The Tao of Dalio

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Bridgewater Associates founder Ray Dalio is one of the most private of investing whales, almost the J.D. Salinger of hedge fund honchos. In a rare interview with The New Yorker he explains how he turned Bridgewater Associates from a company he founded after a few years on the floor of the New York Stock Exchange into the world's largest hedge fund. It's also one of the most successful, outperforming George Soros' fund this last year. Currently, the fund only accepts institutional money, but his stock picks and philosophy are matters of public record.

Similar to Jerry Maguire's mission statement, Dalio wrote his Principles, and like Warren Buffett's annual letter to shareholders, it's a must-read for investors. Around the offices at Bridgewater it's considered their unofficial manual. It's more self-actualization than investment guide, but there are nuggets of gold to be found regarding his investing philiosphy.

Recognize opportunities

"Recognize opportunities where there isn't much to lose and a lot to gain, even if the probability of the gain happening is low." This rephrasing of the contrarian Buffett maxim, "Be fearful when others are greedy and greedy when others are fearful," seems like the rationale behind some of Dalio's recent holdings.

Since the 13-F filing revealing positions from the end of September, Yahoo! (NASDAQ: YHOO) has created a 30% plus gain for Dalio. Analysts believed the probability of a Yahoo! turnaround was low but new CEO Marissa Mayer worked very hard in her 100 or so days to turn a "toxic culture" into one where techies are thronging to work there.

An interesting choice going forward may be Safeway (NYSE: SWY) -- he added 41% to his position, almost twice the percentage he added to his Kroger position, and it's one of his largest holdings. Safeway certainly has its cohort of naysayers. Dalio likely thinks this name hit bottom at $14.73 with its decline in sympathy with Supervalu. It is up some 20% since that low. Safeway has a 3.90% yield and an 8.50 P/E. It does have a large debt burden of close to $6 billion while continuing to buy back shares. It's one of the most highly leveraged defensive retailers and, with thin margins, is one with which I would disagree with Dalio.

The best choices

"Remember that the best choices are the ones with more pros than cons, not those that don't have any cons." In other words, all companies have their weaknesses, even greats like Apple. Microsoft (NASDAQ: MSFT) may be the best example of this as it's had every opportunity to become as great as Apple. Microsoft's weakness is that it's been content to bask in its former glory and isn't as hungry as Apple or Google.

Dalio must have believed that would change with the Surface tablet and Windows 8, adding two more pros to the list along with Xbox and the yield of 3.40% to make it one of his top five holdings. Microsoft trades at a 14.52 P/E  and the analyst price target of $34.44 leaves some 30% upside. However, recent retail reports have shown low adoption of Windows 8 and an embarassing failure of the Surface tablets to gain custom.

A better choice might be his new position in BCE (NYSE: BCE), otherwise known as Bell Canada, the Canadian telecom with a $33 billion market cap. The yield is the largest of these names at 5.30% with a 69% payout ratio, and it has been consistently raised. It has a 13.63 P/E and the company is working on a rollout of 4G LTE to entice new wireless customers across our northern neighbor's far flung borders. It's also venturing into media channels and owns 28 TV stations, 30 specialty television channels, and 33 radio stations.

Don't bet too much on anything

Dalio goes on to add, "Make 15 or more good, uncorrelated bets." If that isn't an argument for diversification I don't know what is. His two largest buys in the fund were for emerging market ETFs. That may be the safest way to get exposure to this growth area rather than picking individual stocks. Vanguard MSCI Emerging Markets ETF (VWO) and the iShares MSCI Emerging Markets Index (EEM) are the number two and three largest positions in the portfolio respectively after the S&P 500 Index ETF (SPY).

There is nothing to fear from truth

He wrote that in the Principles also. Walking the talk, Bridgewater Associates is run as a transparent hedge fund. Dalio prefers companies that are willing to admit mistakes, learn from them, and move on. Maybe that's why he bought shares of Berkshire Hathaway (NYSE: BRK-B) after the Lubrizol scandal was handled with so much integrity by Warren Buffett.

Berkshire Hathaway is a new buy for Bridgewater Associates and is another way he is diversified, with Berkshire Hathaway being classified as an insurance stock but in reality holding many smaller companies that are housing recovery plays as well as media, industrials and so on. Berkshire Hathaway has no yield but offers a double digit annualized return rate, currently near 20%.

Be a "hyperrealist"

Dalio characterizes himself as a hyperrealist, meaning he understands companies are flawed and that macro conditions can wreak havoc on good companies and bad. The biggest thing to take away from his portfolio philosophy is his insistence on clearly valuing a company without rose colored glasses while still having a sense of optimism going forward. Hard to do but that's why he makes the big bucks.

leglamp has no positions in the stocks mentioned above. The Motley Fool owns shares of Berkshire Hathaway and Microsoft. Motley Fool newsletter services recommend Berkshire Hathaway and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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