Friday, November 3, 2023

How does the world's largest hedge fund really make its money?; Bill Ackman blasts Harvard students and administrators; I was right about Sam Bankman-Fried and wrong about Ukraine's counteroffensive

By Whitney Tilson

1) I read an extended excerpt in the New York Times from the forthcoming book, The Fund: Ray Dalio, Bridgewater Associates, and the Unraveling of a Wall Street Legend, with great interest for a number of reasons...

First, as Ray Dalio is the founder of the largest hedge fund in the world – it currently has $124 billion in assets (here's a list of the current top 10) – I hoped to learn some secrets to his success. (This is why I study all successful investors, both current and past, starting with Benjamin Graham, Phil Fisher, Warren Buffett, Charlie Munger, etc.)

Second, I was hoping to see what I was missing: Many people raved about Dalio's book, Principles: Life and Work, but I could never make heads or tails of it.

Lastly, it mentions three old friends of mine: David Einhorn, Kyle Bass, and Bill Ackman. In particular, I remember this event well because I was in the audience:

In early 2015, Bill Ackman, the endlessly opinionated hedge fund manager, took the first whack. The billionaire founder of Pershing Square Capital had long found Mr. Dalio's public pronouncements about his quantitative investment style to be generic and even nonsensical. At a charity event in February that year, Mr. Ackman grilled Mr. Dalio during an onstage interview about how Bridgewater handled the assets it managed.

Mr. Dalio responded: "Well, first of all, I think it's because I could be long and short anything in the world. I'm basically long in liquid stuff. And I can be short or long anything in the world, and I'm short or long practically everything."

He also noted that some 99% of Bridgewater trading was automated, based on longtime, unspecified rules. "They're my criteria, so I'm very comfortable," Mr. Dalio said.

Mr. Ackman tried another tack. He gave Mr. Dalio a layup, the sort of question asked six times an hour on business television. "Let's say you were to buy one asset, or one stock, or one market, or one currency. Where would you put your money?"

There was a pause, then Mr. Dalio said, "I don't do that." He went on to lay out how Bridgewater's hundreds of investment staff members spent their days, describing a data-driven approach.

Onstage, Mr. Ackman would remark that it was "one of the most interesting conversations I've ever had." But he walked away shaking his head.

"What was he even talking about?" he vented afterward.

I had the exact same reaction – Dalio's comments were gibberish, nothing but a word salad.

The closest analogy I can recall was when I attended a speech at Harvard in 1996 by then-professor and current presidential candidate Cornel West. The audience hung on his every word and gushed praise for him after the speech, but I thought he was completely incoherent...

So how did Dalio become so successful? According to the new book, in two primary ways...

First, he gained access to foreign leaders – enabling him to win big bets on certain macro events. Here's how the book puts it:

Back in America, Mr. Dalio's influence slowly petered out. During and after his financial-crisis era fame, he'd had little trouble reaching the Federal Reserve chair, Ben Bernanke. Mr. Bernanke's successor, Janet Yellen, however, apparently wasn't as interested in the Bridgewater founder. Mr. Dalio would regularly rail to others at the company that Ms. Yellen wouldn't return his calls or meet.

Mr. Dalio consistently found more success abroad. Mario Draghi, the Italian-born head of the European Central Bank from 2011 to 2019, frequently chatted with the Bridgewater founder and sought his advice. Mr. Dalio advised him throughout the mid-2010s to introduce more stimulus to the European Union, which would bolster European stocks and hurt the euro. During much of that era, Bridgewater was also betting against the euro.

In Zurich, Mr. Dalio found the ear of the Swiss National Bank. He advised the bank on its efforts to decouple the Swiss economy from ailing broader Europe, according to a former Bridgewater employee who helped make the connection. When the Swiss National Bank in early 2015 yanked the Swiss franc from its peg to the euro, Bridgewater's funds made a fortune.

The longest-term project for Mr. Dalio was in China, where he made frequent trips.

And second, he appears to have just been lucky. Here's more from the book:

Mr. Dalio's grand automated system – his investment engine – wasn't nearly as automated or mechanized as was promoted. If he wanted Bridgewater to short the U.S. dollar (as he did, unsuccessfully, for roughly a decade after the 2008 financial crisis), the trade went in. There was not a rule more important than what Mr. Dalio wanted, Mr. Dalio got.

As 2017 loomed, a handful of top investment staff members decided enough was enough. Pure Alpha was up just 2% for the year, well below most hedge funds.

With the hope of turning around the firm's investment performance, members of the Circle of Trust put together a study of Mr. Dalio's trades. They trawled deep into the Bridgewater archives for a history of Mr. Dalio's individual investment ideas. The team ran the numbers once, then again, and again. The data had to be perfect. Then they sat down with Mr. Dalio, according to current and former employees who were present. (Lawyers for Mr. Dalio and Bridgewater said that no study was commissioned of Mr. Dalio's trades and that no meeting took place to discuss them.)

One young employee, hands shaking, handed over the results: The study showed that Mr. Dalio had been wrong as much as he had been right.

Trading on his ideas lately was often akin to a coin flip.

The group sat quietly, nervously waiting for the Bridgewater founder's response.

Mr. Dalio picked up the piece of paper, crumpled it into a ball and tossed it.

2) Speaking of my college buddy Bill Ackman...

He has been posting extensively on X, formerly known as Twitter, about the antisemitism he is seeing among students and administrators at his alma mater, Harvard (where he, like me, earned his Bachelor of Arts and MBA), and other elite institutions. Here are a few New York Post articles about what he has been saying:

I'm not going to express an opinion here on these matters because, as I wrote in my e-mail last Thursday:

I try hard to keep these e-mails focused on investing, with little personal things like travel tips, life lessons, etc. thrown in – and, above all, to stay away from politics because I have no interest in needlessly alienating my readers.

Instead, I created another personal e-mail list – my 21st! – for articles, commentary, etc. related to the war in Israel/Gaza. If you wish to subscribe to it, simply send a blank e-mail to: [email protected].

(Ten more of my personal e-mail lists are open to my readers – descriptions and sign-up links are in my July 19 e-mail.)

3) As I predicted immediately after FTX and Alameda Research collapsed, a jury took only a few hours yesterday to convict Sam Bankman-Fried of all seven charges against him. Here's the story from the Wall Street Journal: Sam Bankman-Fried Is Convicted of Fraud in FTX Collapse. Excerpt:

For federal prosecutors, the verdict was an expected victory after putting forward what many observers saw as a powerful case that included 18 witnesses...

[The U.S. attorney's office in Manhattan] had accused Bankman-Fried of being a greedy billionaire who lied to customers, investors and lenders while flying on private jets and hobnobbing with current and former heads of state.

Prosecutors presented evidence and testimony showing Bankman-Fried was the architect of a scheme to siphon FTX money to repay the debts of its sister hedge fund, Alameda Research, bankroll risky investments, buy luxury real estate and cover hundreds of millions of dollars in political donations.

His closest former allies took the stand as government witnesses and testified that Bankman-Fried directed them to commit crimes, including secretly changing FTX's code to allow Alameda to borrow virtually unlimited amounts from the exchange.

Caroline Ellison, the government's star witness and Bankman-Fried's ex-girlfriend, told jurors that while she was the chief executive of Alameda, he instructed her to doctor balance sheets to fool the hedge fund's lenders.

Justice was done. Good riddance!

I just wish more wealthy fraudsters were held to account. Sadly, too often, as Shakespeare wrote in King Lear: "Plate sin with gold, and the strong lance of justice hurtless breaks"...

4) Last week, I said that I wouldn't be writing anymore in my investing daily e-mails about the war in Ukraine because the subject became so political. Instead, I invited readers to join my personal Ukraine e-mail list by sending a blank e-mail to: [email protected].

But I'm making an exception to that pledge today because I believe in accountability: I want to acknowledge that what I predicted on March 15 was wrong:

I think Ukraine's widely expected counter-offensive in the spring will be successful (I would guess it begins in May, once the roads – which are currently mud pits – harden). I expect that, after a few weeks of bloody, brutal fighting, the Ukrainians will break through, the Russians will retreat in a disorderly fashion, and by, say, late summer, every Russian military unit will have been driven out of Ukraine, including Crimea.

At that point, Russian President Vladimir Putin (or, hopefully, his successor) will be forced to sign a peace deal that ends the war (likely with two bones thrown to the Russians: Crimea will be part of Ukraine, but as a United Nations protectorate... and Ukraine won't become part of NATO but will have security guarantees that will be the effective equivalent).

My mistake was rooted in what my ninth-grade geometry teacher used to say: "Don't let what you want change what is."

This New York Times article captures the current situation today: Ukraine's Top Commander Says War Has Hit a 'Stalemate'. Excerpt:

Ukraine's top commander has acknowledged that his forces are locked in a "stalemate" with Russia along a front line that has barely shifted despite months of fierce fighting, and that no significant breakthrough was imminent. It is the most candid assessment so far by a leading Ukrainian official of the military's stalled counteroffensive.

"Just like in the First World War we have reached the level of technology that puts us into a stalemate," the commander, Gen. Valery Zaluzhny, told The Economist in an interview published on Wednesday. "There will most likely be no deep and beautiful breakthrough."

His comments marked the first time a top Ukrainian commander said the fighting had reached an impasse, although General Zaluzhny added that breaking the deadlock could require technological advances to achieve air superiority and increase the effectiveness of artillery fire. He added that Russian forces, too, are incapable of advancing.

The general said modern technology and precision weapons on both sides were preventing troops from breaching enemy lines, including the expansive use of drones, and the ability to jam drones. He called for advances in electronic warfare as a way to break the deadlock.

"We need to ride the power embedded in new technologies," he said.

The general also said he underestimated Russia's willingness to sacrifice troops in order to prevent a breakthrough and prolong the war. "That was my mistake," he said. "Russia has lost at least 150,000 dead. In any other country such casualties would have stopped the war."

I, too, thought that once it became clear that there was no path to victory for Russia, its demoralized forces would continue retreating – which is what happened last summer.

But without air power and the most advanced weaponry, the brave Ukrainians like my friend Artem (by the way, thank you to the many readers who responded to my appeal in Wednesday's e-mail and are sponsoring my 24-hour race this weekend to the tune of $240 per mile to raise money for him!) have been unable to make much progress against well-entrenched Russians, especially since Putin seems willing to sacrifice an unlimited amount of his country's men, equipment, and money.

That said, it's important to keep a few things in mind...

  • There is still no path to victory for Russia.
  • It is in Ukraine's best interest to declare a stalemate and appeal for more advanced weaponry from the West "to break the deadlock."
  • At a cost of 5% of the U.S. military budget and mostly second-tier weapons systems, without a single American soldier on the ground, Ukraine has decimated Russia's military.
  • While it's frustrating that U.S. support for Ukraine hasn't resulted in more success this year, it was critical in staving off a quick collapse and helping Ukraine recapture roughly half of its lost territory last year.
  • If we withdraw our support now and Ukraine falls, we would be playing right into Putin's hands and rolling out the red carpet for him and every other dictator to invade their neighbors.

So, in summary, while I was overly optimistic about Ukraine's counteroffensive, I remain confident that Ukraine will ultimately prevail in expelling Russian forces from its territory – and that it would be a catastrophic mistake to abandon our ally.

Best regards,