Ray Dalio closes the hedge fund frontier
These three pioneers still represent three stereotypes of the hedge fund masters of the universe: Soros the daring gambler eager to play no-limit poker with governments and global financial institutions, relying on his aching back to warn him of danger , not in his eyes or his brain; Robertson, the great teacher, sending his little tigers to sort good companies from bad ones and build low-risk hedged portfolios; Dalio sells a process based on theory and quantitative methods that relied on diversification, not gambling, hedging or individual inspiration.
In a sense, it’s just aging. All three managers are well past the normal retirement age. Dalio, the baby of the group, is 73 years old; Robertson died at age 90; and Soros is 92 years old. Each of them has many former employees and imitators to carry on their style. Dalio and Soros wrote influential books.
But in another sense, we remember 1890, when the US Census Bureau declared the US border closed. Today, large hedge funds mainly offer many funds managed in different ways and get money mainly from institutions like pension funds, endowments and sovereign wealth funds. Regulations have tightened on hedge funds and eased on public vehicles, to the point where it is difficult to see a clear line. Hedge funds have become a sector – sometimes just a brand name – in the global asset management industry. Most funds are run by investment professionals with standard resumes, not mavericks and refugees. Management companies employ armies of lawyers, accountants, computer scientists and others – a far cry from the lean organizations of analysts, traders and portfolio managers of the past.
(By the way, it’s a little worrying that the hedge fund managers who started when stagflation and the conflict with Russia were front page news are leaving, our most aggressive remaining investors only having experience with a low inflation, growing economies, and superpower peace.)
One way to think about what Dalio and his cronies did was to bring modern portfolio theory to life. Harry Markowitz invented MPT in the 1950s, but it required cash and leverage to make it work. Institutions were mostly limited to higher quality bonds, with some large corporate stocks. All other markets were dominated by undercapitalized specialists. It took hedge fund managers in the 1970s to apply aggressive leverage and short selling, along with derivatives, and to link markets beyond the most liquid stocks and bonds into global portfolios. .
While this generated billions of dollars for managers and their clients, the real accomplishment was worth trillions of dollars to the global economy. Investors have achieved higher returns on lower risk investments by using much more diversified index funds thanks to the paths blazed by hedge funds. Capital has flowed with fewer distortions and costs to the best uses. The flip side was more creative disruption and destruction, and the sweeping away of the mid-20th century financial infrastructure. Love it or hate it, the global derivatives economy that took the world by storm in the 1990s originated in the hedge funds of the 1970s.
Another perspective goes back to the Investment Company Act of 1940, which stripped public mutual funds of the ability to help investors. Funds were prohibited or discouraged from using leverage or derivatives, making concentration bets, selling short or over-trading. Both useful types of mutual funds – index funds and money market funds – had to be introduced by the backdoor in the 1970s by innovators harassed by regulators. Mutual funds could not charge performance fees, meaning the only way to increase revenue was to increase assets under management, so they became selling organizations rather than seeking organizations. performance. They chased sales charges and dollar kickbacks, while investors lost wealth after fees, inflation and taxes.
Hedge funds arose to avoid these restrictions and apply long-proven strategies for above-market returns. Funds and their investors made money on performance, not sales. While the funds were limited primarily to high net worth individuals and a few forward-looking institutions, the strategies gradually migrated to vehicles available to non-high net worth investors and also benefited the non-high net worth public through their pension funds.
Like any innovation, hedge funds came with their own kinds of disasters and scandals (Long-Term Capital Management and Bernie Madoff come to mind), and they remain controversial to this day. But for better or worse, Dalio and a handful of people like him are responsible for modern financial markets.
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• Active managers have a moment that won’t last: Nir Kaissar
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Aaron Brown is a former Managing Director and Head of Capital Markets Research at AQR Capital Management. He is the author of “The Poker Face of Wall Street”. He may have an interest in the areas he writes about.
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