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Portfolio management involves much more than just an investment idea. For sophisticated investors, it is also about diversification, volatility management, and exposure mitigation.

For a Bridgewater client, the investment process isn’t as much about the hedge fund as it is about the client’s risk management needs. After explaining how the fundamental investment machine works – which operates like a systematic, logic driven machine – Prince explained a portfolio customization method typically reserved for the most sophisticated of algorithmic investors.

While the core investment analysis and “truths” upon which investments are based does not change from investor to investor, the level of volatility and beta benchmark exposure can be adjusted like a dial on an oven. If an investor determines they want 7% volatility, for instance, Bridgewater customizes their investment based on this benchmark by keeping the mix of alphas the same, but adjusting their size. All other performance factors – absolute returns, drawdown, risk exposure – are driven by this volatility dial to various degrees.

The beta benchmark offers investors a method to calibrate the effectiveness of their investment to any one of 22 different benchmarks.

Bridgewater’s strategies are fundamental in nature but driven from a systematic standpoint. In fact, Ray Dalio, the fund’s founder, is credited with being among the early hedge fund leaders to embrace systematic, logic-based algorithms.

The fundamental investment process starts by developing a timeless and universal investment thesis based on “how the world works.” Each performance driver and the logic behind the investment is made entirely transparent to the investment analysis team. Engaging in “radical transparency,” a strong critique and even attack of the investment thesis – modeling through positive and negative market environments – is encouraged. It is not an environment for those who take offense at their ideas or principles being challenged can typically handle. In this respect, it is a survival of the fittest environment to various degrees – and only the strongest uncorrelated ideas rise to the top.

After the research idea makes it through a strong due diligence process, strategies are assessed for goodness and correlation based on a series of qualitative and quantitative metrics. These fundamentally based systems measure the pressure on each market, with pressure dials that scale from fully bullish to fully bearish with smooth gradations in between.

This research, for which Ray Dalio, Bob Prince and Greg Jensen are intimately familiar, is then handed off to the asset management team where portfolio exposure impact is assessed. At each stage of the portfolio management process there are idiosyncratic methods that Bridgewater utilizes to deliver uncorrelated performance improvement.

After asset management, the third and final step of the process is trade execution. Bridgewater doesn’t invest in individual name stocks to the extent of most hedge funds but rather engages in significant derivatives exposure. In large part this is done for the sake of exposure efficiency but also allows the degree of volatility and risk management customization, much of which is done through various leverage adjustments.

Bridgewater is a machine, but a machine based on a systematic logic that is firmly run by humans. The output has been some of the most uncorrelated performance in the history of major hedge funds.

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