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Bridgewater Associates, Inc. • One Glendinning Place • Westport, CT 06880 • 203.226.3030 Tel • 203.291.7300 Fax • www.bwater.com
Dear XXXXXXXX, 
2008 was a year to remember, so now is a good time to reect on it and to extract the important lessons rom it.Most importantly, it was a year in which a lot o mistakes occurred, so there is lots o learning and improvementthat can come rom looking at these mistakes analytically. It was a year in which all investors were stress–tested,and big dierences suraced, which are important to understand. It was also a year that has embedded in it lotso clues about the risks and opportunities that lie ahead, which we want to be sure to mine. So please indulge mewhile I attempt to do this reecting in my usual circuitous and opinionated way.It seems to me that, above all else, what happened last year reected human nature. No exogenous shocks causedwhat happened. The crisis was completely caused by people operating in a manner consistent with their individualnatures and together in ways typical o group dynamics. In other words, people caused their circumstances, whichthey reacted to, which caused new circumstances that they reacted to, and so on. And they did this in ways thatweren’t very complex or unique.
 
For example, i you understand the game o Monopoly®, you can pretty well understand what happened to theeconomy and to people’s fnancial circumstances last year. Early in the game o Monopoly®, people have a loto cash and ew hotels, and it pays to convert cash into hotels. Those who have more hotels make more money.Seeing this, people tend to convert as much cash as possible into property in order to proft rom making otherplayers have to give them cash. So, as the game progresses, more hotels are acquired, which creates more needor cash (to pay the bills o landing on someone else’s property that has lots o hotels on it) at the same time asmany olks have run down their cash to buy hotels. When they are caught needing cash, they are orced to sell theirhotels at discounted prices. So, early in the game “property is king” and later in the game “cash is king.” Those whoare best at playing the game understand how to hold the right mix o property and cash, as this right mix changes.Now let’s imagine how this Monopoly® game would work i we changed the role o the bank so that it can makeloans and take deposits. Players would then be able to borrow money to buy hotels and, rather than holding theircash idly, they would deposit it at the bank to earn interest, which would provide the bank with more money to lend.I Monopoly® were played this way, it would provide an almost perect model or the way our economy operates.More money would be put into hotels sooner than it would be i there were no lending, the amount owed wouldquickly grow to multiples o the amount o money in existence, and the cash shortage or the debtors who holdhotels would become greater, so the cycles would become more pronounced. The bank and those who saved bydepositing their money in it would also get into trouble when the inability to come up with needed cash causedwithdrawals rom the bank at the same time as debtors couldn’t come up with cash to pay the bank. That’s whathappened in 2008.By the way, I suspect that, i the game o Monopoly® were played with the bank operating this way, and more kidsplayed it rom an early age, we would have more astute investors, businesspeople and bankers and, as a result, wewould have less dramatic economic cycles.I we wanted to train our kids to have really rich appreciations o how the economy works, we would have to makeour Monopoly® game only slightly more complex. Most importantly, we would allow the bank to print money.Really, that’s all that we’d have to do to make the game very realistic. But, i we really wanted them to becomesophisticated global macro investors – i.e., to get them to learn about currency trading and “global macro” investing– we would have a ew Monopoly® games going at the same time with each one having a dierent currency andallowing players to reely play in any or all o them.
BRIDGEWATER
 
Bridgewater Associates, Inc. • One Glendinning Place • Westport, CT 06880 • 203.226.3030 Tel • 203.291.7300 Fax • www.bwater.com
I the bank could print the money, it would certainly do so when there was a cash shortage – i.e., when people needa lot o cash, when they can’t pay their debts, when they are selling their hotels, and when banks struggle to comeup with enough money to meet demand, because the players aren’t servicing their debts. Our kids would soonlearn that, all things being equal, printing more money causes its value (i.e., the currency) to all and the increasedmoney supply to buy hotels drives their prices up. But, i the bank prints more money when the demand or it ishigh, and there is a shortage o money when hotels are being dumped, and hotel prices are alling, then the currencywould not all in value and the prices o hotels would not rise, because the increased supply o money would simplynegate the eects o the shortage o it. That’s also what happened in 2008.In other words, in the years immediately prior to 2008, players in the economy took on a lot o debt to buy assetsat high prices, so in 2008 the game progressed to the stage where cash is in short supply, there are debt problems,and assets are written down or liquidated. Naturally, the central bank printed a lot o money, but this didn’t causeits value to all or ination to rise, because this increased supply o money negated some o the eects o theshortage.In Section II o the attached report, “A Template For Understanding What’s Going On”, we explain this debt/economic dynamic in a more eshed out way. I you only have a limited amount o time to read what we aresending, please stop reading this (and anything else that we gave you), and go read that.Because human nature and the basic elements o economics remain essentially the same over time, what happenedin 2008 has happened many times beore. However, unlike recessions that occur more requently, the dynamic thatoccurred in 2008 has happened less requently and has not happened within most people’s lietimes. Because itis in most people’s “nature” to learn rom their experiences, and because investors, businessmen, and governmentofcials did not previously experience the dynamic that happened in 2008, most o them 1) did not plan or it, 2)considered it implausible, and 3) didn’t understand it. That, more than any other reason, is why so many o themwere hurt in 2008.In other words, 2008 was a year in which those who built their strategies on the basis o what happened in theirrecent lietimes did not understand what happened in 2008 and so did badly, while those who had a perspective owhat happened in long ago times and araway places (and why these things happened) did well. Said dierently,i you optimize your investment strategy to work in a certain period without having a deep enough understandingo how it would work in all circumstances, including circumstances that did not occur within the period that’s yourrame o reerence, you will inevitably do very badly – and that is what happened to a lot o people in 2008.You have heard us speak o the importance o having a “timeless and universal” investment process, probably somuch that you are sick o this phrase. What we mean by it is that we believe that one’s investment process needsto have worked well in ALL COUNTRIES AND ALL TIME FRAMES in order to continue to work as things change,because it must be based on essential truths that include understandings o how things change over time. Webelieve that, i investors don’t do this, their process will work until it inevitably doesn’t work (i.e., until it blows up),because things will inevitably change in ways that aren’t understood and incorporated into the process. So, in myopinion, 2008 was a very important year o dierentiating those who operate this way rom those who don’t.Since I believe that a big common mistake that caused many investors problems in 2008 was not having a broadenough perspective, I believe that one o the most important lessons or those who did badly in 2008 is to
have a“timeless and universal investment” perspective
, which means to
broaden your perspective to understand whathappened in long ago times (e.g., in the 1930s) and araway places (like Japan and Latin America)
. Ask yoursel,“what would it be like i we had another year, or another two years, like last year,” because an examination o historyshows that this is well within the realm o possibilities. Nobody really knows what will happen, but we all need toconsider the ull range o possibilities, make sure that our strategies make the worst case scenarios tolerable (i.e.,really control risk!) and look or ways to maximize our opportunities. Taking a timeless and universal perspectivehelps us to do that.
 
Bridgewater Associates, Inc. • One Glendinning Place • Westport, CT 06880 • 203.226.3030 Tel • 203.291.7300 Fax • www.bwater.com
Another reason so many investors did badly in 2008 was that they had big, concentrated exposures to assets andportolios that do well when the economy does well and badly when the economy does badly – and the economydid badly. They had these skewed exposures because:1) The beta (i.e., asset allocation) exposures were not diversifed; they were (and still are) typically much moreheavily concentrated in assets that do well in good times and badly during bad economic times (e.g., public equities,private equity, real estate, high yielding debt, etc.) than in assets that do well in bad times (e.g., Treasury bonds).How did they get this way? It came about because o human nature – i.e., people are prone to do those things thatworked in the past without thinking hard about why they worked or whether they will work in the uture. In otherwords, investors are biased to invest in those assets that perormed best during the timerames that are in theirrame o reerences.2) The alpha exposures (i.e., tactical bets) were also typically not diversifed and were (and still are) skewed to dowell in good times and to do poorly in bad times. For example, the average “hedge” und was (and still is) about70% correlated with stocks. How did all these alphas and betas get so skewed toward doing well in good times andbadly in bad times, and how is it possible that portolios were so undiversifed? And what happened to absolutereturns in absolute return strategies? What happened occurred or the same reason – i.e., because o the tendencyto do what would have worked in the past. So, alphas like betas became those strategies that worked in the recentpast, which were strategies that worked in good times.3) The risk and liquidity premiums eects on returns are correlated to the betas and the alphas in the portolio. Sowhen the economy did badly, these premiums rose and also hurt returns.So, all three major drivers o returns were prone to do well during good times and, as a result, the averageinstitutional investor’s portolio was (and still is) heavily skewed to do well in good times (e.g., over 90% correlatedwith equities) and to do poorly in bad times. And, since 2008 was a really bad time (i.e., economic conditionsturned out worse than discounted), all the olks with these skews did badly.Since most everyone’s portolios were skewed this way long beore the 2008 price decline, and since the disasterscenario or this portolio had happened in Japan where the stock market is still down about 70% rom whereit was 20 years ago, why weren’t investors concerned about the possibility that what happened to Japaneseinvestors could happen to them? I believe that it is because o “human nature” – because their own experiencesinuenced their behaviors more strongly than this peripheral Japanese case. Having seen the most popular assetallocation mixes shit over time, I am confdent that ollowing a ew bad years, new theories will emerge to justiywhy portolios that are biased to do well during bad times are best – e.g., because they are good liability and undinghedges – and that most portolios will be skewed this way. That is because it is human nature to believe that whichhas happened most recently is more likely to occur in the uture, even though that belie is wrong.So, in reecting on 2008 and the lessons or the uture, I believe that one o the most undamental questionsinvestors should ask themselves is whether or not it is logical to have this huge bias to do well in times that arebetter than are discounted (i.e., to be so concentrated in assets and alpha strategies that are positively correlatedwith equities). Personally, I believe that having such huge biases is never logical, let alone at this time. So, I believethat another important lesson o 2008 or most investors is to
avoid having systemic biases in your portolio,which means to restructure your portolio so that it is less vulnerable to any one environment by having betterdiversifcation between and within betas, alphas, and risk premiums.
 
Beore leaving this subject o risk premiums and the strong tendency or investors to believe that what happened inthe past is likely to persist, I’d like to make one more point that pertains to them, in particular as to how they aectswings in ear and greed and how these swings aect pricing.
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