Friday, October 13, 2017

Matt Levine: "The Case Against Bridgewater Isn't Proven"

Following up on "'Is Dalio's Bridgewater A Fraud? Here Are The Troubling Questions Posed By Jim Grant'—UPDATED"
For our innocent readers: "Not Proven" is an acquittal verdict in Scots law.

From Bloomberg View:

The hedge fund is weird, yes, but not in the ways cited in the newsletter. 
A piece in Grant's Interest Rate Observer, the charmingly cranky Wall Street newsletter, about Bridgewater Associates LP, the world's largest hedge-fund firm, has been getting a lot of attention this week. 1  It is titled "The face on the Wall Street milk carton," and it starts with some general tut-tutting at Bridgewater co-founder and spiritual leader Ray Dalio for spending a lot of time writing a book and tweeting and giving TED talks and doing other things that "have one thing in common: They are not investing."

This is true, but of course, if you had to describe in two words what Bridgewater's 1,500 employees do, "not investing" would be a pretty good fit. They have a computer to do the investing! Bridgewater runs on algorithms, and famously few of its employees have much visibility into how the algorithms actually work. They instead spend their time marketing the firm, doing investor relations, and -- crucially -- evaluating and critiquing one another. I once explained my theory of Bridgewater:
One stylized model for thinking about Bridgewater is that it is run by the computer with absolute logic and efficiency; in this model, the computer's main problem is keeping the 1,500 human employees busy so that they don't interfere with its perfect rationality.
On this theory, the computer might have gotten fed up with Dalio -- who by even his own account can be a bit much, as a manager -- and given him some carefully calibrated hints to make himself scarce. "Hey Ray," Bridgetron 4000 probably said, "your insights are so good, you should really put them in a book. And a TED talk. You deserve it. Don't worry about the investing stuff, I'll handle that."

But the meat of the piece is a series of oddities that Grant's editor Jim Grant and his colleague Evan Lorenz found in the Form ADV that Bridgewater files with the Securities and Exchange Commission, and that they take to be worrying signs about Bridgewater's business. Frustratingly, though, none of the oddities are especially odd.

We can just go down the list. First, Grant complains that Bridgewater does a pretty weak job of disclosing its fee structure. That's true. "Fees are negotiable, and individual arrangements are based on Client specific factors, including, but not limited to, assets under management and the risk/return parameters of the investment," begins Bridgewater's disclosure unhelpfully, before going on to note that it charges management and/or performance fees but not what those fees are. 2  Grant argues that this doesn't really fit the spirit of the disclosure requirements, but it would be tough to disclose a bunch of individually negotiated fee arrangements in any helpful way. "Renaissance Technologies, LLC, no more welcoming to prying eyes than Bridgewater, complies with" the requirement to disclose its fee schedule, argues Grant, but not really. Renaissance discloses a management fee of 0 to 5 percent and a performance fee of 0 to 44 percent. That's not so much more helpful than saying "we charge management fees, performance fees or some combination of the two." I mean, like every fund, Bridgewater charges a management fee between 0 and 100 percent and a performance fee between 0 and 100 percent, but the specific combination or combinations is a mystery.

Next, Grant alleges that "Bridgewater lends money to its auditor, KPMG, LLC." This seems to be just a misreading of the -- admittedly dense -- language of Bridgewater's Form ADV. 3 There is a lending relationship, and Bridgewater does disclose it, but it also says that KPMG is cool with it because the lenders are just holders of "non­voting shares of certain Bridgewater Funds" who are "unable to influence policies or management of the funds," and "have no relationship with the KPMG audit team assigned to audit the Bridgewater Funds." The lenders are investors in Bridgewater's funds. This sounds less like Ray Dalio lending money to his auditor to influence its audits, and more like a bank or a pension fund investing a lot of money in Bridgewater funds while also participating in a KPMG credit agreement. You would expect that to happen from time to time, and it does, not just to Bridgewater. Fidelity has the same issue, and the SEC has approved it. 4  Grant cites that precedent dismissively, but if it's fine for Fidelity I am not sure why it is weird for Bridgewater.
Next, Lorenz complains that Bridgewater gets most of its effective leverage by trading a lot of futures, 5  but is not registered as a futures commission merchant:
Filers of an ADV form check boxes to identify the businesses in which they’re engaged. Bridgewater ticks only one: ‘commodity pool operator or commodity trading advisor (whether registered or exempt from registration).’ You’d expect that a firm as large and active as Dalio’s might also mark ‘futures commission merchant.’  
Well. Why? Renaissance doesn't. Being a futures commission merchant is a different business from running a hedge fund. Generally speaking, being an FCM involves ... trading futures on ... commission. 6 That is not exactly a core hedge-fund business. Being an FCM is about being a member of a futures exchange, and being a futures exchange member is no more essential to a hedge fund that trades futures than being a stock exchange member is to a hedge fund that trades stocks.
Next: "Only two of the 33 funds" included in Bridgewater's disclosure "have relationships with prime brokers: Bridgewater Equity Fund, LLC and Bridgewater Event Risk Fund I, Ltd., in which 99% of the investors are Bridgewater employees." I guess that is a little weird? You don't need a prime broker to run a hedge fund, though it is rather customary, and they tend to be useful in providing leverage. One possible explanation is that if Bridgewater gets its leverage mostly through futures, it doesn't really need much in the way of prime brokerage relationships. It can get by with relationships with futures commission merchants. But, yes, this strikes me as kind of a strange disclosure.

Next: Bridgewater owns a lot of its equities through exchange-traded funds. "You wonder why such a sophisticated shop would stoop to such a retail stratagem," says Grant. "Surely the Bridgewater brain trust could replicate the ETFs at a fraction of the cost that the Street charges." It is not hard to replicate an index ETF; you can just buy all the stocks. The usefulness of the ETF is in being able to trade macro themes quickly: Instead of having your trader figure out how to buy 500 stocks all at once, you can buy an ETF and get the exposure efficiently and in one go. And so lots of big institutions do use ETFs as strategic trading vehicles. It would be weird for an activist equity fund to hold most of its equities in ETFs. It's not that weird for a macro-ish risk-parity-ish asset manager to get its equities exposure that way....MUCH MORE
By-the-bye, there is no verdict of innocent, only "Not guilty".