The Alpha Masters: Unlocking the Genius of the World's Top Hedge Funds by Maneet Ahuja Read Free Book Online

debt-service payments would rise relative to income, and the government would be forced to print tons of money and buy long-term assets. As a precaution, he and his team studied Japan’s “lost decade” and the Latin American debt crisis of the 1980s, and, as a result of their findings, the firm’s traders piled into those investments that would be least affected: U.S. Treasury bonds, gold, and the yen.
     
    The first big payoff for Bridgewater’s “D-process” (research on deleveragings and financial crises) came in the spring of 2008. The risk metric for credit-default spreads clicked on, triggering Bridgewater to exit its entire position in several banks like Lehman Brothers and Bear Stearns (the week before Bear Stearns imploded). While most funds were down close to 20 percent that year, Bridgewater’s process led the fund to positions that weren’t tied to the performance of the stock market. Bridgewater was able to segregate risky investments, safer investments, and degrees of risk, causing the fund to clock in a 12 percent gain by the end of the year.
     
    Being able to measure the degree of riskiness of assets in the portfolios by separating their betas helped influence the firm’s positioning in 2008. To help clients better comprehend what was going on, Dalio penned a 20-page explanation of how the economy works called “A Template for Understanding What’s Going On” that Bridgewater included in its 2008 annual report to investors.
     
    Another input factored into Bridgewater’s models: eight years before the financial crisis, the firm put in place a depression gauge. Because it had studied the nature of deleveragings or depressions, the team knew that deleveragings occur when interest rates go to zero and there’s an excessive amount of debt. In January 2008, Dalio forewarned of the dangers of overreliance on tools like historical models during an interview with the Financial Times .
     
    “What is the most common mistake of investors?” he warned. “It is believing that things that worked in the past will continue to work and leveraging up to be on it. Nowadays, with the computer, it is easy to identify what would have worked and, with financial engineering, to create overoptimized strategies. I believe we are entering a period that will not be consistent with the back-testing, and problems will arise. When that dynamic exists and there’s close to zero interest rate, we knew that the ability of the central bank to ease monetary policy is limited.”
     
    When Dalio looks at the world today, he sees it divided into two parts—debtor-developed deficit countries and emerging market creditor countries. He further breaks it down into countries that have independent currency policies, and those whose currency and interest rate policies are linked. Dalio believes that countries like the United States and England that can print their own money are in much less trouble than countries like Spain that don’t have independent monetary policy and have currency links. “You have a debt problem and can’t print money—a terrible situation that’s going to get worse.”
     
    On the other side of the spectrum, a creditor country that can’t print its money and doesn’t have independent monetary policy, such as China, is going to suffer from imported inflation. Dalio explains that debtors can’t ease enough and creditors can’t tighten enough. In the next 10 years or so, Dalio expects a major currency breakup over tensions between the United States and China. Because it will be increasingly hard for countries like the United States to fund their deficits, we’ll see a decreasing willingness of foreign investors to invest in these countries. He predicts the symbiotic relationship between China and the United States, in which the dollar is dominant, will end.
     
    As a result, Dalio is interested in emerging markets’ currencies. “As [countries are] experiencing higher levels of inflation and