0. BRIDGEWATER ASSOCIATES
Alpha Wars: Survival of the Fittest
Bob Prince
Co-Chief Investment Officer
October 2005
One Glendinning Place
Westport, CT 06880
(203)

1. Hold Assets (risk premium)
TWO WAYS TO MAKE MONEY
Hold Assets (risk premium)
Make Bets (timing)
Beta
Alpha

2. Alpha vs. Beta Beta + Alpha Type of risk: Systematic Unsystematic
Source of risk:
Asset class
Manager skill
Return/Risk ratios:
0.2 to 0.3
Unlimited
Correlation:
High
Low
Difficulty:
Easy
Hard
Cost:
Cheap
Expensive

3. THE ALPHA WORLDS ARE CONVERGING
Alpha is a zero sum game, no matter what you call it.
Weaker players will lose to stronger players.
Alpha Overlay
Hedge Funds
Active Management
Traditional

4. SMARTEST BEST RISK MANAGERS THE WINNERS WILL BE… Make good bets
Portfolio theory applied to alpha

5. APPLYING PORTFOLIO THEORY
Ones and Threes
Portfolio of 5
Portfolio of 10
Portfolio of 40
Return
1.0% …
1.0% …
1.0% …
1.0% …
1.0%
Risk
3.0% …
3.0% …
1.4% …
1.1% …
0.8%
Ratio
0.3 …
0.3 …
0.7 …
0.9 …
1.3

6. EXAMPLE OF COMBINING ALPHAS
US Bond Alpha
JPY/USD Alpha
Combined
200%
175%
Information Ratio:
US Bond Alpha =
0.65
JPY/USD Alpha
0.55
Combined
0.87
150%
125%
100%
75%
50%
25% 0%
-25% 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02

7. DIVERSIFIED ALPHA IS BETTER THAN NONDIVERSIFIED ALPHA
Traditional Fixed Income Mandate
Fully Diversified Pure Alpha
Sources of Value Added: 6
Average correlation: 0.25
IR per slice: 0.35
Implied IR: 0.56
Sources of Value Added: 77
Average Correlation: 0.04
IR per slice: 0.35
Implied IR: 1.40

8. SCALABILITY OF OVERLAY
Scaling an Information Ratio of 1.0
20%
18%
GTAA
16%
14%
12%
Alpha/Return
10% 8% 6% 4%
Enhanced Cash
Active
Active
Hedge Funds 2%
Bonds
Equity 0% 0% 2% 4% 6% 8%
10%
12%
14%
16%
18%
20%
Tracking Error/Volatility
Source: Bridgewater analysis

9. OPTIMAL ALPHA REQUIRES
Positive Expected Return
No systematic risk
High sample size
Risk targeting ability
Integration with benchmarks

10. Hedge Funds: Alpha or Beta?

11. HEDGE FUND CORRELATIONS
Average Managers’ Correlations Within Style

12. BETAS IN HEDGE FUNDS Fixed Income Arbitrage
Fixed Income Arbitrage Strategy Hedge Funds
BW Simple Fixed Income Arbitrage Replication
Rolling 6-Month Excess Returns
Correlation:
77%
Cumulative Excess Return

13. Rolling 6-Month Excess Returns Cumulative Excess Return
BETAS IN HEDGE FUNDS
Merger Arbitrage
Merger Arbitrage Strategy Hedge Funds
BW Simple Merger Arbitrage Replication
Rolling 6-Month Excess Returns
Correlation:
56%
Cumulative Excess Return

14. Rolling 6-Month Excess Returns Cumulative Excess Return
BETAS IN HEDGE FUNDS
Emerging Markets
Emerging Markets Strategy Hedge Funds
BW Emerging Markets Strategy Replication
Rolling 6-Month Excess Returns
Correlation:
79%
Cumulative Excess Return

15. Rolling 6-Month Excess Returns Cumulative Excess Return
BETAS IN HEDGE FUNDS
Managed Futures
Managed Futures Strategy Hedge Funds
BW Simple Managed Futures Strategy Replication
Rolling 6-Month Excess Returns
Correlation since Jan. 1999: 90%
Cumulative Excess Return

16. APPLYING HEDGE FUNDS Are you getting alpha or beta? Diversify.
Allocate based on alpha/beta targets.
Overlay HF alpha onto optimal beta.

17. MONEY MIGRATION

18. MANAGER MIGRATION
Traditional Fund Mangers Who Switched to HF/Alpha Overlay:
Jack Meyer Harvard Mgt Alpha Overlay
Brian Posner Warburg Pincus Hygrove Partners
Michael DiCarlo John Hancock DFS Advisors HF
Leon Cooperman Goldman Omega HF
Jeffrey Vinik Fidelity Vinik Asset Mgmt
Rob Donahue Solomon Brothers Own fund
Greg Jackson Oakmark Global Blum Capital HF
David Glancy Fidelity Own fund
Peter Trapp Needham Own fund
Warren Lammert Janus Granite Point Capital
Nicholas Tiller Fidelity Hedge fund
Chirstopher Zepf Fidelity Hedge fund
Dan Szemis Merrill Lynch Hedge fund
Gary Schlarbaum Morgan Stanley Schlarbaum Capital

19. Global Macro Funds
Global macro managers take views on a variety of asset classes (e.g., equities, fixed income, currencies, commodities, etc.) by studying cause-effect relationships between macro economic variables and assessing how these are being (mis)priced in markets
Example of macro economic variables: growth, inflation, central bank policy (e.g., intervention), political events, balance of payments, capital flows
The implementation of these views takes many different shapes and forms:
Systematic – cause-effect are studied and programmed into a logical code
Discretionary – views are typically implemented through directional and concentrated bets
Process Example:
Global Macro
D World
Interest Rates
Outright
Duration
D Relative
Relative
Country
(diffs)
Equity Prices
Equity
D Currency
Forwards
Currency
Real Yields
Inflation
Indexed
Bonds
Country &
Sector
Commodities
Exposure
D Commodity
Prices
Nominal
vs.
Inflation-
Breakeven
Inflation Rates
EMD Credit
Spreads
Developed
Emerging
Market
Debt
we are able to trade all of these markets and we can trade them in multiple countries throughout the world.
Alpha opportunity set larger.
Allows many alpha streams that have a low correlation.

20. Fixed Income Arbitrage
Fixed Income Arbitrage managers are trying to capture spreads and positive carry in various forms, from simple strategies to more complex ones:
Emerging market credit spread - the managers try to time exposure to EMD spreads (duration hedged spread against US treasury), with bias towards being long the spread
Mortgage-backed securities - similar to EMD spreads, the managers are biased towards capturing the spread between MBS/ABS/CMBS and US treasuries by applying models for calculating prepayment risk (the option embedded in MBS). They tend to take the exposure in the less liquid/traded CMO trenches were they think mis-pricing of the prepayment option exists
Volatility trading - the managers take views on volatility and skews and are biased towards being short options and collecting the difference between implied and actual volatility
Carry/yield curve trades - try to capture positive carry (the difference between cash and longer-term rates) and implement views on the shape of the yield curve applying interest-rate models.  These views are applied to the short-end of the curve (Euro$) and the long-end (Bonds)
Currency - managers take some active views on currencies, primarily based on interest rate diffs between countries  
we are able to trade all of these markets and we can trade them in multiple countries throughout the world.
Alpha opportunity set larger.
Allows many alpha streams that have a low correlation.