11 September 2006
Issue 522
Bridgewater seeks competitive
advantage through lateral thinking
Founder Ray Dalio Founder Ray Dalio says his com-
pany’s culture is its most important
says his company’s asset.
Ray Dalio, founder of Bridgewa-
culture is its most ter Associates, places his firm
somewhere between 17th century
important asset violin maker Stradivarius, who
crafted the world’s most expensive
stringed instruments, and com-
writes Renée puter company Apple.
The common theme is innovation.
Schultes Dalio founded Bridgewater in 1975.
Thirty-one years later he is running
a $150bn (€117bn) money manager,
the fastest growing this decade, and
the third-largest hedge fund with
$30bn. He founded Bridgewater
against a backdrop of monetary pol-
icy tightening and recession. The US
dollar floated in 1971 and the first oil
shock came in 1973.
International investing was
beyond the imagination of US insti-
tutional investors absorbed with
domestic equities and bonds.
Instead, Bridgewater worked for
corporations that needed interest
rate and currency exposures
hedged, a skill Dalio developed at
Shearson, Hayden Stone, a New
York broker, since absorbed by
Lehman Brothers. In the mid-1980s
US investors made their first steps
outside the US, which is when Dalio
turned to money management.
He argued if he could manage
corporations’ exposures to interest
rates and currencies, he could likely
do it for pension funds. Bridgewa-
ter’s first bond mandates came in
1985 and its first currency overlay
brief in 1990. But investors did not
©Financial News 2006
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understand Dalio’s philosophy.
Beyond running long-only domes-
tic and global bond funds, Bridge-
water was advocating a separation of
market risk, or beta, from manager
skill, known as alpha, 20 years
before it gained acceptance.
“Interest rates fell between 1982
and 2001, which meant bonds and
stocks rose and traditional portfo-
lios did well. People didn’t want to
change and there was no question-
ing of what was the best way of
doing things. Then stocks fell and
projected returns became unac-
ceptably low so they learned they
had too much money in equities and
needed to raise returns. At the
same time people became smarter
and they started to understand
derivatives and financial engineer-
ing. So, in 2001 and 2002 people
began to accept our thinking about
separating alpha and beta.”
Over a period of almost two Dalio: “conflict in pursuit of
decades Bridgewater worked with excellence is a terrific thing”
clients to develop better ways of
investing. seen by the outside world to be
Dalio likens the firm’s culture to overbearing and confrontational.
Apple Computers, founded one year Britt Harris, who joined Bridgewa-
after Bridgewater in 1976. “It’s a cul- ter as chief executive from Verizon
ture of innovation. Apple isn’t suc- Investment Management in
cessful because they have the iPod. November 2004, left six months
They are successful because they later. At the time Dalio said the cul-
have a culture that invents. Regarding tural fit had been a problem.
having a culture of innovation, the Dalio encourages his employees
main difference between us and to challenge each other, which
Apple is that they’re dealing with the includes himself. “Conflict in the
mass market and we’re dealing with pursuit of excellence is a terrific
an institutional market in which much thing and is strongly encouraged, in
more tailoring can exist.” fact demanded,” he said.
Bridgewater’s culture is often The trick for Dalio has been to
build a culture of people with shared
values.
“In the financial and hedge funds
world, a lot of people are attracted
to the image of a young guy in a
Ferrari. But you cannot be at
Bridgewater and be working for
that sort of reward. You have to like
the notion of intellectually working
yourself through questions and
being challenged to get at the right
answers. We have to challenge and
educate our people to keep them
happy and to have them give back to
us what we want,” he said.
Bridgewater may have built a
thriving hedge fund business but its
success is based on traditional bond
management skills.
In global fixed income, Bridge-
water has achieved an annualised
return of 6.1% over the three years
to the end of June, according to
Mercer Investment Consulting.
The index return over the same
period is 4.1%. This demonstrates
Bridgewater’s record in sovereign
fixed income, where it does not use
its diversified alpha pool. Including
the alpha overlay, returns would be
higher again.
With 500% asset growth since
2000, capacity has been high on the
agenda.
The first step Dalio took was to
stop taking money into traditional
mandates, such as global bonds,
inflation-indexed bonds, currency
overlay and emerging market debt
about 18 months ago. It continued to
accept accounts for portable alpha,
where it adds returns from asset
classes outside the benchmark of
the mandate.
Before 2001 about 80% of man-
dates did not separate beta from
alpha, compared with more than
80% that did afterwards.
Late last year, Bridgewater was
close to reaching capacity and
closed portable alpha strategies. Its
Pure Alpha hedge fund remained
open until early this year, when at
$30bn, it, too, closed to new money.
The All Weather beta fund, which
does not face the same capacity
constraints as its hedge fund or
other active strategies, remains
open. Dalio calls it optimal beta.
“People have concentrated portfo-
lios and are looking at how to
restructure to make them more effi-
cient. There’s not a broad recognition
yet about how to structure this.”
Pure Alpha, started in 1989, is
the diversified alpha source that
Bridgewater combines with other
benchmarks to fuel returns.
The fund takes positions in fixed
income, commodities and curren-
cies but more recently has made its
first equity investments. Dalio said
this would not improve capacity but
rather give the fund another source
of uncorrelated alpha. Bridgewater
takes offsetting long and short posi-
tions in global equities.
“One of the best ways to diversi-
fication is to take spreads, because
each spread is uncorrelated to the
next. Single positions aren’t,” said
Dalio.
Equities account for about 8% of
Pure Alpha but Dalio expects this
could grow to as much as 25% in
the next five years. His team spent
five years researching equities and
testing strategies before making its
first investment.
A US investment consultant said
of the change: “That’s something
we’re going to be watching, espe-
cially since Bridgewater’s history
is as primarily as a currency and
bond manager. Its use of equity
strategies in the Pure Alpha product
isn’t new, and it has been saying for
a while that they expect to increase
these strategies’ share of the risk
budget, so we’re interested to see
how they design and develop these
strategies, and how they operate.”
It took 20 years for Bridgewa-
ter’s concept of portable alpha to
gain credence among pension
funds. With Dalio closed to new
money, there is a quest to identify
the next Bridgewater.
Dalio sees the line between
hedge funds and traditional money
managers disappearing. A market
environment of diminishing liquid-
ity will place greater emphasis on
pure alpha investing. The strategies
Dalio calls trained-monkey ones,
which rely on certain market condi-
tions to work, are relics of the past.
“Alpha managers are competing
for the whole enchilada. It means if
you are a traditional equity manager
you can’t compete with an alpha
overlay manager to produce com-
parable results because you don’t
have the diversification of alpha to
produce the same information ratio.
The radical change that we are
going to see ahead, is that many
others will follow the Bridgewater
model to creating diversified alpha
and porting it and will out-compete
the traditional managers. We’ve got
about a 5 year lead time advantage
by virtue of our experience of hav-
ing done this for 15 years. Invest-
ment managers and investors fol-
lowing this model are going to have
radical implications on how money
is managed. The most fundamental
break will be between alpha and
beta, so there will be alpha man-
agers and beta managers. There
will be no such thing as equity, bond
or hedge fund managers in the tra-
ditional sense,” he said.

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