Follow up to Ray Dalio Talk

Two interesting things that I forgot to mention in my last post about the Ray Dalio interview. Both of them came from the host’s persistent efforts to get Dalio to talk about how he avoided the housing bubble/credit crisis in ’07-’08:

  1. A fundamental theory of the market is that the higher the risk of an investment, the higher the return it needs to offer. The returns offered by an equity are pretty easily quantifiable, the risks, not so much. One popular theory is that riskier stocks tend to have more volatile prices (volatility is represented by the Greek letter beta). At a point in the talk, Dalio mentions that credit default swaps and other derivatives seemed to have low beta, and yet were also profitable. This would seem to contravene the market truism that higher profits necessarily entail higher risk, or at least imply that there was a market inefficiency that you could exploit as long as you were quick enough off the gun. Dalio figured it was too good to be true, and it turned out it wasn’t–the price volatility and risk came back over the medium term and bit us all on the ass.
  2. A big tip off for Dalio was that his own clients were suggesting investment strategies to him. There’s a long-standing joke that investment advisors know there’s a bubble when people start giving them advice, and here it seemed to be true. Dalio didn’t comb through reams of data to figure out that trouble was brewing. He didn’t get some computer scientist to write code to predict the future. His intuition didn’t come solely from reading the markets, but from reading the people who thought they had a leg up on the markets. That says something about folly and the market.
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