What is Pure Alpha? How does the Bridgewater Pure Alpha strategy work, and why did Ray Dalio establish this fund?
Pure Alpha is a fund that Ray Dalio established following some of Bridgewater’s struggles in the 1980s. The Bridgewater Pure Alpha strategy works a little differently than most funds, but it remains one of the most successful funds of all time.
Read more about Pure Alpha and how it works below.
Pure Alpha Strategy: Diversification
After his crash in 1981, Dalio tried to find a way to enjoy high returns with low risk, rather than choosing just high-risk/high-reward or low-risk/low-reward. He wanted to have his cake and eat it too.
He and his team had an epiphany: proper diversification could reduce risk without harming returns. The typical idea of diversification at the time was merely to diversify within an asset class. Instead of just holding a single stock, a fund manager might buy a hundred stocks. However, the stocks were still strongly correlated to each other. Therefore the portfolio of stocks was not all that well diversified—the stocks would generally rise together and fall together.
Bridgewater found that the key was to add assets that were uncorrelated with each other. As a result of their systematic collection of investment principles across a wide range of asset classes, they could assemble a set of uncorrelated assets. Their models showed this approach would reduce the risk of a loss in any given year, without reducing overall returns. The result was a return-to-risk ratio that was multiple times better than their previous strategies, meaning they could make more money with lower risk of losing money. This was true diversification. Dalio called this the Holy Grail of investing.
Based on these principles, Bridgewater introduced a new fund called Pure Alpha. Even though the strategy wasn’t proven in practice, some clients believed in the concepts and invested. In the 26 years since the fund started, it made money in 23 years, and it’s made more money in total than any other fund ever. This means that the Pure Apl[a
The idea of diversification can be generalized, no matter what business you’re in: make a handful of uncorrelated bets to capture the upside without having an unacceptable downside.
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