The Whole Enchilada
Jan 23rd, 2007 | Filed under: CAPM / Alpha Theory“Engineering Targeted Returns and Risks”
By: Ray Dalio, Bridgewater Associates
Published: December 31, 2005
As regular readers may recall, Alpha Male was at a hedge fund conference last fall involving a large number of institutional investors. While the “main stream media” was not invited, AllAboutAlpha.com was able to report on a few general themes and some of the extra-curricular events. One of the speakers was Robert Zink of behemoth money manager Bridgewater Associates, managers of over $150 billion in AUM (and pioneers of alpha-centric investing). He brought with him a very interesting message, but we ran out of space and time to report on it back in October.
Thankfully, a loyal reader just passed along this article by Zink’s boss Ray Dalio (CEO & founder of Bridgewater and super-rich guy) and reminded us to post on these issues. In the article, Dalio makes essentially the same arguments as Zink did last fall - that any asset class can be levered or de-levered to assume any level of risk. Dalio also claims that alpha-centric investing will cause the lines between “hedge funds”, “long-only equity” and all other asset classes will melt away as all asset managers fight for “the whole enchilada“.
To continue reading this article please login (at the right) or click here to learn more about accessing our archives.
If one digs deeper into the argument about leveraging and deleveraging for the beta portfolio, it doesn’t seem to make any sense. All that Dalio is doing is moving the asset classes up and down the capital markets line before combining them into his efficient beta portfolio. ie the Sharpe ratio does not change for any of the asset classes. This levering up and down of asset classes does not change the correlation between them. So how will this bring about any additional diversification? I don’t think it can. In other words, whether you first lever up or lever down individual asset classes and then combine them into an efficient portfolio; or you first combine them into an optimized portfolio and then lever the whole portfolio up or down, you get the same result. Unless you are assuming that there are entire asset classes that lie way off the capital markets line.
The URL to Dalio’s paper has changed (the link above does not work), here is the new link:
http://www.bwater.com/Uploads/FileManager/In_the_News/engineering_targeted_returns_and_risks_pmpt_060215.pdf