The Alpha Masters E-Book

Maneet Ahuja

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Sprache: Englisch

Seitenzahl: 430

Veröffentlichungsjahr: 2012

Beschreibung

The ultimate behind-the-curtain look at the hedge fund industry, unlocking the most valuable stories, secrets, and lessons directly from those who have played the game best.

Written by Maneet Ahuja, the hedge fund industry insider, The Alpha Masters brings the secretive world of hedge funds into the light of day for the first time. As the authority that the biggest names in the business, including John Paulson, David Tepper, and Bill Ackman, go to before breaking major news, Ahuja has access to the innermost workings of the hedge fund industry. For the first time, in Alpha Masters, Ahuja provides both institutional and savvy private investors with tangible, analytical insight into the psychology of the trade, the strategies and investment criteria serious money managers use to determine and evaluate their positions, and special guidance on how the reader can replicate this success themselves.

There are few people with access to the inner chambers of the hedge fund industry, and as a result it remains practically uncharted financial territory. Alpha Masters changes all that, shedding light on star fund managers and how exactly they consistently outperform the market. The book:

• Contains easy-to-follow chapters that are broken down by strategy--Long/Short, Event Arbitrage, Value, Macro, Distressed, Quantitative, Commodities, Activist, pure Short, Fund of Funds.
• Includes insights from the biggest names in the trading game, including Ray Dalio, Marc Lasry, Jim Chanos, Sonia Gardner, Pierre Lagrange, and Tim Wong.
• Features contributions from industry icon Mohamed El-Erian

Many of the subjects profiled in this groundbreaking new book have never spoken so candidly about their field, providing extremely provocative, newsworthy analysis of today's investing landscape.

Leseprobe

Contents

Foreword: The Less Mysterious World of Hedge Funds

Preface

Disclaimer

Chapter 1: The Global Macro Maven

The Makings of a Maven

Coming of Age through a Crisis

Building Bridgewater

Winning Over the World Bank

Belly Up: Learning from the Bad

Calculating Crises

Foreseeing the Financial Crisis

Extracting Alpha

Bringing Home the Alpha

Fund in Focus

Procuring the Principles

Watchful Eye on the World Today

Going After What You Want

Chapter 2: Man versus Machine

Tim Wong: The Engineer

Pierre Lagrange: The Money Maker

Chapter 3: The Risk Arbitrageur

The Making of a Risk Arbitrageur

It’s Not All Numbers

The Stuff of Legends

Knowing What You Don’t Know

“I’m Sort of an Independent Person”

The Greatest Trade Ever

Mispriced Risk: Dow/Rohm & Haas

Jumping into the Deep End: Citigroup

Good as Gold

A Little Help from His Friends

Fighting Back

Chapter 4: Distressed Debt’s Value Seekers

The Auto Bailout

Brother-and-Sister Partnership

Catching the Eye of Robert Bass

Killer Combination

Detecting Diamonds in the Rough

Extracting the Value

Chapter 5: The Fearless First Mover

Gearing Up at Goldman

Pulling in the Profits

“A” for Appaloosa

The Early Days

No “A’s” in High School

Learning and Earning

Fierce and Fearless

Titanic Track Record

International Intrigue

Russian Roulette

Bullish on Bankruptcies

Delphi Dilemma

WaMu Winner

The Force Behind Financials

The ABC’s: AIG, BAC, and C

Sizing Up the Sweet Spot

Chapter 6: The Activist Answer

Bright Beginnings

Getting Gotham Going

The School of Rock

Making a Name for Himself

Return on Invested Brain Damage

Buying the Farm

Rising from the Ashes

Fast Food, Building Record Results

Making Cents at McDonald’s

Borders and Target: A Couple of Clunkers

Zeroing in on Target

MBIA

A Dud

The Greatest Trade

A Penney for His Thoughts

Canadian Pacific on the Rails

What Makes an Activist

Chapter 7: The Poison Pen

The Young Whippersnapper Finds His Way

Catching the Big Wave in the Storm

Evolution and Revolution

The Third Point Tao and Team Approach

Chapter 8: The Cynical Sleuth

Cause for Cynicism

The Contrarian Investor

The Secret Sauce of Short-Selling

Defending an Investment Strategy

China’s Coming Crisis

Back to Business School Basics

Chapter 9: The Derivatives Pioneer

The Rise of a Trailblazer

“Lehman Weekend” at the Fed

The Technicalities of the Trade

Afterword

Appendix

References

Acknowledgments

About the Author

Index

Copyright © 2012 by Maneet Ahuja. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, [phone], fax [phone], or on the Web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, [phone], fax [phone], or online at www.wiley.com/go/permissions.

Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.

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Library of Congress Cataloging-in-Publication Data:

Ahuja, Maneet, 1984-

The alpha masters : unlocking the genius of the world’s top hedge funds / Maneet Ahuja.

p. cm.

Includes index.

ISBN 978-1-118-06552-5 (cloth); ISBN 978-1-118-16759-5 (ebk); ISBN 978-1-118-16758-8 (ebk); ISBN 978-1-118-16757-1 (ebk)

1. Hedge funds. 2. Investment advisors. I. Title.

HG4530.A389 2012

332.64’524—dc23

2012010363

To God — The Ultimate Alpha Master

Long ago, Sir Isaac Newton gave us three laws of motion, which were the work of genius. But Sir Isaac’s talents didn’t extend to investing: He lost a bundle in the South Sea Bubble, explaining later, ‘I can calculate the movement of the stars, but not the madness of men.’ If he had not been traumatized by this loss, Sir Isaac might well have gone on to discover the Fourth Law of Motion: For investors as a whole, returns decrease as motion increases.

—Warren Buffett

Foreword

The Less Mysterious World of Hedge Funds

Mohamed A. El-Erian

CEO and Co-CIO of PIMCO

The mystique of hedge funds is undeniable.

In the investment management world, hedge funds are often referred to as “smart money.” They command premium fees and are thought to attract the best and brightest talent. Beyond this world, they are known for having minted several billionaires and hundreds, if not thousands, of millionaires. And they are an increasingly attractive topic for writers of both fiction and nonfiction.

As much as they are admired, hedge fund managers are also feared and, in some quarters, even loathed. Some see them as investment cowboys who, in ruthless pursuit of profits, pose significant risks to the stability of the global financial systems. No wonder hedge funds have attracted the attention of regulators and, in cases of countries in severe crises (be it Asia in the late 1990s or Europe today) that of politicians pointing an accusatory finger claiming that they are sources of disruptive evil and illicit earnings at the expense of entire nations.

Whether you like them or hate them, there is little denying that the hedge fund industry is here today because of their early well-earned reputation of savvy, agility, and investment coups. In recent years, however, the standing of hedge funds has come under pressure as their numbers have mushroomed, average investment returns have generally disappointed, and the investment landscape has become more complex and harder to navigate. It also has not helped that some investors unexpectedly found themselves “locked” in their hedge fund investments, unable to cash out at a time of severe liquidity pressures.

Nowadays, the popular narrative on hedge funds often oscillates between two extremes, and do so repeatedly: characterizing them as highly adaptable and responsive pools of money that help markets become more efficient and, in the process, generate supernormal returns for their clients in a manner that is consistent with the common good; to viewing them as grossly overpaid investment vehicles that consistently promise more than they can deliver while trying to harvest private gains at the cost of the general public through some practices that can sometimes be considered morally, ethically, and legally questionable.

The associated debates can often get very heated and, in the process, lose sight of two simple yet crucial realities. As complex as it may seem to many, the hedge fund industry essentially boils down to two deterministic factors: the type of investment vehicles and the investment managers that have self-selected to run them.

Investment Vehicles

The first of these two elements is getting quite well understood. While they may vary in their sector focus and styles, hedge funds share four common and interrelated characteristics:

First, they target positive absolute returns rather than simply outperforming a certain market benchmark or a specific style—thus the common claim that hedge funds like to make that they can deliver strong returns regardless of how global stock markets, commodities, currencies, or bonds do.

Second, they have access to a very wide range of investment tools and instruments. Most important, they can go long or short a market, sector, or company. This leads to the common hedge fund claim that they can change their overall positioning quickly and cost effectively, thus “hedging” their investors’ capital from the vagaries of markets.

Third, they can lever their investment footing to a meaningful multiple of their assets under management. This elasticity underpins hedge fund claims of being incredibly flexible when it comes to “scaling” the investment bet commensurate with the depth of their conviction.

Finally, they almost always follow a fee structure involving a base component and a performance component, traditionally known as “2 and 20” (a 2 percent fee that investors pay irrespective of performance and 20 percent of the profits above a specified threshold—though these days many hedge funds find themselves under tremendous pressure to lower their fees).

Investment Managers

The second element is less well known. And this is where Maneet Ahuja’s book comes in forcefully and effectively.

This interesting book takes you on a journey through the fascinating and still-mysterious world of successful hedge fund managers. You will make many interesting, and in some cases surprising stops along the way, getting to know managers, their philosophies, styles, quirks, and working practices.

Maneet will tell you about the world of activist investors whose objective is to unlock hidden value in companies, either through operational improvements or through the more controversial company restructurings and asset stripping. She will also expose you to the inherently cynical and always-suspicious short sellers who obsessively plunge into the details to sort out underlying fundamentals from often intricate and possibly obfuscating packaging.

Your stops will include the macro funds, an approach that George Soros made famous in the 1990s when he boldly took on the United Kingdom’s currency policy and won. These managers treat the world as their oyster, finding it full of both absolute and relative value trades.

Then there are the value investors whose love and passion for the micro is matched only by their disdain for the macro. For them, the world is full of very specific individual opportunities to exploit deep value that is yet to be recognized by investors looking for a quick buck.

Your journey will also make a few “special opportunity” stops. You will thus be exposed to distressed debt investors who find value in the often unexpected yet dramatic fall of companies and countries. Where others see junk and despair, they find attractive opportunities to recover value.

Have no doubts, this book will take you on a captivating and eye-opening journey. It will also expose you to some intriguing human stories.

Through her insightful reporting, Maneet will remind you that most successful hedge fund managers faced enormous difficulties and challenges along the way.

Some found it hard to convince their first set of investors. Others chugged along for years before hitting their stride.

Some hit it big only to see thing crumble in front of their eyes and, worse, under the full spotlight of the media. Some faced the constant challenge of maintaining internal harmony in the midst of unforeseen success. And virtually all can claim a particular moment(s) of good luck that enabled them to decisively pull away from the herd, struggling but failing to differentiate themselves in an incredibly cutthroat competitive environment.

Maneet is uniquely placed to take us on this fascinating journey. And she brings it all together in this book in an effective and skillful manner.

In her role as CNBC’s hedge fund specialist and as a producer for Squawk Box, the network’s highly regarded and widely watched morning show, Maneet has had an unparalleled window into the life of the often secretive hedge fund managers. She has followed them, researched them, analyzed them, interviewed them, and interacted with them in ways that few can or will. Her access is combined with a mix of curiosity and judgment that allows her to balance admiration with realism, and industry analysis with human dimensions.

Beyond the Personalities

Maneet’s book is about personalities who, due to dramatic success, are eagerly followed. And she does a wonderful job telling us some of what makes each of these talented individuals tick.

That, in itself, is an important achievement for this book. Yet it is only part of what Maneet brings to our attention.

In addition to insights about the personalities of some of the most famous and most successful hedge fund managers, and how they have brought this to bear on their investment decisions (good and bad), Maneet allows us to “compare and contrast” in a manner that was not easy to do before. And in doing so, we can derive lots of interesting hypotheses.

Maneet’s analysis suggests that there is no simple formula for success in the hedge fund world. There is no single way of organizing a hedge fund for success. There is no special set of indicators to follow, books to read, or expert analyses to digest.

Maneet will also show you that the academic backgrounds of successful managers have differed a great deal, as have their socioeconomic origins. Some started straight from university while others spun off from larger enterprises. Some managers extended what they learned in the investment world while others managed to apply different expertise and, in some cases, disciplines (albeit related ones).

Personalities cover the whole spectrum, from introvert to extrovert, from forceful enforcers of personal views to skillful compilers of other peoples’ views, and from media averse to publicity hungry.

Motivations are varied. For many, it is about money, but it’s also quite a mixed cocktail with some heavy on hubris and others eager to make the world a better place.

Notwithstanding all these intriguing differences, Maneet’s wonderful portraits also demonstrate that there are some important commonalities.

Successful hedge fund managers are driven individuals with deep self-confidence about what they bring to the investment management table. They are innovative and intellectually curious. They know that they have to be different but in an intelligent and sustainable manner. They are often able and willing to spend a lot of time not just on the “what” of investing, but also the “why” and “how.”

These are individuals who repeatedly show an admirable readiness to handle the discomfort of leaving the herd and, instead, putting on contrarian trades that often go against them for a while. Most important, they learn rather quickly from their mistakes, and show an amazing ability to midcourse correct.

Bottom Line

After reading this book, you will possess a better understanding of the mysterious world of hedge funds. You will see that successful hedge fund managers can be a special breed that is not easily replicated—a challenge that becomes even harder in a world where the ranks of hedge funds continues to multiply.

With this book you will have a better basis for differentiating between reality and myth—a particularly important factor when promises and high fees are often not followed with superior investment performance. This ability to differentiate will become even more critical in a world that, today, is subject to massive realignments, previous unthinkables becoming realities, and changing market structure.

Finally, this is a book that will put you in a better place to think about some of the questions that are yet to be answered decisively. Can certain hedge fund approaches truly deliver on the claim of being “market neutral” in an investment world where many parameters have become variables? Can the herd of hedge funds continue to justify premium fees on account of the success of just a subset of them? And, as sovereign debt crises persist, will regulators feel a need to impose such a low speed levels on hedge funds to render them ineffective?

These are all consequential questions. Yet they remain unanswered at this point.

Preface

I was 17 years old when I got my very first real job—in Citigroup’s Global Corporate & Investment Banking department at their headquarters at 388 Greenwich Street in the uber hip Tribeca area of downtown New York. It was the fall of 2002 and I had started as an intern in the Credit Risk division of the prestigious Financial Institutions Group, or FIG as it was called, where the bank represented such high-profile and lucrative clients as AIG, Washington Mutual, and many of the major banks, broker dealers, and insurance companies.

I had always been a strong math student; however, it was fair to say I was out of place. It felt more like a scene from the movie Wall Street than reality—so different than the world where I had grown up in suburban Westchester, where there wasn’t even a McDonald’s in town and there were practically more deer than people. As I was ushered up to the forty-second floor and led into a conference room with sweeping views of all of midtown Manhattan in the far distance, I knew I’d landed somewhere where people were having a real impact on the world in a big way and felt fortunate to be there.

I was fascinated hearing about how the team identified credit risk and mitigated losses for thousands of clients and outside parties. Hearing about how the bank would work closely with companies advising on potential mergers and takeover targets seemed exciting—this must be what Carl Icahn does, I thought. Citigroup had “the big balance sheet” that dwarfed many of the more prestigious investment banking teams on the Street, and so we were always allowed into the consortium for deals—even as the deal arranger. I left the building with an offer for a semester internship in hand, convinced I had found my calling with the good guys—good guys with nice shoes.

I ended up taking my Series 7 exam and staying with the bank for three and a half years while attending school. Eventually, I moved to the Wall Street Journal after a brief stint at Merrill Lynch in its Global Research & Economics division. During my time at the Journal, the first cracks in the financial system were beginning to show, but it was still unclear how far the plague would spread. After about a year, by late 2007, working at the Journal and following financial stories so closely—minute to minute—made me nostalgic. Figuring everything was mostly okay but looking for an experience beyond plain vanilla banking, I decided to try to go back to the Street and had been interviewing with a bunch of small organizations called “hedge funds,” one of which was founded by a very famous investor: George Soros.

I got called for an interview at the Quantum Fund for a position opening for an analyst covering either retail or health care companies. At the interviews, two young research analysts in their mid- to late 20s wanted to know if I had the technical skills to rip apart an annual report and process all the numbers in a way that could help the team discover if there was any investing potential on the long or short side across industries. After a few simple questions, my interviewer quickly discovered I knew very little about what short-selling—or borrowing stock to sell in the market at its current price with the expectation of further declines—was even about. Little did I know I was about to find myself in the center of it all.

Around the same time as the interview at Quantum Fund, I got an unsolicited e-mail from CNBC, asking if I’d come in for an interview. Growing up watching the network with my father as he talked about the stocks he was buying and selling, I was naturally curious and excited to see what the business news network would be like. The moment I stepped onto the news desk, it was like a different world. Suddenly, all of the news was in real time, up to the second. The buzz, the energy, the bright lights all captivated me. Spending the past few years poring over financial statements, loan documents, credit agreements, and deal “pitch books,” the things the anchors were saying right in front of my eyes on the set made sense to me. I had no formal journalism training or TV experience but my time on the Street landed me the job as a producer on Squawk Box.

A Hedge-ucation

Very quickly after I landed at CNBC in February 2008, it became clear to the entire world that something was seriously wrong—the nation’s entire financial system became crippled by toxic credit products. Words like subprime mortgages began appearing at an almost rapid pace in the news, along with structured investment vehicles (SIVs) and credit derivatives.

Around April, buzz started to spread around a hedge fund manager, David Einhorn of Greenlight Capital, and his new book, Fooling Some of the People All of the Time, detailing his six-year battle with a company he was short, Allied Capital. David agreed to come on Squawk Box to talk about his book the following month. In preparation for the segment, I got an advance copy of the book and started marking it up with colorful Post-it notes with items to remember and reference on the show. The depth of his research and conviction was inspiring to me. The finance geek that I thought I was could not hold a candle to him.

When David came on the show in early May, I made him sign my book. He wrote, “You are my hero for tearing this thing apart!!” I couldn’t help myself. The story had struck a chord with me.

Together, Einhorn and I planned a show centered on short-selling; the guests included a professor from Yale and Einhorn’s fellow hedge fund manager and friend, Bill Ackman from Pershing Square. We even set up a poker game at the end of the show that pitted Neill Chriss, a former SAC Capital portfolio manager who had skills strong enough to challenge Einhorn and who had ranked eighteenth in the World Series of Poker tournament in 2006. That show caused waves across Wall Street; viewer e-mails and calls arrived for days afterwards, telling us how important it was for the network to continue to bring such smart investors to the table.

After that, I started researching names of other smart investors at other hedge funds, their strategies, and their big calls. It wasn’t easy. Most hedge fund managers shied away from the press for fear that the Securities and Exchange Commission would come after them for potentially marketing outside their authorized accredited investor base.

It was an industry that remained under the radar, with the rare manager who would agree to speak to the press. The world knew about the legends that had since retired: Julian Robertson and his fierce “Tiger cubs”; George Soros and his famed short sale of $10 billion in pounds in 1992, earning him the title “The man who broke the Bank of England”; and Michael Steinhardt, known as much for his temper as his trading prowess.

But what of the investors who were following in the footsteps of the legends and who were leaving their own footprint on the markets? How were the strategies they used today different from the ones used before them? As technology and trading was advancing, how was portfolio management? These were compelling questions. To answer them, I began the arduous process that any new journalist must go through when first starting to cover a beat—I started reaching out to every expert in the industry, academic, researcher, trade publication, and magazine I could get my hands on. The more I absorbed about these hedge funds—their freedom to make liberal and exciting and complex trades and deals and investments—the more fascinated I became.

For the next three years, I slowly made progress getting face-to-face meetings with the chief players in today’s hedge fund landscape. Most meetings would take up to a year to coordinate (in some cases, two) and always took place on background, or not for attribution. Once the managers realized I was truly interested in things like portfolio construction and alpha generation—a return in excess of a benchmark adjusted for risk and country analysis—I started to get more access and even some complimentary comments on Squawk Box from Julian Robertson, Michael Steinhardt, and Carl Icahn. Beyond that, I continued to speak to investors and get a pulse for what they were seeing, hearing, and concerned about within hedge funds.

As I continued to study the leaders of this new age of hedge funds, I realized that the investors who had consistently outperformed the broader market for a significant period of time, these alpha masters, were bound together under the hedge fund umbrella, yet were wildly unique. They employed different strategies and had very different views of the world. But the one thing they had in common was that they could see things other investors couldn’t see. Short-sellers like Jim Chanos of $7 billion Kynikos Associates, the world’s largest short-selling fund, were the first to warn investors about massive frauds like Enron, WorldCom, and Tyco in 2001. Others like John Paulson of then $6 billion Paulson & Co. generated earnings of $15 billion on speculative trades betting against the subprime housing market from 2006 to 2008.

The Framework

My goal became to tell their stories with the active and aspiring investors in mind. This book is aimed at those who want to understand the anatomy of a great trade, the analysis for a sound framework, and the sense of self to strike out on their own and stand by their convictions. For two years I was fortunate enough to have hundreds of hours of unprecedented access inside these managers’ offices while they told me their stories.

All of the subjects of my book were generous enough to speak with me candidly, on the record, and many times on topics well beyond the scope of investment. I was privileged enough to see them during periods of stress, moments of reflection, and flashes of sheer genius.

I traveled with some, heard vivid recounts of memorable travels from others, and perhaps unexpected but most valuable of all, I got to see them as human beings—and could share in their successes and failures equally. I was privileged to be able to experience that intriguing journey, and I hope I have been able to accurately transmit these feelings to the reader.

The “Hedge Fund” Misnomer

My research led to another important question, which was: what is, in fact, a hedge fund? I posed the question to Ray Dalio, the 62-year-old founder of the world’s largest hedge fund, Bridgewater Associates, which has $120 billion in assets under management.

“I don’t even know what a hedge fund is!” he exclaimed, half-jokingly as we sat in his glass office surrounded by forest and a lake in Westport, Connecticut.

“What we’re called and how we’re categorized, by our basic structure, doesn’t capture the essence of what we are,” he quipped. “I trade long and short,” he continued. “Does that make me a hedge fund?” he asks rhetorically.

“No. I consider myself a financial engineer. I started trading commodities. Then commodities became various futures, which evolved into various swaps and derivatives. I could separate things in a way that was unique. I evolved.”

These elements are not exactly encompassed by the definition of a hedge fund, which, at its core, groups many of the world’s most sophisticated investors by nothing more than a compensation structure. As Dalio said to me, “I likely have nothing in common with the other managers in the book except for the fact that we are a unique group of good investors doing unique things.”

2011’s Mixed Signals

When I met with the subjects of this book, they were in the middle of steering their ships through stormy markets. We had just emerged from the worst recession since the Great Depression, and the U.S. markets, still smarting from their own severe crisis, were then paralyzed with fear about the voraciously eroding crisis in Europe. The year 2011 represented a time where many managers were defensive for the first half of the year and slowly began to wade back into the markets toward the third and fourth quarters.

It was one of the most tumultuous years the U.S markets had seen following the financial crisis. Markets suffered a high degree of pressure from a high degree of global economic uncertainty, the subsequent downgrade of the U.S. credit rating below “AAA” for the first time in history, and Europe’s increasing debt woes. Yet, for all its volatility, the market ended the year pretty much exactly where it started, with the S&P 500 Index closing within a tenth of a point of its starting place and the Dow up 5.5 percent.

Hedge funds saw more mixed performance, closing the year down 5.13 percent, according to industry data provider Hedge Fund Research. It was only the third calendar-year decline since 1990.

Spending time with the managers during such a tumultuous period was difficult but also very reflective. The managers had no choice but to sit back and really think about the answers they gave. Many had to admit miscalculations by comparison to prior years and point to wrong assumptions and mistakes.

Even though last year’s performance was lackluster, assets continued to climb throughout the year and regained precrisis levels of $2 trillion by the end of the year. Deutsche Bank’s December 2011 Alternative Investment Survey estimated a net inflow of $140 billion in 2012, bringing industry assets to an all-time high of $2.26 trillion by the end of 2012. While a prime driver for hedge fund assets in earlier years was ascribed to wealthy individual investors, it is now governed by the institutional participation, currently making up two-thirds of assets, according to the Deutsche Bank survey.

Still, the weak figures sparked attention. Aren’t hedge funds supposed to deliver “alpha”—returns in excess of expected risk—after all?

Well, according to research by LCH Investments NV, the world’s oldest fund of hedge funds, hedge fund managers made net profits from inception to June 30, 2011, of $557 billion for their investors. Furthermore, LCH found that $324 billion, or 52.8 percent of the profits stemmed from the equity markets.

One thing that mystified me was how, through various applied strategies, managers were able to profit by using publicly available information, and by seeing things in that data that the majority of investors could not see.

Part of it has to do with conviction of character. You will see each of these managers at one time or another with their backs up against a wall and the wolves circling in. Yet they stand their ground time and time again. They are not always media favorites for it, but they hang on to their own conviction with a steadfast faith in what they know to be true and wield it to their advantage.

This isn’t a guideline for how to be like the men profiled in the pages that follow. This is simply the retelling of their stories, the memories that make them who they are, and how they got all of that to work for them. Some came into the game knowing how to play and some invented the rules as they went along, but each instilled their core personalities into their work. The lesson to be learned is that you don’t have to be them for it to work. You just have to make a proven strategy yours. You will take hits. You will take losses. But so long as you do your own research and make the trade your own, you can always land on your feet.

The nature of humanity is that people reveal themselves (not to everyone, not always, but eventually). These are the stories of the moneymakers. They are the big players; the behind-the-curtain rock stars whose strategies and successes surpass those of the vast majority of investors around the globe.

These are the alpha masters. I hope you find their revelations as fascinating as I do.

Maneet Ahuja

April 2012

Disclaimer

This material contained in this book does not constitute an offer or solicitation in any jurisdiction to any person or entity. The information contained herein is not complete with respect to any of the funds described in this book (collectively the “Funds”), including without limitation, important disclosures and risk factors associated with an investment in the Funds, and is subject to change without notice. To the extent that the information contained herein becomes outdated or is otherwise incorrect, we have no obligation to update or correct such outdated or incorrect information. Offers to sell interests in the Funds are made only by the respective Funds’ Private Placement Memoranda (each, a PPM) and not by the information contained in this book. In the event that the descriptions or terms in this book are inconsistent with or contrary to the descriptions in or terms of the respective Funds’ PPM, Partnership Agreement/Memorandum and Articles of Association (as applicable) or such other documents, the PPM, Partnership Agreement/Memorandum and Articles of Association (as applicable) and such other documents shall control.

The interests of these Funds have not been approved or disapproved by the U.S. Securities and Exchange Commission (SEC) or by the securities regulatory authority of any state or of any other jurisdiction, nor has the SEC or any such securities regulatory authority passed upon the accuracy or adequacy of this document. Any representation to the contrary is a criminal offense. The interests have not been registered under the U.S. Securities Act of 1933, as amended (the Securities Act), the securities laws of any state or the securities laws of any other jurisdiction, nor is such registration contemplated. The interests will be offered and sold in the United States under the exemption provided by Section 4(2) of the Securities Act and/or Regulation D promulgated thereunder and other exemptions of similar import in the laws of the jurisdictions where the offering will be made. The interests will be offered and sold outside the United States under the exemption provided by Regulation S under the Securities Act. The Funds will not be registered as an investment company under the U.S. Investment Company Act of 1940, as amended (the Investment Company Act). Consequently, investors will not be afforded the protections of the Investment Company Act. There is no public market for the interests and no such market is expected to develop in the future. The interests may not be sold or transferred except as permitted under the Partnership Agreement, and they are registered under the Securities Act or an exemption exists from such registration thereunder.

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Chapter 1

The Global Macro Maven

Ray Dalio

Bridgewater Associates

Above all else, I want you to think for yourself—to decide 1) what you want, 2) what is true and 3) what to do about it. I want you to do that in a clear-headed thoughtful way, so that you get what you want.

—From the introduction to Ray Dalio’s Principles

In his famous Principles, Raymond, or “Ray,” Dalio tells his employees, “You learn so much more from the bad experiences in your life than the good ones. Make sure to take the time to reflect on them. If you don’t, a precious opportunity will have gone to waste. Remember that pain plus reflection equals progress.”

This is just one of the many aphorisms, precepts, nuggets of wisdom, and practical management tips that the 62-year-old Dalio—the founder of Bridgewater Associates, the global macro fund that is the world’s largest hedge fund, with $120 billion under management—emphasizes time and time again. Bridgewater advises and runs portfolios for the most powerful pension funds, central banks, and countries around the world. In fact, a recent study by London-based research firm Preqin shows that Bridgewater is the most popular hedge fund among public pensions.

If you did a quick search on Dalio, you’d be flooded with stories of his firm’s success in the markets (including generating its best returns in the most difficult markets of the last decade) and get a fair dose of his philosophy on life and management. For example, Dalio has been practicing transcendental meditation for more than 40 years and calls it “the single biggest influence” on his life.

You’d also find that his most important maxims involve his relentless “pursuit of truth” and hunger for “personal evolution.” His unwavering focus on these goals has no doubt affected his performance figures and client satisfaction for the better, but has earned him mixed reviews from employees, some of whom judge his approach as unnecessarily harsh. Dalio is unapologetic. In his Principles, Dalio proudly says, “I have become a ‘hyperrealist.’ ”

Dalio is also well known for how his big-picture, innovative thinking has changed investing in important ways. In fact, industry magazine aiCIO devoted its December 2011 cover story—“Is Ray Dalio the Steve Jobs of Investing?”—to him, highlighting the similarities between the two leaders’ motivations and approaches and how each has impacted his industry. Dalio, like Jobs, feels his life is a journey during which he must turn his bold visions into reality. Dalio’s industry-changing innovations have earned him two lifetime achievement awards and won Bridgewater dozens of “Best of” awards.

Dalio says the form of meditation he practices “is a combination of relaxation and a very blissful experience. That sounds more like an orgasm than it really is; by blissful I just mean that I just feel really good and relaxed and in good shape. You go into a different mental state—neither conscious nor unconscious. But unlike when you’re sleeping, if a pin drops all of a sudden, it can reverberate through you; it’s shocking.”

It took some time for Dalio to discover a meditation technique he could master, but eventually he began to notice that even 20 minutes of meditation could make up for hours of lost sleep. It also began to change the way he was thinking about things: he became more centered and more creative. Meditation put Dalio in a clear-headed state so that when challenges came at him, he could handle them “like a Ninja—in a calm, thoughtful way.” He says, “When you’re centered, your emotions are not hijacking you. You have the ability to think clearly, put things in their right place, and have good perspective.”

The Makings of a Maven

Sitting in his modern Westport, Connecticut, office in a blue Bridgewater polo shirt and khakis, Dalio seemed comfortable and at peace. But cultivating a calm mind and demeanor hasn’t dampened his lifelong desire for independent thinking. Growing up the son of a jazz musician and a homemaker, Dalio didn’t like following instructions or remembering what he was taught. Instead, he loved chasing after what he wanted and figuring out for himself how to get it. Because his parents afforded him the freedom to do this, he feels, he received a better-than-normal education, learning more from negative experiences than the positive ones and developing the skills that serve him so well to this day. One of the problems with traditional education, Dalio believes, is that it punishes people for making mistakes rather than teaching them how to use those mistakes to learn and grow.

The idea of someday starting his own firm was the last thing on his mind when a 12-year-old Dalio began caddying to make extra money at the Links Golf Club in Manhasset, New York, near his home. He earned $6 a bag and had some regulars, many of whom were Wall Street investors. It was 1961, and he felt like he heard about stocks everywhere he went. “If I got a haircut, the barber would be talking about stocks,” he remembers. “If I got my shoes shined, the shoeshine guy would be talking about stocks. I didn’t know if I could do it, but it looked very interesting to me.” Dalio began combing the Wall Street Journal and started looking for stocks that fit his criteria: they had to cost less than $5, have a name he had heard of, and be available if he wanted to buy more. He landed on Northeast Airlines, a stock that tripled in value shortly after his purchase. “I saw all these names in the paper and figured it must be easy because I only have to pick one that goes up. If that didn’t happen and I lost money,” says Dalio, “I could have easily ended up in another field.” The big win with his first stock piqued his interest to continue. So he began reading Fortune magazine, and sending in coupons requesting corporate annual reports. “The mailman would lug in all these annual reports and I would spend hours studying them.” Studying caused him to ask a lot of questions. “And questions lead the way,” he says. “Learning is through questions, it’s not through being told.” Through the 1967–1968 bear market, he taught himself how to sell short and by the time he was in high school, he had already amassed a stock portfolio worth several thousand dollars.

In 1967, Dalio was admitted, just barely, to Long Island University’s C.W. Post Campus in Brookville, New York. Unlike in high school, in college Dalio thrived. He took some finance classes and developed a love of learning. He could finally learn about things that interested him and, for the first time, studied because he enjoyed it, not because he was forced to. He also learned to meditate during his freshman year. Dalio did so well that, after graduating, he gained admission to Harvard Business School. “With a more centered, more open state of mind, everything got better. My grades went up. Everything became easier,” he says with a smile.

Coming of Age through a Crisis

The summer before starting Harvard Business School in 1971, Dalio clerked on the floor of the New York Stock Exchange. During that summer, the Bretton Woods system broke down, and it left an indelible impression on him.

“It was one of the most dramatic economic events ever,” says Dalio, “a very, very big deal and I was at the epicenter of it on the floor of the New York Stock Exchange. It thrilled me.” Dalio remembers President Nixon making a nationally televised address on a Sunday night. “He was spinning political speak, but what he was saying was that the U.S. has defaulted on its debts. And it got me thinking about what money is. What are dollars if they are not tied to gold?”

Recognizing that the currency crisis was now driving all other market behaviors, Dalio delved into a study of the currency markets. He began to pay attention to Paul Volcker, now a friend and adviser, then the Treasury Department’s Undersecretary for Monetary Affairs. He began reading all the public statements, then tried to reconcile them with reality. “I saw how the government lied or certainly spun things in a certain way. I had all these philosophical questions, like Whom do you believe? What is actually truthfully going on? All of this pulled me into global macro markets. The currency markets would be important to me for the rest of my life.”

At business school, Dalio was like a duck in water, as he likes to say. He felt he had climbed to the top of the academic heap and would be learning with the best of the best. Harvard’s case study method excited him because it allowed students to have the freedom to lead with their own thinking. There was very little classic teaching or memorization, techniques Dalio had resisted for so long. Dalio felt, at long last, he had found his ideal environment. “Basically, all you were given was the description of the case and a situation. It was up to us to decide what was important. There were no questions, let alone anyone telling you what to do. I always had this desire to talk about what’s true, and here was a process where there was a quality debate and discussion among smart people with different points of view. It was not left-brain learning. It was right-brain learning in the sense that you’re learning through the experience. It was so exciting.”

Dalio would eventually take this learning method with him when he formed Bridgewater, where he, above all, encourages the search for truth and excellence.

In 1972, the summer between Dalio’s two years at business school, he decided he wanted to learn more about the world of trading commodities, and he convinced the director of commodities at Merrill Lynch to give him a shot. Because of commodities’ low margin requirements and, at that time, relative obscurity, Dalio figured he was likely to be successful and make money. He was wrong. “I hardly made any money,” he says, recalling his summer as an assistant at Merrill, “but I remember I loved it. And that was great. Even back then, I was never really concerned with money past a certain point of utility. I was happy sleeping on a cot in a studio apartment. All I cared about was having the freedom to do what I wanted to do.”

As luck would have it, Dalio’s return to Harvard coincided with a huge surge of inflation. The breakdown of the monetary system in 1971 had caused a surge that pushed commodity prices higher and created the first oil shock in 1973. To combat inflation, the Federal Reserve tightened monetary policy, which brought on what until then was the worst bear market since the Great Depression. All of a sudden, there was a rush into previously unfashionable commodities futures trading, and brokerage houses clamored to build new trading departments. Because Dalio had experience trading commodities, had worked for the commodity division head at Merrill Lynch the previous summer, and had a Harvard MBA, he immediately got a job as the director of commodities at a midsize brokerage and was tasked with setting up the new division. When the brokerage house folded, Dalio moved to Shearson Hayden Stone, the brokerage firm run by Sanford Weill.

At Shearson, Dalio was in charge of the institutional/hedging business, advising clients on how to hedge their business risks. He did not last long. He was fired, he says, shortly after having a drunken argument with his boss on New Year’s Eve in 1974. Dalio decided to strike out on his own. He was 26 years old.

Building Bridgewater

Ringing in 1974 on a positive note, Dalio set up shop in his two-bedroom apartment on East 64th Street in Manhattan on New Year’s Day. He had been trading the markets since he was 12 years old and had planned to continue doing so as he developed his outfit. It seemed the stars had aligned—he already had incorporated the name “Bridgewater” for an association he had cofounded with some former Harvard Business School classmates. They wanted a generic name that made sense for a physical commodities import business. Though that business didn’t take off, the “boring” name they chose would last for quite a while.

Dalio was never afraid to dive into unfamiliar territory. “I think ego stands in the way of a lot of people doing that. It’s like learning how to ski. . . . The sting of the fall hurts for about a minute but that’s how you learn.” So he pored over as many annual reports as he could get his hands on. He didn’t know they contained income statements, balance sheets, or cash flow statements. As he started studying, he began to ask himself a lot of questions. “And questions lead the way,” he says.

From the start, Dalio never built Bridgewater to draw in investors. Instead, he wanted to focus on managing exposures, writing research, and continuing the pursuit of truth and excellence while he continued to study currency and commodities markets. He remembers being calm and pragmatic about the new venture. “I didn’t really feel any anxiety about starting out on my own,” says Dalio. “I could pay the rent. I had free time to do what I wanted—I liked the independence. And so I thought if it didn’t work out, I’d go get a job. And if it did work out, then I’m home free.”

He also thought he had the right personality to handle the pressure. “I think anybody who is a great investor, a good investor, a successful investor has to be a person who can be both aggressive and defensive, too. You have to be able to bet. But you also have to have enough fear to have the caution. But you can’t let the fear control you.”

Dalio found opportunity in the many large institutions that had exposure in different commodities as well as interest rates and currencies. Currencies, interest rates, and commodities were the things he understood. “There were a bunch of institutional clients at Shearson,” he says, “who wanted to pay me for advice. Commodities were so volatile they needed direction.” So he began consulting and managing exposures for corporations and institutional hedgers, and collecting his thoughts and observations in a kind of client letter called Daily Observations. “Because of my derivatives background, I traded commodities, which became various futures, which evolved into swaps and derivatives. I got evolved. I could separate things in a way that was unique.”

Winning Over the World Bank

Dalio soon built a reputation for quality macro research. His Daily Observations