What's Behind Billionaire Ray Dalio's Anomalous 2012?

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Billionaire Ray Dalio and Bridgewater Associates had an anomalous 2012. Per Bridgewater's 2012 client letter its key hedge fund, Pure Alpha, was up only 0.8% for the year, compared to the S&P 500's over 13% return. As of 2011, the Pure Alpha fund had lost money in only three of its 20 years of existence, and had an average annualized return of 18%. 

Bridgewater's firm as a whole posted returns of 23% in 2011, where the average hedge fund portfolio lost 5%. What's more is that over the last 20 years, Bridgewater had annualized returns of 14.7%, compared to the S&P 500 Index's 8.7%. So why did Dalio's performance slip in 2012? Dalio appears to be early in his bet that the bond 'bubble' will burst. Many analysts and economists have noted the overvaluing in the bond market. Dalio's big bets on stocks would indeed payoff if bond prices fall and investors rotate toward stocks (check out Ray Dalio's entire portfolio).

The flood into bonds was warranted when the stock market was in disarray during the financial crisis. According to fund flow tracking firm EPFR, investors have pumped some $210 billion in bond mutual funds and ETFs since the beginning of 2008, and yanked nearly $700 billion out of U.S. stocks. Then in 2012, investors upped their stake in bonds by $90 billion and pulled $150 billion from stocks.

With nearly three decades of interest rate declines, rates now sit near all-time lows. A number of Wall Street analysts think the proverbial bond bubble might be about to burst. What should help bring about a sinking in bond prices would be a rise in rates and a move of investor money from bonds to stocks. Helping bring about this change should be expected global economic growth:  the IMF foresees global growth of 3.5% in 2013 and 4.1% in 2014, up from 3.2% in 2012. 

PIMCO co-founder Bill Gross has also taken notice of the said bond bubble, saying... 

...the inflationary dragons lurk in the "out" years towards which long-term bond yields are measured. You should avoid them and confine your maturities and bond durations to short/intermediate targets supported by Fed policies.  

So instead of betting on individual stocks, Dalio has made big bets on the broader equity markets. For the first nine months of 2012, Dalio kept almost 60% of his 13F portfolio invested in SPDR S&P 500 ETF Trust (NYSEARCA: SPY) and Vanguard MSCI Emerging Markets ETF (NYSEARCA: VWO). As of the end of the third quarter he had 35.3% of his portfolio in the SPDR ETF and 27.6% the Vanguard ETF. Dalio is not the only fund manager keeping a heavy concentration in the SPDR S&P 500 ETF; as of the third quarter, Longhorn Capital had 78% of its portfolio invested and Axial Capital had 60% (check out other hedge funds invested heavily in the S&P).

Both ETFs should benefit from a shift from bonds to stocks, but the emerging market ETF should also benefit from a bolstering Chinese economy. The Vanguard MSCI ETF is more exposed to China than any other country, at over 18% of its portfolio. The Organization for Economic Cooperation and Development predicts that China will soon surpass the United States to become the world’s largest economy, and will account for 28% of global gross domestic product by 2030. The OECD also predicts that by 2060 the combined GDP of China and India will overtake that of the OECD economies.

Dalio's three biggest stock picks for the end of the third quarter were Microsoft (NASDAQ: MSFT), Safeway (NYSE: SWY) and Hewlett Packard (NYSE: HPQ). For the third quarter his top three stocks made up only 1.68% of his portfolio. Dalio was making some shakeups with his individual holdings during the third quarter (check out Dalio's big moves). Even so, they have all been down over the past twelve months. 

<table> <tbody> <tr> <td> <p><strong>Company</strong></p> </td> <td> <p><strong>TTM Stock Move</strong></p> </td> </tr> <tr> <td> <p>Microsoft</p> </td> <td> <p>-7%</p> </td> </tr> <tr> <td> <p>Safeway</p> </td> <td> <p>-11.5%</p> </td> </tr> <tr> <td> <p>HP</p> </td> <td> <p>-39% </p> </td> </tr> </tbody> </table>

Positive initiatives for Microsoft, which should help diversify the company away from a dying PC market, include its Surface tablet, Windows mobile operating system, Xbox gaming console, and its recent partnership with Facebook. Microsoft has also partnered with Facebook to provide results for Facebook's Graph Search. The current price to earnings multiple (15.3 times) that Microsoft is trading at is below major peers and its historical average.

Although HP's valuation is "unconsciously" cheap, the recovery in the stock could be longer-dated than 2013. The company is currently focused on a cost-restructuring that might not be fully completed until 2014. The other fundamental headwinds for the company includes weak PC demand, thanks in part to tablets and smartphones, and greater competition from lower-cost manufactures.

Safeway's overall visibility has been reduced thanks to an influx of new competition by organic grocers, namely Whole Foods and The Fresh Market. This competition will play a key part in expected margin for the interim. However, Safeway's shares have seen a boost of late on news that the grocery chain could be looking to sell its Canadian operations. A BMO Capital analyst values the Canadian operations at around $5.5 billion. Taking it a step further, BMO suggest a 25% boost, $25 price target for Safeway's current stock price contingent on the transaction. 

Now that 2012 is over, how will Dalio's top picks do in 2013? The revenue and earnings figures for his top three picks stack up as follows:

<table> <tbody> <tr> <td> <p><strong>Company</strong></p> </td> <td> <p><strong>Next Year Revenue Growth (estimated)</strong></p> </td> <td> <p><strong>Next Year Earnings Growth (estimated)</strong></p> </td> </tr> <tr> <td> <p>Microsoft (ending Jun.)</p> </td> <td> <p>8.3%</p> </td> <td> <p>4.7%</p> </td> </tr> <tr> <td> <p>Safeway (ending Dec.)   </p> </td> <td> <p>1.9%</p> </td> <td> <p>4.4%</p> </td> </tr> <tr> <td> <p>HP (ending Oct.)</p> </td> <td> <p>-6.7%</p> </td> <td> <p>-18%</p> </td> </tr> </tbody> </table>

Dalio's top pick, Microsoft, could be a bright spot for Dalio in 2013. The diversified tech company looks to be quite a value and also has the best revenue/earnings growth and one of the more stable product portfolios on the market. However, Safeway could see upside from operation consolidation, but HP may well continue to struggle as the PC market continues declining.  

The guys over at Insider Monkey are pros at tracking hedge funds, and so they record the returns of hedge funds based in the top 1500 stocks in the market and their long positions only. According to their performance tracker, Bridgewater only returned roughly 1% in each of the first three quarters of 2012. This compared to the 13.8% the S&P 500 Index returned over the same nine months. With over 60% of Dalio's portfolio invested in broad market ETFs, Dalio might not leave the S&P 500 Index (a common benchmark) in the dust, but he would indeed capitalize on a bond bubble bursting. 


mhargra has no position in any stocks mentioned. The Motley Fool owns shares of 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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