With $160 billion in assets under management, Bridgewater Associates is the largest hedge fund in the world, thanks, in large part, to the sustained success of its flagship Pure Alpha macro strategy.
Yet in the current climate of enhanced market and economic uncertainty, it is Bridgewater’s All Weather portfolio strategy that has started to really shine. The comparatively defensive strategy offered by the All Weather Fund may represent exactly the sort of positioning that intelligent investors should adopt in the face of mounting volatility and multiplying economic storm clouds on the horizon.
Not-so-pure alpha
Under the leadership of Ray Dalio (Trades, Portfolio), Bridgewater has developed a potent reputation for macro strategies. That reputation has been reinforced over nearly three decades. Bridgewater’s flagship Pure Alpha fund has returned an average of 12% since its inception.
Yet, 2019 has not been great for macro hedge fund strategies thus far. Despite a large number of funds having reported market-beating performances in August, the strategy has unquestionably seen better days. Even the modest summer improvements experienced by macro funds overall failed to translate for Bridgewater’s Pure Alpha fund. The flagship macro strategy lost a whopping 6% year to date, a sad letdown for a fund that returned 14.6% in 2018.
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As we discussed in a recent research note, Bridgewater’s recent woes come as a result of taking the wrong side of the bond yields trade; Dalio, anticipating a more hawkish Federal Reserve, did not expect the central bank to be quite so interventionist. But, as we have commented elsewhere, fear of being blamed for a bear market, or even a recession, has caused the Fed to prop up asset prices with zeal.
Preparing for harsh weather
Interestingly, Bridgewater’s All Weather fund, which holds a mix of liquid assets (almost exclusively stocks, bonds and currencies), has proven it can indeed shine in all financial weather. Through August, the All Weather strategy has reportedly delivered a 12.5% positive return.
The fund, designed to protect investors’ wealth in troubled market conditions, may be just what the doctor ordered in these trying times. As the firm noted in an overview of the fund:
“The principles behind All Weather relate to answering a deceptively straight-forward question explored by Ray [Dalio] with co-Chief Investment Officer Bob Prince and other early colleagues at Bridgewater - what kind of investment portfolio would you hold that would perform well across all environments, be it a devaluation or something completely different? After decades of study...Bridgewater created an investment strategy structured to be indifferent to shifts in discounted economic conditions. Launched in 1996, All Weather was originally created for Ray’s trust assets. It is predicated on the notion that asset classes react in understandable ways based on the relationship of their cash flows to the economic environment. By balancing assets based on these structural characteristics the impact of economic surprises can be minimized.”
In other words, All Weather is designed to survive and do well under even the most extreme economic and market conditions. It may have to prove itself in far harsher conditions before the next full-throated economic expansion has a chance of getting underway.
Dalio’s self-assessment
In January, Dalio reflected on the issues facing financial markets and the global economy, as well as Bridgewater’s ability to meet a range of challenges, in the context of Pure Alpha’s unexpectedly huge performance in 2018:
“If you are worried when the stock market goes down and happy when it goes up it probably indicates that your portfolio is unbalanced. If your income is also tied to how the economy does, you are doubly at risk because your portfolio can go down when your income is worst which is scary. Most people and companies are in that position and many make it even riskier by borrowing money to be in that position in an even bigger way. That's what makes the financial rollercoaster ups and downs so big and dramatic. To me, the key is to not have any systematic biases by structuring your portfolios and your incomes so that they hedge each other and are in balance. Achieving good balance is the most important thing."
While Dalio was talking about the Pure Alpha strategy’s impressive return in 2018, his comments sounded far more reminiscent of the All Weather strategy. Read in the context of what has become an ever more frantic and dubious financial roller coaster, Dalio’s observations are especially valuable.
Verdict
It seems that battening down the financial hatches would not be unwise at the present juncture. The current market certainly looks more favorable for defensive “all weather” portfolios than for “pure alpha” strategies.
Anything can happen in the current high-tension political and economic climate. Be prepared.
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