Resurrected

Victor Niederhoffer might be the world's most eccentric trader. The son of a Jewish cop, the Brooklyn-born Niederhoffer doesn't wear shoes in the office, says the only periodical he reads is The National Enquirer and credits his success as a trader to the teachings of a 19th century African adventurer, who wrote about the habits of marauding monkeys and stampeding elephants.

There are many eccentric people who speculate in the capital markets, but Niederhoffer is different because, well, he was good, even top rated at one time. In fact, Niederhoffer had an amazing run of successful speculating in the futures market beginning in 1992, running two funds that posted a minimum of 25 percent average annual returns. One of Niederhoffer's funds ranked fourth in performance in 1994 and, as Niederhoffer notes in his 1997 autobiography, The Education of a Speculator (Wiley), “During one beautiful month, my picture was featured in Business Week, The National Enquirer, Financial Trader and The Wall Street Journal.” Of course, Niederhoffer made for good copy: A five-time U.S. squash champion, Niederhoffer says he can find a direct correlation between the stock market and any number of phenomena, such as musical scores and the number of books on sex published since 1886.

But Niederhoffer had a yen for risk, one that made him and his clients lots of money. For his performance in 1996, MAR Hedge, the New York-based hedge fund tracker, ranked his fund as No. 1. Eventually, his risk-taking and contrarian strategies would contribute to his going under in 1997, utterly erasing his reputation and the strong numbers he had put up prior to that time. The fact that Niederhoffer didn't fear risk wouldn't have been a surprise to those who know him. Legendary investor George Soros saw it first hand. In August 1992, Niederhoffer, who often played chess with Soros, as well as managed money for him, was testing the rough waters off the beach of South Hampton, N.Y., during a storm caused by Hurricane Andrew, one of worst storms to ever hit the U.S. “Get out! You're in over your head,” Soros called out to Niederhoffer. It's a pity Niederhoffer didn't take that warning as some divine sign. Days later, the U.S. stock and bond markets fell sharply on concerns that insurance companies would be forced to sell bonds to settle disaster claims. Niederhoffer's analysis had him holding the wrong bets, and he almost went under. Niederhoffer escaped just as he always seemed to do. (He recounts several near-death financial experiences in his autobiography, including the 1995 “dollar/yen debacle,” as he puts it, when his firm lost 50 percent of its assets.)

Athletically and speculatively, his performance was enviable. Indeed, he is a hardball squash legend, having won the U.S. Nationals five times and the U.S. Open in 1975. (His Harvard squash coach used to tell a story about how Niederhoffer went around Harvard his freshman year boasting that he would become a champion — and hadn't yet stepped on a squash court). Niederhoffer's fierce desire to win (and even to confound and annoy his rivals) carried over to Niederhoffer the asset manager.

A Yen for Reward — and a Stomach for Risk

Although he was regarded as a somewhat methodical squash player (if not rude), he developed a strong stomach for risk in the game of asset management. Most people shun risk, but Niederhoffer finds it exhilarating, and even helpful. “Life, like the markets,” writes Niederhoffer in his follow-up book Practical Speculation (Wiley, 2003), “offers the greatest rewards to those willing to assume risk. Assuming risk brings uncertainty, anxiety and occasional loss. But it also brings out the best in us.” Up to a point.

For Niederhoffer that point came in October 1997, during the Asian currency crisis, which was sparked by the devaluation of the Thais bath, which had a ripple affect that upset the world's financial markets. Characteristically speculating against the flow, Niederhoffer bet big that U.S and Thai stocks would move upward using highly levered futures and options contracts. But the markets plummeted, triggering a rule that closed the NYSE. As Niederhoffer notes, “Confronted with a demand to come up with many millions to meet margins the next day, I was forced to close my fund.”

Niederhoffer's strategy is to make leveraged bets on anomalous trading patterns, patterns that go unnoticed by others. Thai stocks should have rebounded, according to Niederhoffer's analysis. And the U.S. market should have also shown some strength. Only they didn't. One Wall Street analyst, who asked that his name not be printed, says, “Brilliant though he is, Victor Niederhoffer confused the idea of being right in the long term with being right all the time. When you make the kinds of bets he does, you simply can't do that. It was sheer hubris on his part.”

Niederhoffer told Registered Rep., “You might say I succumbed to the dream of emerging markets. Many people made that mistake but not to the extent that I did. In retrospect, I allowed the probability of ruination to be too high. It created a domino effect that led to my complete vulnerability and a Titanic-like concatenation of events. It was a terrible catastrophe, one I think about every day.”

As longtime Niederhoffer partner Steve Wisdom explains: “We got sucked through the Asian crisis. We were completely long and wrong and lost half our equity over a couple of months. Bear in mind the Thai stock market, as denominated in U.S. dollar terms, went down by 95 percent in a couple of years, an almost inconceivable decline. We lost a substantial amount of money even though we weren't that levered. Then, weakened, we were doing some options and futures trading, as we always do, and within a couple of weeks we had taken such a cash hit from that loss, and an even worse illiquid loss in the emerging markets, that all of a sudden we were just pinned to the wall.”

What happened next, according to Wisdom, was a “messy liquidation” that left him looking for work with a name “that was not so wonderful given his association with a guy who'd been wiped out.” (He's since rejoined his longtime partner.) To raise cash, Niederhoffer took out a mortgage on his house and sold his prized collection of silver trophy pieces, which, according to The New York Times, included a “five-foot horn of plenty made of silver and podollan ox horn, once the property of Charles XV of Sweden.” Niederhoffer continued to trade for his own account. Over time the tarnish wore off. As Niederhoffer puts it, “I had six kids and a lot of expenses, so I didn't have the luxury of wallowing in my misery. I had to fight back if I was going to survive.”

Survive he did, financially as well as intellectually. During the period of 1998 to 2002, Niederhoffer, working with ex-Bloomberg editor Laurel Kenner, began a side career as a financial journalist and developed a Web site (dailyspeculations.com) that offers daily commentary on markets and musings on a wide range of matters, under department headings: Child Rearing, Barbecuing, Physics and Trees (imagine a site devoted to thoughts on trees and stock prices). Niederhoffer continues to sponsor Junto, a monthly meeting of free-market libertarians held in New York that he founded in the 1980s; the gatherings are inspired by Benjamin Franklin's own meetings of intellectuals, which was also called Junto and ran for 30 years.

While Niederhoffer has always had a broad interest in science and ideas, his book tends toward the cautionary, which makes sense considering it opens with the closing of his fund. In the book, he seems to have finally taken to heart the geography lesson of his grandfather, who once reminded him that Wall Street “has a graveyard at one end and a river at the other.”

Back In the Arena

Niederhoffer officially returned to managed futures trading in February 2002 by forming Matador, an offshore fund that trades stock index futures and options on stock index futures. The numbers tell the story: Matador returned 3.14 percent, 40.57 percent and 50.12 percent for the years 2002 through 2004, according to HedgeFund.net, and was the top-managed futures fund for 2004, according to Tremont's TASS report.

But it's hardly the size of his former fund. As of midyear, Matador had $156 million in assets under management. Not that Niederhoffer needs or seeks new investors. According to his partner Wisdom, Matador is very different from most alternative funds, since “all you want to do is maximize your base and not have a really bad performance.” In contrast, “Victor's primary interest in the world is trading for his own account. At times he's reluctant to take money to manage, because the logic on his end is, if I'm getting some percent of the performance as an incentive fee, there's a limited niche in the market and I can trade only up to a certain amount; I'm better off filling that niche with my own capital because I can make 100 percent of the profit.”

Clients seem satisfied. Dick Dodson, president of ADM Investors Service, the firm that clears and executes for Matador, invested money in Niederhoffer. “Vic has proven very successful and done very well, and he's someone I trust, which is why we took a modest stake with him.”

What is the former squash champion and finance professor saying about the markets? It's very hard to figure out on his Web site, since his writings are almost like reading a private language, one that seems to be aimed at hardcore technicians. But in an interview, Niederhoffer, without detailing any specific trading strategies (he says he is not a stock-picker), lets on that he is generally bullish. The differential between earning yields — the inverse of the price/earnings ratio — and bond yields, Niederhoffer says, “Is about as favorable as it has ever been, about 3 percentage points. When that differential has been 1 percent or higher, over the past 30 years, there's never been a time when the market has gone down more than 5 percent and the average move upward is more than 20 percent.”

He adds, “I think your broker/readers will think back to what their customers were saying a year ago. That is, ‘Why the hell should I be getting 1 percent on my money market when I pay taxes and there's inflation?’ Wasn't it just a few years ago that people were talking about making 10 percent a year on stocks?” Niederhoffer thinks this will lead retail investors into fixed income, where they believe there is less risk. But, they would be wrong. He believes that fixed income is “out of sync with stocks” and that stocks are the place to be, “being a lot more attractive than fixed income.” So, once again, Niederhoffer is going against the grain. “That's the kind of anomaly that I look for,” he says.

Advice From an Expert Speculator

Niederhoffer is forever creating lists of rules for conduct, on the squash court, playing chess and cruising through Harvard with as little work as possible. The following, “Some Rules of Poker and Speculation,” is excerpted from his autobiography, The Education of a Speculator.