressive at the same time. If you are not aggressive, you're not going to make money, and if you are not defensive, you are not going to keep money.".
12). Bridgewater views diversification and asset correlation differently than most. As Dalio puts it, "People think that a thing called correlation exists. That's wrong.". Instead, he describes a world in which assets behave a certain way in response to environmental determinants. Correlations between say, stocks and bonds, are not static, but are changing in response to "drivers" (catalysts) that can cause assets to move together or inversely.
13). By studying how asset prices move in response to certain drivers, Bridgewater looks to build portfolios of truly uncorrelated assets. By combining assets that have very slight correlations, they are able to diversify among 15 assets (instead of 100 or 1000 more closely linked assets). This helps them cut volatility and greatly improve their return/risk ratio.
14). We are currently in the midst of a "broad global deleveraging" that is negative for growth. Since the United States can print its own money, it will do so to alleviate the pressures of deflation and depression. The effectiveness of quantitative easing will be limited, since owners of bonds purchased by the Fed will use the money to buy similar assets. Dalio elaborates on our future economic course and possible policy approaches to these problems throughout the interview.
There's a lot more in Schwager's chapter with Ray Dalio. These notes just scratch the surface on Bridgewater's process and their quest for the Holy Grail of investing.
There is also an addendum to the chapter containing Dalio's big picture view of long-term economic cycles and a historical "stage analysis" of the economic rise and fall of nations.
Be sure to check out this latest Market Wizards book (a very worthwhile read) and look for our upcoming posts for more "Lessons from Hedge Fund Market Wizards". In the meantime, you'll find more lessons and interviews in our related posts below.
- Lessons from Hedge Fund Market Wizards: Colm O'Shea.
- Jack Schwager interviews on Hedge Fund Market Wizards.
- Ray Dalio in Barron's: "It's a D-Process".
- Ray Dalio's 'Principles'.