One day in the early 1980s, a young trader named Ray Dalio placed a bet in the bond market. Then he reached for a yellow pad of paper.
Dalio jotted down the reason for his trade. Now 56, Dalio says he doesn't remember what he wrote that day — maybe something about inflation. From then on, when Dalio made a trade he'd grab his pad and start writing.
"Eventually, I had this pad of rules," he said.
That handwritten list of trading axioms became the blueprint for Bridgewater Associates Inc., the $141 billion money-management firm that Dalio runs out of an anonymous, glass-and-stone building in the woods in Westport, Conn. Today, Dalio manages money for central banks, corporations, endowments and public pension funds. And he's luring these giant institutions to the $1.08 trillion world of hedge funds.
Dalio is converting U.S. pension funds, which oversee about $5.5 trillion, to what he calls a new, better way of investing. He has built an investing system that marries the decades-old principle of diversification — that is, that investors should spread their money among stocks, bonds and other investments to reduce risk — to hedge funds' ability to wager on or against markets around the world.
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Hedge funds are investment pools that are lightly regulated and take more risks than mutual funds. Their managers often sell stocks short, use borrowed money and take large positions in stocks, all in hopes of beating the market.
Once the exclusive province of the rich, these often secretive and sometimes volatile investment vehicles strive to make money in bull and bear markets.
Like an earthquake
Dalio exemplifies a seismic shift taking place on Wall Street. During the 1980s, hedge funds catered mostly to rich people who could afford to make a minimum investment of, say, $1 million. Then, during the '90s, universities and foundations invaded the industry. Now, corporate, public and union pension funds are turning to hedge funds as never before.
U.S. pension funds will have to earn billions on their investments in the coming years in order to keep their promises to workers and retirees. These pension funds' assets got hammered when stocks and interest rates slid in the early part of this decade, and many are now in a hole.
In 2000, 221 U.S. corporate pension plans were underfunded by $50 million or more, according to the U.S. Pension Benefit Guaranty Corp. By 2004, that number had risen to 1,108 pension plans.
These gaps are particularly daunting because the 76 million U.S. baby boomers born between 1946 and 1964 are now nearing retirement age.
So pension funds are turning to money managers like Dalio.
In 2001, U.S. pension funds had 0.2 percent of their assets invested in hedge funds, according to Greenwich Associates, a Greenwich, Connecticut-based consulting firm. By 2004, that figure had climbed to 0.7 percent. Sounds minuscule — until you remember that pension funds oversaw $5.5 trillion in assets in 2004. A mere 0.7 percent of that amounts to $37 billion.
Pension funds will stake even more on hedge funds in coming years, says Edwin Burton, former chief investment officer of the $45 billion Virginia Retirement System. As much as $400 billion, mostly from institutions, is likely to pour into hedge funds by 2009, says Burton, now an economics professor at the University of Virginia.
More invested = more money
For hedge funds, size means money. Like many hedge fund managers, Dalio usually collects an annual management fee equal to about 2 percent of assets under management, he says. The more investors plow into his hedge funds, the more Dalio pockets in management commissions.
On top of that, Dalio usually takes a cut of about 20 percent of any profits, again the industry standard. His management fee alone amounts to $136 million annually.
Despite the costs, Dalio's firm has become a quiet giant of money management. Its customers include the $196 billion California Public Employees' Retirement System (Calpers) and the $27 billion Pennsylvania State Employees' Retirement System. Virtually unknown outside Wall Street circles, Dalio's firm now surpasses Denver-based Janus Capital Group Inc., which managed some of the hottest U.S. mutual funds during the 1990s bull stock market and today oversees $139.4 billion.
Sprawled across a couch in a conference room at Bridgewater's headquarters, Dalio hardly comes across as a hedge-fund hotshot. Dressed in an open-neck, checked shirt and everyday-casual khakis, Dalio says he stalks deer and elk with a bow and arrow and sometimes eats what he kills.
But in the hedge-fund world, hunting is getting harder.
With more hedge funds trading than ever before, scoring standout investment returns will only get tougher. Among hedge funds, smart managers take money from stupid ones. Some hedge-fund managers — and, Dalio says, their investors — will learn that lesson the hard way when the shakeout finally arrives.
"There will be hedge funds who will come out of that and benefit and perform well," Dalio says. "The majority will perform poorly."
Some of the richest institutions in the world have bet billions of dollars that Ray Dalio will be one who delivers.
World's largest hedge-fund managers, ranked by assets under management in billions of U.S. dollars.
1. D.E. Shaw New York $19.3
2. Bridgewater Associates Westport, Conn. $18.7
3. Goldman Sachs Asset Management New York $15.3
4. Man Investments London $14.2
5. Farallon Capital Management San Francisco 13.8
6. Barclays Global Investors San Francisco 12.5
7. Caxton Associates New York 12.3
8. Citadel Investment Group Chicago 12.3
9. Maverick Capital New York 12.1
10. Och-Ziff Capital Management Group New York 12.0
Sources: Bloomberg News, Hedge Fund Research