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My career began before computers were common, before we knew about cell phones and email. We actually relied on our own ability to make calculations and had to speak with people one person at a time. It was the Dark Ages. It was, however, the beginning of a new era in finance and investing. Some important things had just occurred. ERISA [the Employee Retirement Income Security Act] had just been passed, and the era of institutional investment management was being launched. Ibbotson and Sinquefield had just published research that made risk premiums for stocks over bonds, for small cap over large cap, [as well as] for duration and default, a matter of “investment science.” Index funds were emerging onto the scene. Nobody knew much about what all this meant at the time, but it turned out to be the foundation of, and explosion in, the world of both finance and investing.
I began in the consolidated accounting department of Texas Utilities—not the place you would probably look first for a CIO candidate. What I did have, that many others didn’t, was the opportunity to work with highly professional men who set a good example for me of what a professional looks like and how he conducted himself and treated others. Sadly, these kinds of men and these examples of true professionalism are often lacking today. Relatively quickly, I moved into the treasury group, where I probably helped with as much financing as anyone in my age group, over a couple of years.
Then, a day came when the men I worked for decided to create a holding company and consolidate several subsidiaries into a single enterprise. One of the minor results was that a pension fund emerged with a consolidated value of around $300 million. This figure was too small to be assigned to anyone truly important in the firm but too large to completely ignore. In other words, it was just right for a young guy like me. I just had one small problem: I did not know anything. Thankfully for me, because the industry was in its infancy, neither did most others. I wasn’t as far behind as I would be if I were to start again today.
My training took place over the next three years, and a lot of it occurred on the city bus as I rode an hour each way to and from work. It was very clear that I knew very little at that time, but each morning I would prepare to hear whatever investment ideas would be presented that day. During each day, I would listen carefully to every story and every idea. Then I would review them on the way home. Every day, of every week, for three years.
As it turned out, that first portfolio did well. One day, I walked into the office and was congratulated by a colleague. He told me that I had been named one of the top 25 investors in America. I was 28 and did not know that kind of recognition even existed. No one could have possibly been more surprised and humbled by that designation than I was at that time. It was a big day for me.
Since then, I have managed several funds, and I have been blessed by each opportunity. Combustion Engineering, Asea Brown Boveri, GTE, Verizon—everywhere I’ve been, I’ve been surrounded by challenges, opportunities, and great people.
Of all my many career stops, people seem particularly curious about my time at Bridgewater. Obviously, Bridgewater is a wildly successful investment firm with a global, almost cultish, following. And, of course, everyone had read the principles written by Ray that define its culture. It is a surreal document drafted over the last decade that defines Ray’s worldview and his expectations of those with whom he works. It reflects the intersection of the three people that combine to become the one Ray Dalio—an investor, an entrepreneur, and a philosopher. Never forget that Ray’s parents were musicians and you will understand him a little easier. In the end, Ray is a dear friend and someone for whom I have tremendous respect. Ray, Bob Prince, and I have lived most of our adult lives in close collaboration, and, together, we have achieved some interesting things. Pure Alpha came, at least partially, out of a conversation Bob and I had while our families vacationed together. When Ray and Bob asked me to become their CEO, it was, in some ways, just a natural extension of all the work we had already done together over more than a decade.
Why did I leave so quickly? The primary reason was that shortly after moving to Bridgewater I became ill; perhaps some would call it extreme burnout. Whatever the choice of words, it became obvious to me that I needed to resign and recover. It was a kind of “half-time” in my life, and perhaps I had played the first half too hard. Fortunately, with the support of both Ray and Bob, I was able to leave to recharge and even reconsider what I might want to do with the rest of my life. It was a luxury for which I am thankful.
When I ultimately decided to return to work, I was a somewhat different man than when I left. In a word, I found myself wanting to be more generous and, hopefully, slightly less selfish. Two verses out of the book of Matthew had a particular impact on me, both then and now: “Jesus saw all the people and He had compassion on them because they were helpless and harassed like sheep without a shepherd,” and “You have been treated with great generosity; live with great generosity.” I have now chosen to try harder to be grateful and found it a much better way to live. It has made me both a more effective man and a better investor, too.
No truly rational person in investments would normally consider moving from the private sector to the public sector. In many ways, the public sector is an upside-down world. When you move to the public sector, you make less money, receive more criticism and media hostility—while managing vastly larger funds for a significantly greater number of people—and you have many more meetings. Of course, this is a travesty and generally unjustifiable unless you are in politics, where power is more important than production of results.
Consider this: A public pension fund is a very large return-seeking enterprise within a very large cost-minimizing government operation, particularly in Texas. Funds such as ours operate in a competitive environment against highly motivated and highly resourced competitors from all over the world. The Teacher Retirement System of Texas (TRS) is the second largest return-seeking enterprise in the state. Only Exxon is larger, and Exxon is one of the largest companies in the world. Over long periods of time, we are expected to make about $9 billion per year for our members. That is around $40 million per day. Public pension funds are massive for-profit operations residing in a government structure that is also very large but with vastly different metrics of operation, a completely different monetary objective function, and a totally different culture. For a public fund to perform exceptionally well, all of this has to be recognized, fully accepted, and then much better investment-oriented structures can be created for the people we serve.
Story continues…
It is our belief that every great organization has an extreme culture. We have that at TRS.
We believe that we are only slightly unique in four important ways—but each is significant and gives us a viable competitive advantage over most others. We are large, long-term, liquid, and not levered. In other words, when we operate well, we are the market’s proverbial “strong hands.” We are a $120 billion investment fund, and in the top 25 largest portfolios in the world. There are very few funds that can invest in many of the attractive, but larger, investments that we see regularly now. The duration of our liability is 24 years, meaning that we can take a longer view. The liquidity of the fund is high; our net payout ratio is only about 3%. Risk is well managed. These are all huge advantages.
Our investment plan is also different. We don’t believe that traditional diversification really works, for one simple reason: Being diversified on average is not important if you are not diversified at the right time. As a result, we structure the fund around economic outcomes more than simple long-term correlation averages. Our “central” portfolio assumes that economic conditions are supportive for long-term investors and is invested accordingly (public, developed-country stock markets, emerging country stock markets, directional hedge funds, and private equity). Around that “central” portfolio, we maintain two “economic hedge” strategies. The first is against deflation (long bonds, nondirectional hedge funds, cash). The second is intended to hedge the trust against unexpected reflation (TIPS, real estate, energy, gold). All of this is implemented within a risk-management framework that monitors for extreme valuations in more than 100 markets, as well as the economic and political conditions of the world’s major investment regions.
We have views on the efficiency of various markets, over time, and on the relative resources and capabilities of our internal and external teams. We also accept that we are resource constrained. As a result, we focus more than most on the creation of unique and somewhat proprietary investment networks with fewer firms. The most obvious are the two strategic partnership networks that we have created for investing in public and private markets. In Texas, we don’t really believe in “one night stand” relationships. Instead, we work diligently to find truly professional organizations whose cultures match our own, whose people are highly professional, whose focus is on generating long-term superior results for their clients, and who have the size and breadth required to match up with a fund as large and as diverse as ours is.
In order to implement the plan competently and effectively, we have to attract and retain extremely capable people, give them a healthy and professional culture, provide proper financial incentives (in a way that rewards performance and is aligned with the best interests of your customer), give them the resources and training they need, and then help them stay on track by expecting exceptional results and consistency of behavior with our agreed cultural norms. People are the key to everything. The wrong ones create all your problems, and the right ones save you from all your problems. You can’t win with just a good plan. You need good people who are true professionals to help execute that plan well.
The mistake I made—that I remember best—was a personal one. In my early 20s, I invested too much of the little money my wife and I had in a single stock. At first, that stock rose, before then declaring bankruptcy and dropping quickly and significantly. Upon an honest reflection, I concluded that I did not know enough about investing and that I had put in very little effort to change that. As a result, I got a painful lesson. It is either ignorant, arrogant, or immoral to believe that you should be well-rewarded for something where you put in very little effort. Of course, learning that lesson on a little of my personal money has helped me lose a little less of the money of others since then.
It is always easy to assume either that things today are not as good as they were in the past or that they aren’t going to be as good in the future. The first is irrelevant, and the second is usually not a good bet. Mankind is pretty amazing at doing foolish things to create problems and then finding brilliant ways to overcome them. I am not unaware of the world’s many current problems, but I am optimistic nonetheless. Pessimistic people always sound smarter than optimists, but optimists generally live in bigger houses.
With that said, some things are obvious and will have to be reckoned with. The era of disinflation, declining interest rates, multiple expansion, and easy credit is ending—or has ended. So, too, has the time of protracted deregulation and declining government. Taxes are going to rise. Demographically, the developed countries of the world are aging, but the less developed countries are not yet ready to take up the slack in growth that may create. Monetary authorities all over the world are on high alert. Political in-fighting is unusually high. Full-scale war has been replaced by cyber-terror and vigilante groups. These are the winds of our time, and it may take a while to sail through them.
My career began against this backdrop of fiduciary change, financial innovation and discovery, high inflation, cheap markets, and political and monetary migration. This is called “luck.” Thankfully, there really is such a thing as “return on luck”—and that might be the summation of my career.