The Investment Ecosystem course on due diligence and manager selection is designed to give allocators exposure to concepts and tactics that they can apply to the qualitative analysis of asset managers.
An investment memo that recommends hiring a manager summarizes its philosophy, people, process, decision making, pedigree (the subject of our last posting), and the like. If you view such a memo next to the marketing materials of the manager in question, you can see how closely the descriptions resemble each other. Often they are very similar, without any significant elaboration or evidence of independent discovery having taken place.
On one dimension, asset management firms are narrative creation machines. That’s not surprising, since all individuals and organizations are such machines by nature. We curate (even create) our stories for others.
The job of someone doing due diligence is to crack that narrative and to find the reality behind it.
Standing apart
The culture module of the due diligence course offers a number of ways to analyze and classify an organization’s culture; the goal is to get past the way those involved say they get things done to find the way that they really get things done. That requires inquiries that go beyond the standard fare found in manager questionnaires and interviews.
Since the course was created in 2020, this slide has appeared at the end of the culture module:
The ledger had been introduced earlier in the course to emphasize the importance of identifying the factors that differentiate one manager from others. Its normal application would involve listing the “same as” and “different than” attributes of the manager. In this case, it was used to show that Bridgewater had positioned itself as being different — and better — than others when it came to organizational culture. The module closes with a case study about the firm.
The book
In the fall of 2023, The Fund was published. The book, written by Rob Copeland, is subtitled “Ray Dalio, Bridgewater Associates, and the Unraveling of a Wall Street Legend.” It paints a withering picture of Dalio and the culture he created at the firm.
In a sense, it is narrative versus narrative, Dalio’s utopian descriptions of “radical transparency” as the ultimate in organizational behavior and Copeland’s account of a dystopian reality much different from the advertised version.
If you check the reviews on Amazon, you’ll find people who said they worked at Bridgewater giving it one star and calling it a hit job — and others awarding it five stars and saying it is a dead-on portrayal of the environment and events at the firm. Dalio posted his objections to the “tabloid book” on LinkedIn, and an interview with Copeland on the Longform podcast includes background on the investigative process and the fact-checking regimen that was involved before his account was published.
While the whole book is worth your time, sections of it (and reviews about it) are available online; an edition of the Fortnightly after the book’s release included links to excerpts published in a number of high-profile publications, and an article from the New Yorker provides an excellent overview of the themes of the book.
The backdrop
Dalio created the firm as a research consultancy and not long thereafter began publishing “Daily Observations,” which summarized his economic and market views. After a decade Bridgewater began to manage money and quickly started an ascent that led to it becoming the world’s largest hedge fund, a rise that was driven by good investment results and a reputation for client service and effective communication about big picture issues of interest to investors.
On the investment front, Dalio claimed to have a systematic method of investment, based upon a series of if-then actions that mapped what he came to call the “economic machine.” But over the past two decades, his focus turned to a machine of a different sort — Bridgewater as an organization — and to the propagation of his behavioral and management principles to a wider audience.
Principles
Inside the firm, Dalio had been promoting those Principles (capitalized here in concert with both Dalio and Copeland) as the key to personal and organizational effectiveness. Over time, they became an end in themselves rather than a means to the end of investment excellence.
Employees were judged via “baseball cards” on a large number of attributes that Dalio felt represented the practical application of his doctrine. Improved technology allowed for the creation of the Dot Collector, the Dispute Resolver, PriOS (the Principles Operating System), and the Book of the Future, each new attempted iteration adding more complexity. In addition there were “issue logs” to be filled out if you had a complaint about something or somebody — about matters from the important to the comically mundane.
The premises were outfitted with cameras, so almost all meetings were recorded and available for replay in the Transparency Library. Some were edited for training purposes (allowing for the possibility that the radically-transparent original was compromised by a motivated editor). There were mandatory Principles training films and tests. All of this activity became more and more time consuming for employees, and created an environment of criticism rather than cooperation.
To judge the implementation of the ideas within the firm, Principles Captains were appointed, as well as Auditors and Overseers, with a Politburo above all. (Copeland: “Though theoretically meant to adjudicate disputes, the Politburo often created new ones.”) And public trials for some accused of not living up to the Principles.
Stop for a second and — based upon your own experience in organizations — imagine what kind of a culture might result from such structures.
In the book, Dalio comes across as mean and manipulative, definitely not a leader whose own behavior modeled the behaviors he espoused. And while he would publicly state that even the lowest person on the organization chart could give him a poor grade as a part of the daily feedback collection process, in reality he had his thumb on the scale. The system was tweaked so that he was ranked highest in “believability,” a key factor in determining how collective input was aggregated; everyone else had to earn their rankings based upon the assessments of others.
The promised meritocracy was compromised in a variety of ways, and ultimately a new Principle backed away from the ones that had come before:
Expect those who receive the radical transparency to handle it responsibly and don’t give it to them if they can’t.
Descriptions of the working environment cited in the book include “living in a psychology experiment,” “a feedback loop of self-destruction,” “a religion,” and “a fraud” (not a financial one but a cultural one).
Dalio sought out academics and journalists who would put their stamp of approval on his ideas. Some did, including Adam Grant in his book Originals: How Non-Conformists Move the World. A psychology professor published a working paper based on interviews with just twelve Bridgewater employees, selected by referral. (It is not referenced in the book and can no longer be found online.) The paper concluded: “Results indicate that it is possible to actively implement a learning culture in an asset management organization.” However:
The rating tools, polls and the forced ranking is a way to ensure that the underlying goal of having “the right people doing the right things” (Dalio, 2011) is fulfilled. Although many of these data gathering methods can be very well understood within a learning context they can appear cruel and inhumane. In order not to be emotionally harmed within this type of system a person must truly value learning over pride. It implies a deep love and acceptance of oneself and a profound trust that the system is well functioning. If any of these conditions is not fulfilled, people might be seriously emotionally hurt in this environment.
Dalio hired an acknowledged computer science expert, David Ferrucci, to convert his Principles into a one-stop system for managing organizations. Copeland:
Ferrucci, the AI expert, shared with colleagues a gradual awakening: Dalio’s system contained more artifice than intelligence.
Promotion
One (internal) version of the ever-changing list of Principles was made public by Dealbreaker in 2010. (That set, which featured 42 pages of overview and explanation, along with descriptions of 210 Principles, can be found here.) After that, Dalio took his ideas to the public in a variety of ways, including three books about the Principles (among others from Dalio), apps and personality assessments, and a TED Talk (“How to build a company where the best ideas win”).
That presentation included personal reflections by Dalio (“What an arrogant jerk!” he said after showing a video of himself from decades before), a demonstration of the non-stop grading of everyone by everyone at the firm (“Yup, we really do this”), and an explanation of his motivation:
I wanted to make an idea meritocracy. In other words, not an autocracy in which I would lead and others would follow and not a democracy in which everybody’s points of view were equally valued, but I wanted to have an idea meritocracy in which the best ideas would win out.
He ended by saying, of the radical transparency that was coming for all of us, “I hope it is as wonderful for you as it is for me.”
Investments
The Fund is mostly about the people and culture at Bridgewater — and not much about investment process. But well before the book’s publication, the investment function at the firm seemed odd to others in the business.
Bloomberg columnist Matt Levine referenced that divide many times over the years, including in a 2022 piece:
I have joked that Bridgewater has a computer that picks the investments, and a lot of interpersonal drama and management hooey to distract the human employees so they don’t interfere with the computer.
In Copeland’s telling, very few people at the firm had any idea how investment decisions were actually made. Only ten or so out of the couple thousand at the firm were a part of what Dalio called the Circle of Trust. They were given lifetime contracts and allowed to see the inner workings of the investment process that was advertised as systematic, based upon if-then rules built up by Dalio over time.
But the evidence of such a system is elusive. In a footnote, Copeland cites an arbitration case that Bridgewater brought against two former employees:
The panel wrote that Bridgewater “argued that its economic success as a hedge fund supported its assertions that it had and has valuable trade secrets but . . . produced no evidence of a ‘methodology’.” What Bridgewater claimed as its trade secrets were “publicly available information or generally available to professionals in the industry.”
To the extent that an information advantage did exist, it stemmed from Dalio’s assiduous cultivation of government officials around the world. Gleanings from them were important, but not systematic.
The machine in the investment realm was like the organizational one: promised as algorithmic but far from it in practice. Dalio could make decisions in the moment, despite the preestablished rules that were to be followed.
Narratives
The specifics of Bridgewater make it an unusual case, but the overriding concern is universal: To what extent should we believe the stories that we are being told?
By all accounts, the firm has been good at client service and investment narratives. From the earliest days, Dalio saw the importance of communicating investment ideas. The success of Daily Observations was attributable to the desire on the behalf of asset owners for that kind of content and the ability of Dalio/Bridgewater to deliver it.
(A 2021 Capital Allocators interview with Greg Jensen, co-CIO of Bridgewater, is a good example of someone speaking in depth about the investment landscape.)
Clients and prospects are drawn to people who sound smart about economic and market events and possibilities. (That’s why most investment committee meetings have entirely too much of that content.) But of more lasting importance to long-term success are the underpinnings of an organization’s leadership, culture, structure, and process.
Bridgewater told good stories about its culture and its investment process, but how true were they? Copeland’s book punches holes in the narratives, but it doesn’t address an important question: Did the theory of radical transparency or even pretty-good transparency extend to Bridgewater clients? Given the secrecy about its methods, apparently not.
Due diligence questions
For those charged with doing due diligence on managers, studying Bridgewater surfaces some foundational questions for any evaluation:
~ Why do you believe what you believe?
~ How do you discount the things that you are told but aren’t allowed to verify yourself?
~ What techniques can be used to crack the narratives that are fundamental to your selection and retention decisions?
~ To what degree do you allow narratives about the economy, markets, and investment opportunities to influence your thinking versus evidence of how an organization operates and makes investment decisions?
~ Where is the line between a firm’s claim of proprietary information and a client’s right to know?
~ When faced with the frequent turnover of people in key positions — and/or the constantly changing retirement plans of a founder — how do you change your view of an organization?
~ If there are uncertainties or qualms about a firm but performance has been good historically, do you act on the concerns (or at least investigate them in new ways) or wait until performance deteriorates?
~ What do you think when the old saying “No one ever got fired for hiring IBM” is altered to refer to a manager on your roster?
A new day
With Ray Dalio having officially retired, Bridgewater has an enormous pile of assets to protect, and it is no doubt busy defending its previous story while promoting a new one.
Through his extensive research and reporting, Rob Copeland has provided a gift, in that investors have an excuse to dig further than they ever have before, to discover whether the Bridgewater that was marketed was realistic — and how its current incarnation is the same or different than its past one.
In the due diligence course, right after the introduction of the concept of differentiation comes that of “edge.” Not all differences add value. Some subtract.
The narrative creation machines are always running. Due diligence is about finding what’s real.
If your organization would like to explore new ways of doing qualitative due diligence, please get in touch.
Published: February 21, 2024
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