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

they’re tightening monetary policy,” he says, “it’s going to be harmful for the bond and beneficial for the currencies.” Dalio also feels the currency appreciation will hurt equities because appreciation makes a company less competitive in the world and the asset prices measured in its own currency go up along with the currency. “So it’s particularly those emerging market currencies in countries that are large creditor countries,” Dalio says, “which are running still large surpluses and that are overheating.”
     
    Extracting Alpha
     
    In March 2010, after walking on stage to accept the Lifetime Achievement Award from Alternative Investment News, Dalio projected the future of the hedge fund sector—and it wasn’t good. The tragedy, he explained, was that the average hedge fund is still about 90 percent correlated with equities.
     
    “The industry is severely belying its central purpose by being persistently exposed to too much beta,” stated Dalio. “By eliminating the beta in their portfolios, hedge funds would inevitably become more attractive to large pools of institutional capital.” Deemed the world’s first institutionalized hedge fund, with 300 clients, Bridgewater is known for accepting capital only from large pension funds, endowments, central banks, and governments.
     
    Dalio believes that the issue of not having any systematic bias is a big thing. In other words, there’s no good reason there should be a bad or good environment for hedge funds—they shouldn’t have any beta—period. “There’s an equal opportunity up or down in any kind of environment,” says Dalio. “There should be just the alpha, and that is important in terms of what the role of hedge funds is and for portfolio diversification.”
     
    By the end of 2010, Bridgewater reported its best year ever, increasing assets by $15.3 billion and earning about $3 billion for Dalio personally. The flagship Pure Alpha Fund II returned 44.8 percent, and the firm as a whole made more money for its investors than the 2010 profits for Google, Yahoo!, Amazon, and eBay combined. In 2011, the Pure Alpha Fund II returned 25.4 percent, bringing its cumulative gains for investors to nearly $50 billion—more than any other hedge fund.
     
    From its first experiment separating alpha and beta for its clients in 1990, Bridgewater found it was the best way to manage money. Its method is to take a value-added return from active management (alpha) minus the return from passively holding a portfolio (beta) and create optimal portfolios for each where clients specify their desired targeted level of risk. Bridgewater called its first optimal alpha strategy Pure Alpha, and it would be an integral step in the process for every investment made across the fund.
     
    Bringing Home the Alpha
     
    To generate alpha, Bridgewater follows a fundamental and systematic investment process. It uses analysis of past events to help stress-test its thinking of how markets work, using over 100 million data series that extend across developed and emerging countries, and in some cases back 100 years or more. Once the criteria are proven to be sound, they can be processed instantly to stay on top of market developments.
     
    Dalio explains the process this way: “What we’re basically doing is that there are individual concepts that are being multiplied in a number of cases—it’s not like there are 100 million independent observations,” says Dalio. Once the criteria are established, the work of engineering a portfolio begins. The criteria can be applied in 100 million cases or a single case. Broken down, the process allows the firm to better understand what is going on. “There’s information management that allows me to do quality fundamental analysis through my computerization,” says Dalio, “really high quality analysis that has a large sample size. And that large sample size allows me to produce a lot of uncorrelated bets.”
     
    The skill comes