Read The Alpha Masters: Unlocking the Genius of the World's Top Hedge Funds for Free Online

the profits I created on top of the fees.”
     
    Frequently these days, Dalio’s Daily Observations lead to discussions with policy makers and clients. Dalio doesn’t reveal the timing of transactions or what banks he is trading with. He says, “I don’t want to disclose things pertaining to what positions we’re going into and why. So I’m just describing what I think in those Daily Observations , which is pretty open.”
     
    Bridgewater evolved from corporate consultant to money manager in 1985, when the officials of the World Bank, after reading Daily Observations religiously for several years, approached Dalio with a $5 million test portfolio of domestic bonds to manage. For the first few years Bridgewater managed the accounts by creating a benchmark portfolio, as any manager would. That would be the neutral position. Then it would take deviations from the benchmark because there are always two portfolios—alpha and the benchmark replication (beta). Dalio knew that in order to protect downside risk and promote alpha generation, he’d need to convince the World Bank to let him transition from traditional asset management practices, where a portfolio manager would peg his hedges and positions to a benchmark, to an active manager that could take a variety of alpha positions around the benchmark. “I always wanted diversified alpha. So I encouraged the World Bank to give me greater leeway, saying there’s no reason you should be giving me a domestic bond account because you’re getting much less diversification.”
     
    Bridgewater pursued a similar strategy in currency markets—managing “hedge portfolios” for clients based on their international equity exposure, but then deviating from that hedge portfolio in all currency markets. For example, a U.S. client could own a portfolio of European equities and hire Bridgewater to hedge his euro/U.S. dollar exposure, and, to add value, Bridgewater would trade all the major currency pairs globally long and short. By building an active portfolio that was fully diversified and free of systematic biases (no tendency to be long or short), Dalio felt the firm would be better suited to add value consistently and regardless of the particular market environment.
     
    Driven by Dalio’s hunger for innovation and his passion for truth and excellence, Bridgewater moved forward. Eschewing retail investors, Dalio preferred to work with institutions. “I like to deal with people who are thoughtful and I can have quality communications with,” he explains. He likes clients who don’t simply put blind faith in the firm, but want to engage in a good dialogue, and then give their manager the freedom to execute. “Somebody said to us, ‘Never have a stupid client.’ And so why not manage money for clients who give you $300 million or $500 million and are smart?”
     
    In 1991, Bridgewater set up its flagship Pure Alpha strategy. Pure Alpha traded global bond markets, currencies, equities, commodities, and emerging market debt. At any point in time, it would combine these 60 to 100 positions with any client-chosen benchmark. For the Kodak pension fund, an early client, Bridgewater managed Pure Alpha combined with a passive holding in long-duration bonds and inflation-indexed bonds. It was the best way to produce the best risk return. “Now it would be called innovative,” says Dalio. “Back then I guess it would be called crazy.” By doing this, the client could always specify beta.
     
    “This is how we manage money now,” says Dalio. “Clients tell us they would like an equity account and set a benchmark, like the S&P 500. We either replicate the benchmark or buy futures to equal the benchmark. After they put money into Pure Alpha, it’s overlaid on that benchmark. So Pure Alpha is just our best mix of alphas, calibrated at 12 or 18 percent volatility, depending on the leverage they’d like.”
     
    Dalio likens it to a two-column Chinese menu: choose your beta from