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Hedge funds

Bridgewater’s Dalio talks life, work in new book

Bridgewater Associates founder Raymond Dalio

Institutional investors play a prominent role in "Principles," Raymond T. Dalio's new book about his life and work as the founder, co-chief investment officer and co-chairman of Bridgewater Associates LP.

In fact, it was a request in 1990 for help in hedging the equity risk of Eastman Kodak Co.'s pension fund from Russell "Rusty" Olson, the chief investment officer at the time, that led Mr. Dalio and his colleagues to devise the firm's flagship Pure Alpha investment strategy.

The 550-page book, which hits virtual and brick-and-mortar book stores Sept. 19, is designed to be a how-to manual for personal and work life issues and is neatly divided into two parts.

In the first half, Mr. Dalio focuses on his professional life and the principles he developed to help himself and other Bridgewater employees make better decisions.

The second segment is an updated version of Bridgewater's widely known — and controversial — internal working principles that focus on and foster "radical truth" and transparency among the firm's employees who manage $165 billion in hedge fund and risk-parity portfolios for an institutional client base.

In an interview with Pensions & Investments, Mr. Dalio said "Principles" resulted from his preparation to step away from managing the business side of Westport, Conn.-based Bridgewater. He relinquished the role of co-CEO earlier this year, leaving the administration of the firm to co-CEOs David McCormick and Eileen Murray.

"It was very important that I write everything down so I'm not needed to run the firm. 2017 is my transition year out of management but not out of investment management, which I intend to do for the rest of my life," Mr. Dalio said during the telephone interview.

That Mr. Dalio founded Bridgewater in 1975 from a two-bedroom apartment has become the stuff of investment industry legend but what's not well known is that he did not set out to be a money manager and an institutional specialist.

"Unlike most people who work in the markets, I never had any desire to build investment products, especially conventional ones, just because they would sell well. All I wanted was to trade the markets and build relationships, doing for our clients exactly what I would do if I were in their shoes," Mr. Dalio wrote.

In the early years, Mr. Dalio and his team focused on developing systematic trading systems utilizing the "rapidly expanding power of computers during that era," he wrote. The firm's three main businesses were fee-based consulting, managing companies' risks for incentive fees and selling its research.

Until late 1983, Bridgewater's business grew by word of mouth. But realizing that "clearly, there was a growing demand for our research" and that selling the research would supplement trading and consulting income, Mr. Dalio wrote, he hired a marketer, Rob Fried, a former door-to-door Bible salesman.

The road trips Messrs. Dalio and Fried made to sell the company's $3,000-per-month research package, including daily telexes, weekly conference calls, biweekly and quarterly research reports, and quarterly meetings, resulted in asset owners such as The World Bank, General Electric, The Singer Co., Loews Corp. and GTE Corp., as well as institutional money managers such as Wellington Management Co., Loomis Sayles & Co. LP and Brandywine Global Investment Management LLC becoming Bridgewater clients.

Having dealt closely with these new external clients, Mr. Dalio wrote that he changed his mind about managing money. "By the mid-1980s, a couple of things were clear to me: First, we were making good calls in the interest rate and currency markets, and the institutional investment managers who were buying our research were using it to make money. Second, we were successfully managing companies' interest rate and currency exposures. With those two things going as well as they were, I figured we could become successful institutional investment managers ourselves."

Mr. Dalio's first pitch for money management services was to Hilda Ochoa, then CIO of the World Bank's pension fund, and "despite the fact that we had no assets under management and no track record, she gave us a $5 million U.S. bond account to manage," wrote Mr. Dalio, adding "that was a huge turning point for us, as it was the start of Bridgewater as we know it today."

The strategy Bridgewater used for managing the World Bank mandate "did very well and before long, other large institutional investors gave us money to manage as well," Mr. Dalio wrote, noting Mobil Oil and Singer were the firm's next two institutional investment management clients.

By 1990, Bridgewater's 24 employees were running $180 million but were "still trying to grab a larger foothold in the institutional investment business," Mr. Dalio wrote.

The 1990 fax from Eastman Kodak's Mr. Olson — who was not yet a Bridgewater client — was a pivotal point for the firm.

"The Kodak pension fund was heavily invested in equities and Rusty was worried about what would happen in an environment in which the value of his assets fell badly. He had been trying to come up with a way to hedge himself against this risk without reducing his expected return," Mr. Dalio said in his book.

The Bridgewater team deconstructed the Kodak portfolio into its constituent parts — essentially what produced alpha and what produced beta — and devised a portfolio management solution that "drew on the portfolio engineering ideas that would later become core to Bridgewater's unique way of managing money," Mr. Dalio wrote. Mr. Olson ended up investing $100 million in the proposed strategy.

"That was a game changer," Mr. Dalio wrote, adding "not only did it bring us a lot of credibility, it provided us with a reliable source of income at a time when we needed it."

Building on the portfolio engineering processes used for the Kodak strategy, Bridgewater researchers delved further into portfolio diversification to see how alpha and beta could be separated. The team tested Mr. Dalio's theory that the volatility of a portfolio would decline and its quality improve if investments with different correlations were added.

The results of the experiment "struck me with the same force I imagine (Albert) Einstein must have felt when he discovered E=mc2," Mr. Dalio wrote, noting, "I saw that with 15 to 20 good, uncorrelated return streams, I could dramatically reduce my risks without reducing my expected returns."

The discovery led to the development and launch in 1991 of the firm's flagship Pure Alpha strategy, an alpha overlay that allowed investors to get the return of whatever asset class they chose plus the return from the bets Bridgewater was making across asset classes.

The rest is investment industry history. Institutional investors have flocked to the Pure Alpha approach: assets now total $83 billion and the strategy is closed to new investors.

Mr. Dalio noted in the book that Pure Alpha strategy has produced positive returns in 23 of its 26 years and made "more money in total for our clients than any other hedge fund ever."

During the telephone interview, Mr. Dalio said one of his accomplishments was his contribution to the separation of alpha and beta sources and the ways investors can calibrate the right proportion of each in their portfolios.

One of the upsides of shifting his concentration back to money management is the ability to spend time with more of Bridgewater's institutional investors, working out solutions to thorny investment issues, he said.

The timing of Mr. Dalio's move back to the investment side of the firm comes at a crucial time for institutional investors who are going to find it "harder than ever to beat their hurdles" in a low-return environment, he said.

"It's all about how you diversify your portfolio. You need to really understand financial engineering This is a time when you do not want to be too concentrated because debt and financial obligations are going to lead to low nominal and low real returns," he added.

Mr. Dalio discussed his life and work principles in a TED talk in September.

He also spoke with Pensions & Investments' Christine Williamson and Joel Chernoff about how the firm's Pure Alpha strategy not only survived but thrived during the 2008 financial crisis in a vintage 2009 podcast from Bridgewater's Westport, Conn. headquarters.