Ray Dalio – Part Seven: Making Mistakes – 2013

July 7, 2015

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By Michael Ide. Originally published at ValueWalk.

This is part seven of a ten part series on Ray Dalio (and part of our upcoming ebook on Ray Dalio, which will include much information not available to the public), founder of Bridgewater Associates the world’s largest hedge fund manager.

Founded by Dalio during 1975 from his two-bedroom apartment, today Bridgewater manages $171 billion for a wide array of institutional clients, including foreign governments and central banks, corporate and public pension funds. Parts one through six of the series can be found at the links below.

Ray Dalio — Part Seven: Making Mistakes

Continued from part six…

…Dalio replicates this approach at Bridgewater. Ray Dalio tries to put in place what he calls “true open-mindedness”. This, as Dalio describes it, is a process of being intensely worried about being wrong and asking questions instead of defending a position.

“This approach comes to life at Bridgewater in our weekly research meetings, in which our experts on various areas openly disagree with one another and explore the pros and cons of alternative view. This is the fastest way to get a good education and enhance decision-making. When everyone agrees and their reasoning makes sense to me, I’m usually in good shape to make a decision. When people continue to disagree and I can’t make sense of their reasoning, I know I need to ask more probing questions or get more triangulation from other experts before deciding.” — Ray Dalio on his unconventional wisdom.

But even though Ray Dalio works 24/7 to ensure that Bridgewater avoid making serious mistakes, mistakes do happen. Bridgewater has lost money in three years since its inception, and some speedbumps along the way have slowed growth.

For example, Bridgewater’s All Weather fund stumbled during the first half of 2013. Dalio was bullish on the market, betting that both stocks and bonds would head higher throughout the year. Then in May, a mini taper-tantrum sent stocks and bonds plunging.

Bridgewater’s exposure to bonds, like Treasury inflation protected securities, or TIPS held the fund back. TIPS lost over 8.2% during the first half of 2013. (All Weather is designed to perform best when there is a sharp sell-off in either stocks or bonds.) What’s more, Bridgewater was hit by a large level of leverage on the fixed income side, which magnified losses — we know this as Ray Dalio actually wrote in Bridgewater’s 300-page 2013 report (issued at the beginning of 2014 and reviewed by ValueWalk) that “borrowing cash to hold risky assets is as attractive as it has ever been.” From the New York Times:

“A number of risk-parity funds like All Weather were caught off guard by a sudden rise in Treasury yields last summer. Treasury yields began to rise last May after speculation began that the Federal Reserve would soon scale back its monthly purchases of United States Treasury’s and mortgage-backed securities. The Fed began slowly scaling back its purchases, which are intended to stoke economic growth, last month. Last year also was a particularly rough one for TIPS and other inflation-protected securities. TIPS tend to perform poorly when Treasury yields rise and inflation is low. Last year, iShares TIPS, an exchange traded fund that tracks the inflation-protected securities market, fell about 9 percent.”

Dismal year

At the end of June 2013, Bridgewater’s All Weather fund was down 8% for the year. However, it managed to recover some of these losses during the second half. The fund ended the year down 3.8%. Unfortunately, these returns looked dismal compared to the wider market’s performance. The S&P 500 rose by more than 30% during the year. Bridgewater’s Pure Alpha fund rose 5.25% for the year.

The blog Zerohedge provided an explanation as to why Bridgewater had such a dismal 2013:

“Long story short, the internal assumptions behind Risk Parity blew up spectacularly in a year in which yield soared, while equity markets dipped initially only to rebound furiously, without a concurrent spike in inflation expectations.”

Which is an assumption that goes against Ray Dalio’s own advice to anticipate everything and plan for every eventuality:

“…how it would work in all circumstances, including circumstances that did not occur within the period that’s your frame of reference, you will inevitably do badly.”

Simply put, during 2013, Bridgewater was caught off guard.

Defying critics

All Weather performance during 2013 dented Ray Dalio’s reputation. Nevertheless, criticism of his strategy didn’t last for long. During the first half of 2014 All Weather returned 11.2%, almost double the return of the S&P 500 over the same period.

Over the 12 months to the end of June 2014 the fund returned 17.0% erasing all of the losses racked up during 2013. During the first half of 2013 Bridgewater’s Pure Alpha fund returned 7.8%.