tv Studio 1.0 Bloomberg October 18, 2015 9:30am-10:01am EDT
bonds, the problem with that is you are dominated by equities because it has twice the volatility. i need more volatility in order to create a balance because i want to bet equally on two things. the thing about it is, in the traditional way, you have to buy more bonds and as you buy more bonds, you are buying a lower return of assets. as we turn out the assets, you dilute your turn and you're not getting much. in order to have an equal amount on each one of those things, you have to have an equal amount of risk. if you look at risk-return through time, those that have risky assets or volatile assets, or volatile assets, tend to have a higher return and a higher risk. that is structural because they have a longer duration and because assets are leveraged themselves. the average s&p 500 company has a debt-equity ratio of 1-1. it has embedded leverage.
the idea of taking a bond and changing its complexion of return by borrowing cash and having, say, 2 bonds. tech gives me the same amount of risk in those assets and raised the return because the return of cash is lower than the return of bonds over that amount of time. that meant i can create diversification. the most important thing is how do you create diversification without lowering your return? i don't know in any ten-year amount of time what will be good and not good. i needed balance. tom: when your leverage bond portfolio and your unleveraged equity correlate and stock and bond prices go down together, what is the shock analysis that you see with this? ray: i imagine it would be equal to stocks.
you have 100% correlation between these two assets. i have made it more leveraged so it has the same volatility and risk. if they were 100% correlated, the they will equal the volatility of stocks. but the fact is if it is not 100% correlated we get into what drives correlation. what it means is that you are going to have, as a result, diversification. without lowering your returns. comparable volatility. i get diversification. then i can have -- the most important thing is diversify my portfolio. i look today and i say i would be terrified to own any other portfolio.
the reason i would be terrified to own any other, am i going to own stocks? will i be concentrated in stocks? will i be concentrated in bonds? i don't want to be concentrated in either. tom: where you are almost too diversified whether it is by leveraging up or it is by going to different assets? how do you respond to the criticism of diversification? ray: diversification of assets where you don't know which is going to be the better return, similar expected returns and risk, it does not lower your return. tom: is this operational within the great dispersion we live in right now? do you have to amend a risk-parity strategy? ray: i have, almost my entire net worth in it. the reason i have is i need a balanced portfolio. i have a balanced portfolio, i'm
scared. i learned to be scared. i tested it through the most severe. i tested it through the great depression, i tested it through the republic in germany. tom: did you tested through the giants game this weekend? it's nice to make jokes about this but this is serious. ray: i want to be clear. nothing is a sure thing. let me say that. if you have a well diversified portfolio, and it underperforms in cash, the only times in that situation that it did badly were depressions. what that means is as the federal reserve is tightening monetary policy, if they cause
asset prices as a whole to go down, the only time it really did badly in the great depression and in 2008, something and both of those years, 20-25%, those are tolerable contractions because the traditional portfolio fell at about 60%. when i look at that, i am saying we have the central banks on your side. otherwise, you will be concentrating and some assets. michael: you have suggested to people that you are starting to step back. what are your plans? ray: i'm talking about stepping back in management, not investment. i am an addict, i started at 12. ♪
♪ michael: your risk fund lost 5% in august according to most reports. is that a failure of risk parity or the assets you bought? ray: on a month-to-month basis, i didn't know the stock market was down. the assets were down. i think it is a lousy month for us. if you look at the longer-term returns, they are what they are which is good. you have the stock market down, whatever. that was a month. you could lose 5% in a year. i could look back and say it is down 6% this year. the stock market, if you look at the whole history, the stock market in 2008 was down 38%.
warren buffett, one of the greatest investors, his bed year -- his bad year was down 48%, 47%. to me, i feel like i'm fine. tom: there are people here that are actually in the racket. coverage in august, was it -- we went to 50 intraday. you took six weeks off in august. right? it was wild. ray: let me be clear, just to get the facts right. we have our all-weather fund which is down 6% for the year now because of those reasons. i know it will be balanced. we have our alpha funds that are up materially. tom: how much are they up?
ray: depends on which fund you are in, some were about 6%. michael: where are you getting the alpha? ray: we could go long and short in a lot of different markets. michael: you are applying the hobby machine works to this time period. you said we are in secular stagnation, i will go back to where is american business right now, and even global business? what is the ability of businesses to turn a profit so you can make money? ray: american businesses right now are the number one thing, they are flush with cash. they are the biggest floors on -- as a result, the biggest force in the market right now is with buybacks and purchase and acquisition. something like 70% of my by an the stock market is along those lines. i think you know as well as i have the change in the
complexion of the businesses. i think productivity numbers are very distorted because of the fact that we cannot count. tom: you are more optimistic. like many others. ray: the way we do our accounting for productivity, it means photos have collapsed. what is the value of a photo? tom: are you on instagram? ray: no. tom: i'm not either. but we look at the map of the seriousness of this, i promised i would not bring a probability distributions but in the math of it, looking at rare events. within all the work you have done, all the experience you have, are these derivative strategies around bonds and equities able to withstand the
shock of the next market swing? ray: there are all sorts of embedded risks in different ways. i would say that we are better i would say that we are better able to withstand them then we -- than we have been before. there is less liquidity in the market. there is a fair amount of dynamic hedging. that is a way for insurance companies when they take their protection in terms of insurance rate risks, that is an issue. i would say we are better to withstand them in terms of, not the short-term volatility type of thing. but in terms of the bigger moves, we are better able to withstand them provided that we do not have that big event i am talking about just the tightening of monetary policy. what scares me or worries me is what the next downturn in the economy looks like with asset prices where they are, and lesser ability of central banks to squeeze monetary bonds.
michael: some would say if we raise rates now we have ammunition. you sound like you disagree. ray: it is a restrictive policy, i don't care whether they raised 25 basis points. i don't see the reason for it. in 2007, i was watching this incredible bubble happen. it was a finance on a lot of debt and it was an obvious bubble. the fed just gave attention to the gdp gap and we had an economic collapse. now we have a situation in the mid part of the cycle, they are trying to identify where inflation is. what they are worried about, we have a lot of liquidity around. there are little glimmers. there are always little glimmers of something. i think they are worried too
much about the short-term debt cycle and not enough about the long-term debt cycle. i don't get it given those asymmetrical risks and that is a look at the world. we are in a world economy. countries outside should be tightening monetary policy. michael: bloomberg radio and television worldwide, we are at the corel arrowwood conference center in new york. in the time we have left, i want to talk about you and bridgewater. you have been around for a while. as tom noted, you have suggested to people you are starting to step back. a lot of people are saying, this man with his abilities, should stay in the game. what are your plans? ray: it has been 40 years, we just celebrated 40 years. what i'm talking about is stepping back in management, not setting back in investments. i am an addict, i started at 12
and can't stop. i love the game. there is some confusion about what stepping back is. i will always be playing. michael: do you have a succession plan in place? ray: bob prince who has been working with me for 27 years. i think he's 55-years-old. greg jensen has worked with me for 17 years. he just turned 40. this team, i have a lot of people that have been there for a long time. we've all played the game, we are used to doing it. i could step out and it doesn't matter. tom: an historic meeting, i think it was thursday morning. everybody runs a company differently. everybody has a style. when you have a meeting at
bridgewater, with the incredibly trained individuals you choose to hire, how do you inject humility? ray: the business we're in teaches us that. we have a very unusual culture. the unusual culture is that we -- well, nothing is like that. it is a meritocracy and what we do is we tape everything so everything can listen to -- everybody can listen to everything. there is nothing hidden. it is a very straightforward way. it is an unusual idea and meritocracy. that is why the young, best people come there. everyone has the right to make sense of anything. there is no traditional hierarchy. you can ask any question. that keeps you on your toes. the best way to do it, what did they call it in parliament. michael: question time? ray: you stand up in front and
♪ >> are you having a greater debate about china? when you have debates about china, are they heated or collegial? ray: it is not heated because the culture is very analytical. keep it, say anything you want to say. if you have this template, it just dropped the number in the template. michael: that is an interesting
situation because china is one of the few times that people have seen you actually come out with a mea culpa. ray: what's your question? michael: how did you miss it with the template? ray: we miss things. by the way, that's where we learn the humility. in terms of that, what happened is when they went to the bubble bursting, you went from -- you have two problems in china. you have a debt problem, local governments have to restructure. that is a manageable problem. it is in their local currency. the people, i've gotten to know a number of policymakers. they are intelligent and prudent. more than people understand. restructuring debt in local
currency is a manageable exercise. we have done it three times, we defaulted in 1971. we had the latin american debt crisis. and the s&l crisis -- . that is a manageable crisis. the other issue they have is they have to restructure what they are spending money on. they have to rebuild a new economy to replace the old one. that is a challenge. that is like a heart transplant, a serious operation. tends to weaken them. but like most heart transplants nowadays, you will get through it ok if you have good surgery. they have a bubble, the third thing is they went from an equity market, which is normal in the early emerging stages of many economies where you get the speculator in and hyped up and leveraged on margin.
and they had that bubble. that bubble was a negative at the same time. you went from a bull market and you are having another force, a negative force coming in at the same time. you have those three negative forces. if you look at the economies having an analogous set of circumstances, what are economies that had to restructure debt, what is it like? that is a negative for economic activity. what comes next? we know certain things come next. my statement was, when we have that bubble burst, that we shifted from one kind of a set of circumstances, two minuses and a plus. i still think we exaggerate over the short-term. a lot of importance is there. we look at everything up close. when you look at china, i think china is going to be just fine. it will be weaker.
but i think their weak growth will probably still be twice our normal growth. tom: i love how you come back with these beautiful historical charts on currency depreciation. see that now in brazil, i promised i wouldn't ask you for currency quotes. but at the end of the day, is the solution of the international prime level always going to be currency depreciation? ray: it has always been that if you are facing a domestic contraction, and you have a choice, you want to depreciate your currency. what happens is, that was a
lesson i learned in 1971. i was a clerk on the floor of the nyse. i walked on the floor, richard nixon, on sunday night, and -- announces that he is going off the gold standard. i walk on the floor of the nyse and it is up a lot. and i learned that every time, but you have is it stimulates and makes everything cheaper and causes things to go up. in other words, when you have zero interest rates, what are you going to do? michael: you have an economic model, central banks around the world have to ease the u.s. and secular stagnation, you are optimistic about china but they will be slow. for investors. ray: i don't think the secular stagnation, i shouldn't even
interrupt your question. michael: what kind of returns, in the next 10 years, can investors expect? is it going to be different? ray: you know it. you will have returns that are probably going to average somewhere in the vicinity of 3% or 4%. this is a major pension fund problem because the way assets work is when there is quantitative easing for these purchases and prices go up, that is producing a present value effect. it is like a bond. as your bond price goes up, you invest in, sorry i am not saying it clearly. if you invest in a 10 year bond that is 2.25%, you are going to get that.
if your bond price goes up you can be jubilant but when you collect that profit and sell it and invest it at a lower interest rate, the lower interest rate means you will still get the two and a quarter percent. when you look at the whole structure of asset prices from cash to the 2.25%, and you carry that all the way through, that has permeated all assets. that has permeated venture capital, private equity, real estate. all asset classes going forward will have a very low return. that means you need a whole lot more money in order to immunize something. supposing you have $100,000 per year expenditures, how much money do you have to immunize a $100,000 expenditure? we do that to get going as it did but we have a situation where we know it is certain have -- we are to have very low returns. tom: i had to give a signal to
the cameras, one minute or one more hour with you. we went with one more minute. here at hbs, everyone wants to go find the next uber out in silicon valley. what the you say to a 26-year-old smart kid to go into finance? how do you sell them on that in 2015? ray: i think that when you can go long or short, anything in the world, or everything in the world, that means you don't have any cycles. that means you get to think about the whole world and how it is connected. there is nothing more exciting and there are no excuses. if you go into any other business, you'll have a cycle. if you going to the tech cycle, anything. if you take financial engineering, every investment that you go into in business, if i bought -- michael: well, he can caddy.
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