If you want to interview Ray Dalio, you had better come prepared. The founder of the world’s most powerful hedge fund Bridgewater wants to be assured that you’ve read his brief to investors, complete with charts and tables that document how the world is reaching the pinnacle of a long-running debt cycle.
It’s been a challenging year for the world’s hedge funds and other investors with uncertainties ranging from the Chinese economy to the U.S. Federal Reserve to the debt and refugee crisis in Europe. Some high profile names from past years made bad bets, like Bill Ackman’s Pershing Square who invested in pharmaceutical group Valeant.
On average, hedge funds lost 3.5 percent last year. Yet the top 25 hedge funds managed to earn $12 billion in total, according to Forbes magazine – slightly more than in 2014. Mr. Dalio once again held his own in the top 10, with Bridgewater Associates earning $500 million.
Many are expecting even tougher times in the coming years. Part of the reason might be higher taxes when the next U.S. president takes office.
U.S. Democratic presidential candidate Hillary Clinton regularly complains that the 25 best-earning hedge funds in the world are “making more than all of America’s kindergarten teachers combined” (that being about 158,000 teachers). Even Donald Trump, the front-runner for the Republican nomination, has called for closing loopholes for the rich and demands hedge funds pay their fair share.
Mr. Dalio, in an exclusive interview with Handelsblatt, said he agrees. At the very least, he said the government should close loopholes allowing hedge fund managers to book earnings as “carried interest” rather than income.
One of the challenges in a democracy is when relatively poorly informed and emotional people choose incompetent and dangerous leaders. We will learn a lot over the next several months. Ray Dalio, Founder, Chairman Bridgewater Associates
Mr. Dalio insists that running a hedge fund has never been about the money for him. If anything, he worries too much money could be dangerous for his own family. Recently, he signed up to Microsoft founder Bill Gates’ Giving Pledge, a commitment by the world’s wealthiest to give more than half their fortunes to charity.
On the global economy, Mr. Dalio offered a gloomy picture. Likening the current crisis more to the 1930s than 2008, he argued that central banks are fast running out of options and should consider ways to put money directly in the hands of those in debt if they want to boost inflation and economies around the world.
Nor is he happy with the state of politics in the United States and Europe at the moment – he warned of the rise of nationalism on both sides of the Atlantic.
The following is the full transcript of Handelsblatt's interview with Mr. Dalio.
Handelsblatt: Mr. Dalio, you have become a multiple billionaire because you founded and developed Bridgewater. However, it seems like luxury doesn’t mean a lot to you. What drives you?
Ray Dalio: You're right about my never working for money, let alone luxuries. I could as well have become a chess player. I simply love the game and have loved it since I started investing at the age of 12. Money is just what one gets when you play the game well.
Meaning: You don’t care about money at all? That’s hard to believe.
I wanted enough money to take care of my family and do interesting things, but beyond that I never valued it much. Don't get me wrong, I like putting it to good use, including helping great causes and great people who are underfunded, but beyond taking care of the basics for me and my family, acquiring wealth has been more of an accident than a goal. As someone who has moved from having nothing at the beginning to having a lot now, I can tell you that having a lot doesn't make one happier, though it certainly provides one with more resources to do great things.
How important is charity to you?
Very important. Each year, I give more than I earn. I have joined Bill Gate’s charity club, the “Giving Pledge.” He really is a role model. Here’s the thing: If you do not have money, you want it to take care of your family and make sure that they are fine. But if you have too much money, it can harm them. What I want for my family and wish most for others is for them to be strong, and being strong requires struggling.
Why don’t you just give without joining Bill Gate’s initiative?
Because I want to learn and because I want to help show others this path of making money and then recycling it back to others. Charity is not an easy thing to do. To give money can be much more difficult than earning it. This may sound strange, but the reason is quite simple: If you want to make and save money, you know for certain whether or not you are wasting your money because you face the losses yourself. But by contrast, if you give money for charitable reasons, you may never experience whether or not you are wasting your money. I have learned a lot from Bill and the other philanthropists that I've met though the Giving Pledge.
Hedge fund managers could simply pay more taxes – just like Hillary Clinton has suggested. Is she right to suggest this?
If you consider the big picture, yes, she is right. You are referring to how fund managers can get their fees in the form of carried interests rather than income, and pay a lower tax rate. While that is technically possible, it is not appropriate. We don't do that. We have no so-called carried interest. We have always paid income taxes on our fees.
At many other hedge funds this is not the case.
This is true. The carried interest is being treated as a capital gain when it comes to taxes. Technically seen, this is correct but the truth is that the work is nothing else but earned income, because a fund manager does not necessarily have to put in his own money.
These days the performance of hedge fund managers has also been pretty lackluster. Hedge funds have lost an average of 3.5 percentage in the past year. Even some of your funds performed poorly. Is the industry still worth its money?
To clarify, in our actively-administered funds, the less aggressive one had a profit of 5 percent and the more aggressive one gained about 10 percent last year. We also have one fund that just passively holds a static mix of assets, which lost 7 percent because most asset classes went down last year.
But are hedge funds still worth the high fees?
Speaking of hedge funds in general is like speaking about mutual funds in general. They do all sorts of things and have a mix of investment managers of varying capabilities. One has to be an expert to sort between them, so I would recommend that non-professional investors stay out of them.
In recent weeks, there was a dispute between you and your co-leader, Greg Jensen, about your succession. How did it come about?
I'm glad you asked because it gives me an opportunity to point out what we all know, which is that some media folks like to make high drama out of minor disagreements, and this is one of those cases.
But will Greg Jensen still be your successor?
I want to be clear: I expect that Greg and I will be partners for the foreseeable future and that along with our other partners, of which there are several, we will together figure out what is best for each of us to do. Greg and Bob Prince have been partners for 20 years and 30 years respectively. We have lots of other partners and are constantly figuring out who should do what. It has always been that way and I couldn't imagine it being different.
The dispute has thrown the spotlight on Bridgewater's unique culture of radical transparency, where all conversations are recorded and those that talk behind others backs are considered “traitors.” Why do you do this?
We want to have an idea-meritocracy and doing this is essential for an idea meritocracy because it allows people to see for themselves what's really going on. It promotes an honesty that wouldn't exist otherwise. It eliminates back-room politics. It helps to make sure that people are behaving well. Bad things happen in the dark and behind closed doors, so we want to avoid that.
This culture has sometimes been called cult-like. Can you understand why?
To me, a cult is a place where people blindly follow. Bridgewater is exactly the opposite because the goal of the place is to encourage open, independent thinking. We value disagreement and have processes for us to learn and work ourselves toward better understandings. I think it would be better to say that we have a unique culture in which the goal is to have meaningful work and meaningful relationships through radical truth and radical transparency.
Mr. Dalio, let us talk about recent market turbulences. In the over 40 years since Bridgewater was founded, have you ever experienced more uncertain times than today?
Yes, actually often, but today we are experiencing a particularly special and extremely critical time.
In what sense?
We are currently at the end of a long-term debt cycle, when debt can't rise in relation to income anymore and when central bankers are beginning to "push on a string." Deflationary forces are significant despite all of the bonds purchased by the central banks, and the risk of deflation is now greater than ever at a time when central banks' powers to reverse it are limited. As a result, central bankers will need a new type of monetary policy, what I call Monetary Policy 3, to deal with it. MP1 was interest rates, MP2 was quantitative easing, which was the purchase of financial assets from investors. QE only works when the risk premiums of the "risky" financial assets like stocks and lending, which finance spending, are large enough that the seller of the bond buys them instead. That is not now the case. MP3 will work by putting money more directly into the hands of spenders. All of this has happened before, just not in our lifetimes.
In Europe, the risk premiums of the southern European countries are rising again. Do you see the return of national debt crises?
Not if Europe and the euro stays the course and doesn't break up. The capacities to deal with these issues exist if they are approached in a united way. Admittedly, that's a big if.
The current situation is often compared with 2008. A misleading comparison?
Yes, the situation is completely different from 2008. At that time, there was a debt bubble and it was clear that there was a big systemic problem with the service of credits. Today, the debt service problems are not nearly as large relative to the resources available to deal with them. The situation today can better be compared with 1937/38 or with Japan over the past few decades.
In what sense?
With interest rates at zero percent and asset risk premiums so low, the abilities of central banks to ease in order to reverse a downturn are very limited. The analog with the 1930s is noteworthy. In 1932, interest rates hit zero percent as they hit zero percent in 2008. In response, central banks "printed money" in the subsequent five to seven years, which led financial assets and the economy to rebound, which reduced risk premiums. Then the Fed tightened slightly and other countries devalued their currencies and the markets and economy had major declines. What happened in Japan is largely similar: Interest rates hit zero percent and risk premiums shrank and the debt burdens remained large.
And the same will happen again now?
I can say with some assurance that the risks are asymmetric on the downside. I can also say with some confidence that the Fed has been paying too much attention to the business cycle and has not given adequate attention to the long-term debt cycle. It's time to reexamine some of the fundamentals that were more apparent before our lifetimes. These fundamentals affect all countries. For example, the debt and balance of payments challenges are classic and will have an important effect on the world economy this year. The capital outflow from China is a challenge that will probably lead to increased capital controls that most likely won't adequately resolve the issue. As a result, there is some risk that the Chinese currency will devalue, which will increase deflationary pressure worldwide. We find ourselves in a new world, which is more like the 1930s, when currency devaluations have to be greater because interest rate can't be cut.
That’s nothing other than a currency war.
We will see a great deal of devaluation with the goal of increasing the competitiveness of the respective country. This is another parallel to 1937/38.
Isn't this a situation where everyone loses in the end?
In the 1930s, each currency devalued one at a time and the currencies ended up exactly where they started, but with a whole lot more monetary and fiscal stimulation.
Do you also anticipate political instability and even war, as in the 30s?
I don’t want to overdramatize things, but it's certainly the case that during hard times, tensions and conflicts increase and greater populism emerges. People are tired of politicians who don’t improve their lives, and there is an increasing desire for strong nationalistic leaders who can take control and make sure "the trains run on time." There is a rejection of the governing elite and hostility between people who are different economically, ethnically, and socially. We are seeing that in the United States and Europe.
Will that remain controllable?
That is in the hands of the citizens. Such times test our collective character. If we remain calm, informed and wise, this is all manageable. One of the challenges in a democracy is when relatively poorly informed and emotional people choose incompetent and dangerous leaders. We will learn a lot over the next several months.
The interview was conducted by Daniel Schäfer, Handelsblatt’s finance section chief based in Frankfurt and a former correspondent with the Financial Times. To contact the author: [email protected]