Saturday, September 15, 2012

Ray Dalio on Striking the Right Balance

Juliet Chung of the WSJ reports, Ray Dalio: Southern Europe Is About to Enter a ‘Lost Decade’:
The euro zone crisis will likely create a “lost decade” in southern Europe, hedge-fund honcho Ray Dalio said Wednesday.

The founder of the hedge-fund giant Bridgewater Associates was speaking Wednesday morning at the Council on Foreign Relations in New York. During his hour-long remarks, Dalio touched on everything from how economic cycles work to the proper role of gold in a portfolio.
He devoted special attention to Europe’s debt crisis, comparing the situation to the Latin American debt crisis and Japan’s lost decade.

Southern European countries are in the early stages of a major deleveraging that will produce a Depression-like environment, Dalio said.

“I think we’re going to have a bad set of economic conditions,” Dalio said. “You’ll go through 10 years of cycles, very much like Japan, where you’ll have bull markets and bear markets.”

But he added lost decades could be survived and typically took about 15 years to work through.

Expounding on Europe, Dalio predicted that any fix relying on a transfer of wealth from northern Europe to the south would not be enough. He added that if any member country were forced out of the euro zone, it would more likely be Germany since the southern European members have the votes to control monetary policy.

Asked whether he thought Greece would leave the euro within a year, Dalio said he thought there was a 50-50 chance Greece would exit, before adjusting that to 60-40 in favor of Greece staying.

Turning to China, Dalio said if China were socially stable, its economy “will have its undulations like we have our contractions.” Those movements could take China’s growth rate to as low as 4 or 5%, he said. But he added that while China’s capital markets don’t function as smoothly as those in the U.S., “the power exists to then create that kind of shift and move things up.”

Dalio described the U.S. economy as healthy and said it was likely to operate in a sustainable manner as long as good monetary and fiscal policies were in place.

“We were through a car crash and we destroyed large parts of the system. We were in the intensive care unit and we have largely created a healing.”

Dalio said his biggest worry was that there would be a failure to strike a balance of monetary and political policy. He attributed possible failure to policymakers having an “imprecise understanding” of what the right mix of policies was and to a politicization of the decision-making process.

Those looking to glean new investing tips from Dalio wound up disappointed. Dalio said he wasn’t buying oil because he didn’t have big views on oil. While he praised gold and said he owned it, he also said he didn’t want to overemphasize it. “If you’re going to own currency, it’s not sensible not to own gold,” he said, suggesting 10% could be a reasonable holding

Dalio added that most people should focus on structuring their portfolios in a way that assumes the future is unknowable. Too many overemphasize asset classes that have been profitable in the recent past, he said.

Instead, investors should focus on “risk parity,” or allocating with an eye toward balancing the risk of various asset classes.

“I play the game of betting against others, so it’s like going on the poker table, and I know how difficult that game is. [There are] very few winners,” Dalio said. “If I’m not engrossed in it and we’re not engrossed in it, I’m worried and I do worry about it when I am engrossed in it.”

“So the average investor and most people should not be playing that game. They’re going to lose at the poker table.”
Classic Ray, especially that last line on how most people should not be playing the game as they're going to "lose at the poker table." (If you want to know what Bridgewater is betting on in the stock market, check out their latest 13F filings).

I met Ray Dalio back in 2004. It was a hell of interesting meeting where I challenged his "all-weather" views with my strong deflationary views. He looked at me and simply said: "son, what's your track record?".

Funny thing is that I also challenged the portfolio managers at Vega Asset Management back in June 2003 with the same views. They were shorting Treasuries, convinced that rates would rise.

The rest, as they say, is history. I turned out to be right. Vega subsequently lost a bundle and Dalio eventually jumped on the deflation bandwagon and has since become a "hedge fund legend."

I have tremendous respect for Ray Dalio and his team at Bridgewater. Unlike most hedge funds, they have managed to maintain alignment of interests and focus on performance despite managing an ungodly amount of money.

Have some concerns going forward but the truth is they foster the right culture, always 'probing' each other, setting egos aside to focus on process and producing great research to back their investment approach and themes.

Below, take the time to listen to a couple of interviews from earlier this week. The first was a a meeting as part of the Council of Foreign Relations' Corporate Program's CEO Speaker Series, which provides a forum for leading global CEOs to share their priorities and insights before a high-level audience of CFR members. The second was an interview with Jonathan Tepperman, Managing Editor of Foreign Affairs.

Have to tell you, found Maria Bartiromo incredibly annoying, often interrupting with silly questions/ remarks, but focus your attention carefully on what Ray Dalio says on deleveraging, austerity and striking the right balance between fiscal and monetary policy, not just in the US, but around the world. Notice he doesn't castigate quantitative easing, fully understanding why central bankers adopted these measures.

Also, listen carefully to why he still feels that deflation is a bigger threat to the global economy short-term and inflation longer-term (5 years out). More importantly, his remarks about low growth and low returns and higher volatility  given the current level of historic low interest rates are bang on, which just tells me there are structural factors at work which will make active management that much more difficult in this environment.

Do I agree with everything he says? Of course not, would challenge his views on holding 10% gold as a diversifier (just trade it...at least he's not a gold shill!) and think he's way too pessimistic on southern Europe. But I do agree with what he says about striking the right balance between monetary and fiscal policy and think he understands how social tensions can easily boil over if policymakers don't achieve this goal (my sense is that this truly concerns him).

And always remember his wise advice on diversifying your risk appropriately. If you don't, the next major "air pocket" might deal a lethal blow to your portfolio (institutional investors should read this presentation).

Finally, would enjoy meeting Ray again in the future to discuss striking the right balance in life, health and happiness. Also, would love to talk about his views on how the economic machine works, reminding him of our first discussion and how my call on deflation turned out pretty good for a guy without a track record.