Technology is a double-edged sword: It helps corporate profitability; but by replacing people in jobs, it hurts employment, a contributing cause to the slow-growth U.S. economy. This is one reason that, even as the stock market is at an all-time high, the economy continues to grow at a slow pace. So says Ray Dalio, founder of $160 billion Bridgewater Associates, the largest hedge fund in history.
The famed investor explains the current economy and market, issues warnings, discusses unconventional ways his firm operates and offers blunt advice to financial advisors, in an interview with ThinkAdvisor.
Early in his career, Dalio, 68, worked in the brokerage business, notably at Shearson. The firm fired him for unruly behavior, an event prompting him, in 1975, to start his own firm, to which his clients were all too happy to move, he writes.
This past spring he handed over management of his 1,500-employee company to Eileen Murray and David McCormick, co-CEOs, while he remains co-chief investment officer and co-chair.
In his just-published book, “Principles: Life and Work” (Simon and Schuster), Dalio sets forth hundreds of his principles, or rules — many of them unconventional — under which his company operates. A second book, to focus solely on his economic and investment principles, will arrive by 2019.
Technology is Dalio’s vital partner, and he has been at the forefront of using it in unique ways. Indeed, for the last 30 years, Bridgewater techies have converted his investing principles into algorithms, which are employed in tandem with managers to make investment decisions. Other principles-converted algorithms help make management decisions.
Bridgewater, whose clients are mainly large firms, pensions and banks, is the fifth most important private company in the U.S., according to Fortune. Fund of funds LCH Investments says the firm has made more money for clients than any other hedge fund ever. Its best known strategies are the All Weather (beta) and the (value-added) Alpha portfolios.
Dalio’s 567-page “Principles” is partly autobiographic, partly a guide on how his life and work principles can be broadly used by others to run their companies. In fact, he plans to make available to large firms a smartphone app of tools based on these principles.
In the interview, Dalio gives a peek into what his economic and investment principles book will and won’t reveal. He also discusses his reported plan to launch an investment fund in China.
Bridgewater, based in Westport, Connecticut, is run as an “idea meritocracy,” as Dalio describes it: Disagreement is encouraged, and the best ideas win out. The system requires “radical truth” — an accurate understanding of reality — and “radical transparency” — employees not hiding what they really think.
Some uncommon practices, such as videotaping meetings, have been criticized as Big Brother-ish. Dalio’s response: “Sensationalistic writers,” who have never worked at Bridgewater or even visited, have served up “distorted” representations.
On the other hand, Dalio’s M.O. scores high praise from academics who have studied Bridgewater’s culture: “When employees share independent viewpoints instead of conforming to the majority, there’s a much higher chance that Bridgewater will make investment decisions no one else has considered and recognize financial trends no one else has discerned,” writes Adam Grant, a professor at the Wharton School of the University of Pennsylvania.
ThinkAdvisor recently spoke by phone with Dalio, a native New Yorker, born in Jackson Heights, Queens, bred in New Hyde Park, on Long Island. As a risk-taker betting on what’s likely to occur in the economy and markets, he calls his role essentially that of “economic mechanic.” Here are highlights of our interview:
THINKADVISOR: Your website says: “Bridgewater is even more a technology company than it is a hedge fund.” How’s that?
RAY DALIO: We use computers to take our thinking and convert it into algorithmic decision-making. So the technology pieces are as important as the investment pieces.
How does that systematic decision-making work with regard to investing?
We write down the criteria and principles of how to deal with a certain type of situation and then convert those into algorithms. Every time we go through an experience or think about making a decision, we test those back in time to gain good perspective. The computer makes the decisions next to us. It’s very much like running with your GPS. If it says that you turn right, you think, “Do I turn right here?”
What about people-management issues?
We operate similarly. We write down the principles of how we’re going to deal with each other — knowing how to make the most of disagreeing to get the better decisions — and in some cases we put those into algorithms.
There doesn’t appear to be much room for improvising in your decision-making. Seems very scientific.
It starts with improvising, and then it goes to systemization. It starts with imagination, and that has to be carried down to execution. It’s probably very similar to [the M.O. at] Steve Jobs’ Apple. Systematizing decision-making is very powerful, but the imagination part is equally as powerful.
You begin the introduction of your book: “…I want to establish that I’m a ‘dumb shit’ who doesn’t know much relative to what I need to know.” And then you take nearly 600 pages to tell how smart you are.
No. I don’t. As I explained further on, whatever success I’ve had in life has been because of my knowing how to deal with my not knowing things. It isn’t what’s in my head that’s most valuable, although I did learn a lot along the way; it’s knowing how to deal with not knowing that’s been the source of my success.
You’re writing another book about your economic and investment principles. Will you reveal how your firm has made so much money investing?
No. We’re not going to reveal any algorithms or anything that would do us harm or threaten our well-being. These are going to be concepts [in the book], which are not proprietary.
You plan to share your apps with some large companies. Will they be tools for investing?
No. They’re for people management rather than investment management.
Reports are that you plan to raise a fund in China. True?
Our involvement in China will develop. I’ve been going there since 1984 and have a unique relationship with it. We manage money for large Chinese institutions. The markets right now have developed an openness to foreign investment and a liquidity, which means there’s no good reason not to invest in China. If there are no barriers to entry, there’s no reason we shouldn’t be as active in China as we are in other countries.
Do you see a disconnect between the U.S. stock market’s being at an all-time high, while at the same time the economy continues to grow slowly?
No, I don’t. Markets, in general, are driven by the interest rate. As interest rates go down, as they have, that’s helped. Second, the purchases of financial assets by central banks have pushed asset prices up. Third, the expected returns of bonds and equites going forward are at relatively normal premiums to the existing short-term interest rate.
What are the implications of all that?
People buy profits, not the economy. So if the corporate tax rate is cut, a company is worth more even though the economy might or might not pick up on that. If regulation is reduced, that stimulates business. It might have other consequences, but it causes profits to rise.
Any other critical reason for what’s happening in the economy and market?
Technology, which is improving profitability, is also worsening [employment]. That worsens the economy because technology is replacing people [in jobs]. Improving profitability [through technology] is good for companies but not good for the economy as a whole because the people losing jobs are also the people who are more inclined to spend income. I call that group the lower 60%. So technology helps profits but hurts employment and helps to cause a slower economy at the same time it has caused companies to be worth more.
Has the U.S. ever been in a situation like that before?
We had a similar one between 1935 and 1940. I would say that 1937 [during the Great Depression, two years before start of World War II] is most like the year today. We had the same sort of debt crisis; interest rates went to zero; and the central banks printed a lot of money and bought financial assets, which went up in price. We had the same sort of wealth gap and the same sort of populism around the world.
So is there a lesson from 1937?
It’s very important that the Federal Reserve be very cautious and slow to tighten monetary and fiscal policy because we have asymmetrical risks: many more risks on the downside than on the upside. And be cautious about how political and social conflict is handled. Can we work together, or are we going to be split? Even though the stock market is at its peak and the unemployment rate is at a low, for the bottom 60% it’s a bad economy. We must not have an economic downturn.
What advice can you offer financial advisors?
I was in their shoes. I’d have my products, so to speak, to sell. The advice I have for wealth managers is to find clients you have a simpatico with, who let you do what’s important to you so that you can be honest [open]. In the long run, don’t be two-faced. Don’t lose integrity. Be authentic. If you’re two-faced and put the product and your own interest ahead of the client’s interest, that will be a problem.
What did you do to become successful in the brokerage business?
I needed to be an original, independent thinker. So I did investments strategies that had never been done before. I created risk parity, the separation of alpha and beta, and currency overlay. At first, it would separate my clients because these were unusual strategies, but I needed to do what I felt was best.
You write that collective decision-making is the “secret sauce” behind your success. How so?
In order to be successful in the market, as I said, you have to be an independent thinker who bets against the consensus and is right. It’s so easy to be wrong. If you have quality collective decision-making with people who are willing to disagree well and work themselves through it well, you raise the probability of being right.
You stress in your book that one of the greatest tragedies is people’s persisting to hold opinions in their head that are wrong. Why is that a tragedy?
They don’t put them out to stress-test, and that causes them to make worse decisions. If people could be more open-minded and assertive at the same time, they can learn a lot. You can’t be attached to what you know. That’s the most important thing in my book. And also, to learn from painful mistakes.
Have you made any of those?
Yes. In 1982 I made a terrible [investment] decision and had to let everybody in my company go. I had to borrow $4,000 from my dad to help take care of my family. I was broke. It was one of the most painful experiences of my life, but it changed my mindset from thinking, “I know” to asking myself, “How do I know?” That led to [using a system of] idea meritocratic thinking.
The most important secret to our success is to have an idea meritocracy in which the goals are meaningful work and meaningful relationships — that is, you hold each other at a high standard. The way you get there is through radical truthfulness and radical transparency, where people put their honest opinions on the table for all of us to look at. The second step is to have a quality back-and-forth so you can take full advantage of different perspectives. Third, you need a way of getting past disagreements. If you can do those things, magic happens.
One of your firm’s practices is videotaping meetings. That strikes some outsiders as strange. Do you do that as a practical matter or to capture people’s opinions and ideas?
It’s for the purpose of radical transparency so that people can see things themselves. If you don’t see something yourself, you’re subject to “spin” — somebody else describing it. By being able to see what’s going on yourself, you can have that idea meritocracy.
Another rule is that managers reporting to you send you a daily memo describing what they’ve done that day. How does that translate into helping Bridgewater make smart investments?
Whenever I’m dealing with people, whether it’s through investing or management work, I’ve found it very helpful to stay in touch that way, and [vice-versa]. We built that into a tool that allows other people to stay in touch and also to collect, on an ongoing basis, a lot of data about what they’re encountering; for example, if they’re finding inefficiency someplace or what the mood or the work level is.
What’s your take on the long-running debate about active vs. passive management and the move toward ETFs and other passive investments?
The question is: How much alpha can I buy by going to [a manager]? That alpha game is a zero-sum game. So don’t expect, on average, to get alpha because when somebody buys, somebody else has to sell. It’s like at a poker table: somebody will take money from somebody else — and there will be better players. There will always be smart people who will be able to make better decisions and pursue alpha. The challenge is to find them because those who are good at it are largely closed to new investors.
How did you get interested in trading stocks when you were only 12?
I caddied at a golf course, and everybody was talking about the market. So I took my caddying money and put it in the market. The first stock I bought was the only company I ever heard of that was selling for less than $5 a share [Northeast Airlines]. I figured if I bought more shares, I’d make more money. That was a dumb strategy. I was 12 years old! The company was about to go bankrupt, but some other company acquired it. I tripled my money and was hooked. I’ll always invest. Economics and investing are my passions.
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