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hello and welcome to the hedge be explained series in this series we will dive deep into the strategies of the most legendary funds on wall street and decode their secrets to success today we will examine the bridgewater fund and its founder ray dalia with 160 billion dollars in assets under management bridgewater is one of the world's largest hedge funds since its founding in 1975 bridgewater has delivered 58 billion dollars in gains for its clients in the 30 years before 2019 its performance was consistently robust with only a three years ending with a negative return bridgewater even recorded positive returns during the 2009 financial crisis despite dramatic market volatility in 2018 bridgewater still witnessed a 14.6 percent gain such a legendary performance wouldn't be possible without the leadership and vision of bridgewater's founder ray dalia he is known as a dazzling innovator in the financial world and two of his initiatives merit a deeper look first is the flagship fund he launched in 1991 known as pure alpha bridgewater was a pioneer by being the first firm to separate alpha and beta pure alpha's main investment strategy is to build an optimal alpha portfolio by reducing investment risk through allocating investments among a wide range of uncorrelated assets the fund is 30 or 40 simultaneously traded bonds currencies equity indices and commodity positions allowing for a complete separation between alpha and beta returns through this initiative bridgewater is looking to gain excess returns while shouldering a lower risk from its inception to 2018 pure alpha only suffered losses in three years none of which exceeded two percent over the past 20 years pure alpha has earned an annual return of almost 15 percent per year if pure alpha is alpha's optimal portfolio then all weather is beta's optimal portfolio ray dalio describes all weather as a sort of master key meaning it can unlock and operate in any market condition similar to a temperate climate an economic cycle has market conditions known as seasons that affect asset prices these seasons are one higher than expected inflation or price increases two lower than expected inflation or deflation three above the expected economic growth rate and four below the expected economic growth rate these dynamics are often unpredictable and difficult to forecast however by wielding an all-weather umbrella that can withstand the fluctuations of the economic cycle bridgewater can better insulate itself from unpredictability here's how all weather works ray dalio believes that stocks are three times riskier than bonds so the volatility of stocks can be offset by an allocation to bonds at the same time you must balance your portfolio with assets that also remain stable during accelerating inflation specifically you need a certain ratio say 7.5 in gold and 7.5 percent other commodities these assets although highly volatile can be used to smoothen risk during seasons when rapid inflation takes its toll on stock and bond markets finally the portfolio must be rebalanced periodically the advantage of an all-weather portfolio is that risk can be well managed under different economic conditions this risk parity approach to asset allocation where each asset brings the same volatility to the portfolio regional investors especially pensions endowments foreign governments and central banks however this risk-averse strategy biased towards lower volatility has its drawbacks for one it has trouble outperforming the s p 500 from 1984 to 2013 the annualized return of the s p 500 was at 11.1 percent while all weather was just 9.7 then from 2014 to 2018 the annualized return of the all-weather portfolio dipped further to just 4.15 percent while the s p 500 posted a corresponding out annualized return of 8.34 although bridgewater lags more aggressive funds in terms of its single year returns its performance has been consistently stable after all for many of bridgewater's institutional clients stability is what they value most the average lifespan of wall street hedge funds is seven years while bridgewater's performance has been remarkably stable for more than 40 years recently however bridgewater's consistently positive returns have been put to the test since 2019 it has ceased making profits the large institutions that favored bridgewater's reputation for stability began to withdraw their capital and ray dalio's star began to shine with a little less luster in 2020 as the pandemic spread a true black swan event crude oil prices plunge leading to sharp reverses in stocks bonds commodities and credits resulting in severe losses for the fund in march 2020 the bridgewater fund recorded its largest loss in history even sparking rumors of margin calls as we have discussed bridgewater's risk parity logic leveraged low-risk alphas while deleveraging high-risk betas leading to notable success however the arrival of the pandemic triggered black swan events leading the u.s stock market to experience circuit breakers four times in a short period as a result bridgewater's low risk alpha portion performed poorly and leveraging it would have impacted bridgewater even more negatively while warnings and bargaining calls were premature bridgewater had run up hefty losses in early 2020 ray dalio steered bridgewater to adjust its investment model in response to unprecedented governance stimulus and the worsening pandemic but the adjustment had a minimal impact global major funds were exceptionally profitable in 2020 data showed that the top 20 hedge funds made a total of 63.5 billion dollars in 2020 setting a record for the past decade by contrast bridgewater lost 12.1 billion for its investors erasing gains made over the last five years in theory during a market crash bridgewater's risk control style shouldn't have participated such a significant drawdown but ray dalio's algorithm though built and refined over decades had consistently misread market movements bridgewater's previous strategy was based on negative correlations between stocks and bonds to reduce volatility however with an unusually volatile market where both bonds and stocks were plummeting this negative correlation vanished the risk of the entire portfolio was magnified and thus returns were negatively impacted this crystal ball after running for decades and cementing bridgewater status as a top performing fund known for its consistently stable returns seems to have failed over the last two years industry experts have long warned that ray dalio's flagship funds have had a history of underperformance but these criticisms receive little attention critics said that ray dalio's charismatic charm and halo have obscured this fact doubts in all weather and risk parity type funds stem from the fact that they make money simply by magnifying bond returns and the dalios funds have had the fortune to operate in a decades-long bull market for bonds as the market passes through this abnormal period and the fed starts promoting its tapering schedule will bridgewater's crystal ball regain its clarity and once again be crowned king of hedge funds we'll wait and see
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