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Niederhoffer, Humbled by '97 Blowup, Posts 56 Percent Return
2006-05-31 00:44 (New York)
By Deepak Gopinath
May 31 (Bloomberg) -- One evening in April, Victor
Niederhoffer went to a party at the St. Regis Hotel in New York.
Niederhoffer, 62, used to be one of the most prominent hedge
fund managers in the U.S. He made a fortune during the 1980s and
'90s, trading out of his New York office and chalet-style mansion
in Weston, Connecticut. Then Niederhoffer lost it all -- his $130
million fund and most of his own savings -- when his bets on the
markets went wrong.
Niederhoffer's life collapsed beneath him. He closed his
firm. He mortgaged his house and sold his cherished collection of
antique silver. Among those treasures was a 5-foot (1.5-meter)
horn of plenty that had once belonged to King Charles XV of
Sweden. Niederhoffer says he became so depressed that his family
feared he might kill himself.
As he walked beneath the gilt chandeliers of the St. Regis
that April night, sporting a lavender blazer, Niederhoffer was
back on top. He was being honored at a fete for some of the
country's top money managers. Since 2002, Niederhoffer has
parlayed $2 million into a new, $346 million hedge fund, Matador
Fund Ltd. Last year, he posted a 56 percent return, for an
average annual return of 41 percent.
``I appreciate the difficulty and the courage it took to
give me an award, since I once went under,'' Niederhoffer told
the crowd of 300 money managers.
It's been a long journey back for Niederhoffer, a Wall
Street iconoclast who celebrated his early achievements in a
memoir titled ``The Education of a Speculator'' (John Wiley &
Sons, 1996).
`Underdog Capital'
The book traced his personal odyssey from Brighton Beach,
Brooklyn -- ``the underdog capital of the world,'' he called it -
- to the pinnacles of finance. Niederhoffer wrote of his prowess
on the squash court, his unflinching concentration, his high-
stakes trades. He told of his games of chess and tennis with
billionaire financier George Soros, for whom he'd once managed
about $100 million.
No sooner had the book been published than Niederhoffer's
unhedged trades in U.S. stock options and Thai equities blew up.
Niederhoffer was wiped out, as a chain reaction of devaluations
in Asia rocked world markets. The fiasco foreshadowed the
spectacular collapse of Long-Term Capital Management LP, John
Meriwether's hedge fund firm in nearby Greenwich, Connecticut,
which lost more than $4 billion in 1998 after Russia defaulted on
debt.
`Over His Head'
Niederhoffer became a Wall Street pariah, the butt of black
humor and gossip. Brokers refused his business, he says. When he
walked into the Four Seasons restaurant in Manhattan, the
whispers would start. He says co-owner Alex von Bidder told him
the restaurant's patrons got a thrill from seeing the mighty
humbled.
``You know how people like to talk,'' von Bidder told him.
```There's Niederhoffer. He just went under. Went in over his
head. Got too big for his britches.''' Von Bidder picked up his
tab.
Niederhoffer's 1997 debacle still resonates on Wall Street.
When his old broker, Refco Inc., collapsed in scandal last
October, word spread that the New York-based firm might have
hidden losses that it had incurred on Niederhoffer's trades years
before. The talk irked Niederhoffer and prompted him to deny what
he calls unsubstantiated rumors. He says he had nothing to do
with Refco's unraveling.
Niederhoffer says he's emerged from the ashes a changed man.
His failure has taught him humility, he says.
Appetite for Risk
A Harvard College graduate with a Ph.D. in finance from the
University of Chicago and, colleagues say, a preternatural
tolerance for risk, Niederhoffer says he no longer believes he
can master all markets. He refuses to chase profit in faraway
places such as Thailand, where he once lost $50 million. Instead,
he focuses almost exclusively on the $130 billion-a-day market in
futures and options on the Standard & Poor's 500 Index.
``I try not to reach for the stars,'' Niederhoffer says.
Niederhoffer hasn't lost his appetite for risk, however. As
he was during the 1990s, Niederhoffer is a bull. In the argot of
Wall Street, he's long-biased. He tries to make money from short-
term movements in the S&P 500. To do that, he buys and sells
various futures and options contracts on the index as many as two
dozen times a day. He typically holds each position for one to
five days.
To stoke returns, he employs a tool common to hedge funds,
one that accelerated his undoing nine years ago: leverage.
Niederhoffer buys on margin, or with borrowed money.
Steep Losses
The value of the positions he holds far outstrips the amount
of money he actually has. And because Niederhoffer is a bull,
he's vulnerable to market declines. He has lost as much as 30
percent in a month.
Sol Waksman, founder of Barclay Group Ltd., a Fairfield,
Iowa-based firm that tracks hedge fund performance, says he lost
some of his own money -- he won't say how much -- when
Niederhoffer went under in 1997. He says he doesn't have the
stomach to invest with him again.
``I never thought in my wildest dreams that it would go to
zero,'' Waksman says of his investment. ``I wasn't fully aware of
the risks he was taking.''
Even before disaster struck, Soros had warned that
Niederhoffer might be swamped by big moves in the markets.
``There was a flaw in his approach,'' Soros, 75, wrote in ``Soros
on Soros'' (John Wiley & Sons, 1995). ``It is valid only in a
trendless market.'' Soros, who stopped using Niederhoffer to
manage money in 1995, declined to be interviewed for this story.
`Tidal Movement'
Niederhoffer says he does take risks. That's the only way to
reap market-beating returns, he says. ``Not an hour goes by here
that we don't have direct action taken to prevent ourselves from
being overwhelmed by tidal movement,'' he says.
On a sunny, late-January afternoon, Niederhoffer and his
nine researchers/traders are at work in the second-floor trading
rooms of his 20,000-square-foot (1,858-square-meter) Connecticut
mansion. The estate sprawls over 13 acres in bucolic Weston. A
narrow drive stretches past a dozen wooden bulls and bears. One
of the bears is 12 feet tall. To the right is a racquetball court
that Niederhoffer, a five-time U.S. squash champion, uses to work
on his tennis strokes.
Niederhoffer is about 6-foot-2 and has close-cropped gray
hair. He favors blazers and trousers in pastel hues of pink,
blue, orange and yellow. He never wears shoes indoors.
A collector of 19th- and 20th-century American folk art,
Niederhoffer has filled his home with 2,500 paintings, sculptures
and carvings. Among them are pictures he has commissioned of
people and places that have shaped his life: his father, Artie
Niederhoffer, a policeman who worked in Brooklyn's Coney Island;
a trading floor; Brighton Beach in the 1950s.
Books, Shells, Toys
One room contains nothing but glass shelves holding
seashells. (Niederhoffer says he's fascinated by evolution.)
Another is filled with antique toys.
Niederhoffer has stocked his library with more than 15,000
books. He owns a first edition of ``The Wealth of Nations'' by
Adam Smith and a sketch of the light bulb by Thomas Edison.
One of Niederhoffer's icons is Francis Galton, a Victorian
polymath who pioneered statistical correlation and regression
(and, among other things, invented fingerprint identification).
Niederhoffer named the eldest of his six daughters Galt, and a
portrait of Galton hangs in the library. Another hero is Ayn
Rand, author of ``The Fountainhead'' and ``Atlas Shrugged'' and a
champion of free markets. His library holds some of her letters.
Niederhoffer named his third daughter Rand.
`The Chair'
Up on the second floor, Niederhoffer and his team sit at
wooden desks in two rooms connected by a door and an open window.
Niederhoffer, whom his colleagues call ``The Chair,'' sits in one
room. A few feet away is Steve ``Mr. Wiz'' Wisdom, 44,
Niederhoffer's right-hand man. Only Niederhoffer and Wisdom trade
with investors' money.
The rest of the team tests ideas by trading with the $50
million house account, part of Niederhoffer's personal fortune,
which he has replenished through profitable investments.
It's an eclectic crew. House trader Ari ``Ace'' Siegel, 36,
put himself through the Yale School of Management by playing
poker on the Internet. Now he trades futures on the euro, bonds,
oil and U.S. and German stocks for Niederhoffer.
Alex ``Doc'' Castaldo, a graduate of the Massachusetts
Institute of Technology with a Ph.D. in finance from the City
University of New York, stays on top of academic research and
European markets.
Show Tunes
Charles ``The Professor'' Pennington, a former physics
professor at Ohio State University, specializes in futures and
individual stocks. Duncan ``The Director'' Coker, a former real
estate developer and an early Matador investor, researches
futures. California native Michael ``Dude'' Pomada trades stocks.
No one wears shoes. No one speaks. Though they sit just
desks away from each other, everyone communicates via e-mail. A
stereo softly plays songs from ``Show Boat'' and other Broadway
musicals. Once in a while, someone pads to the kitchen to grab a
snack or make tea for Niederhoffer. Occasionally, two men
disappear for a game in the indoor squash court, just beyond the
library.
Above Niederhoffer's desk hang two paintings by New York
illustrator Tom Lovell. One depicts a 19th-century daredevil
who's tightrope walking across Niagara Falls while carrying a man
on his back. The other shows escape artist Harry Houdini, his
hands bound, about to jump off a bridge.
Now in his seventh decade, Niederhoffer says he's determined
to show the world he isn't a failure. He says his crash cost him
more than money; it cost him his reputation. It hurts to be
branded as a loser, he says.
Policeman's Son
``The ridiculous thing, in all candor, is that I think I've
had the greatest run of success in the history of speculation,''
Niederhoffer says.
Niederhoffer's story begins in Brooklyn, in an era when
people drank egg creams on the Coney Island boardwalk and cheered
``Da Bums,'' the Dodgers baseball team. It was there that Victor
Niederhoffer was born in 1943.
His father, Arthur, graduated from Brooklyn Law School in
1939, and he became a policeman because the job offered better
pay and more security than working as a lawyer. Victor's mother,
Elaine, taught school. Young Victor grew up in a small, art deco
apartment a block from the beach, the elevated train and Public
School 225.
Brooklyn was then a town of working-class stiffs, rebels and
losers, according to Niederhoffer. ``The mere mention of the name
is traditionally good for a raised eyebrow, a snicker or a
joke,'' he wrote.
Brighton Beach
By his own account, Brighton Beach taught him much of what
he needed to become a successful trader. ``The games, bargains,
music, sex and fauna taught me to appreciate the earthy and the
nitty-gritty,'' he wrote. ``That's the proper foundation for
buying low and selling high, the trade of a speculator.''
The streets of Brighton Beach, teeming with gamblers and
dandies, were the Harvard of his boyhood. Victor spent his
Sundays there watching handball players with nicknames such as
``Bitter Irving,'' ``Bookie,'' ``The Animal'' and ``The Milkman''
play while ``Louie the Lion'' held a $50 stake under his hat.
``Kids aspired to emulate the champions, and Vic was exposed
to that,'' his uncle, Howard Eisenberg, says. ``It became very
important to win and compete.''
Artie soon introduced his son to tennis, and young Victor
went on to become the junior champion of New York City five years
in a row and win a scholarship to Harvard.
There he took up squash and vowed to become a champion. He
practiced one shot every day for a month, over and over and over,
until he mastered it, and then he moved on to another shot,
Eisenberg says.
Squash Champ
Niederhoffer often wore mismatched sneakers on the court, a
habit that earned him a reputation as an oddball. By the time he
graduated in 1964 with a degree in economics, he'd become the
U.S. intercollegiate squash champ. He went on to win the U.S.
national championship five times.
He was never a graceful athlete, says Vic Elmaleh, his
doubles partner at the 1968 nationals. He won because he was
consistent, Elmaleh, 87, says. ``He was also one of the most
confident people I had ever known,'' he says.
Niederhoffer was an iconoclast off the court, too. His
senior thesis, ``Non-Randomness in Stock Prices: A New Model of
Price Movements,'' challenged the so-called random walk theory,
which holds that market prices follow a haphazard path.
He argued that stocks followed patterns. For example, he
found that when stocks fell on a Friday, they usually declined
the following Monday, too.
Berkeley Professor
``At that time, it was considered academic heresy,'' says
Ronald Volpe, 63, a professor of finance at Youngstown State
University in Ohio.
From Harvard, Niederhoffer headed west, first to the
University of Chicago, where he collected his doctorate in 1969,
and then on to the University of California, Berkeley, where he
became an assistant professor of finance.
He didn't stay in academia for long. While teaching at
Berkeley, he co-founded a boutique investment bank with Frank
Cross, a former Merrill Lynch & Co. executive, and Richard
Zeckhauser, a friend from his Harvard days who had a Ph.D. in
economics.
The firm, Niederhoffer, Cross & Zeckhauser, which started
out with $400 of capital, pioneered mail-order mergers,
soliciting small, private companies with advertisements or
letters and then lining up buyers for them.
``Victor took a business that was very hush-hush --
investment bankers meeting CEOs in a private club -- and changed
it into a mass-marketing business,'' says Daniel Grossman, 64, a
former lawyer at NCZ and now an entrepreneur.
`Weird and Brilliant'
Niederhoffer bought several companies himself. One sold
snails whose shells had been decorated with rhinestones. ``It was
a fantastical, whimsical idea that was, in retrospect,
foolhardy,'' Niederhoffer says.
As he had on the squash court, Niederhoffer projected a
quirky image to impress clients and unnerve competitors, says
Henry Juszkiewicz, who worked at NCZ in the early 1980s and is
now chief executive officer of Nashville, Tennessee-based Gibson
Guitar Corp. ``He acted kind of weird and brilliant during client
meetings,'' Juszkiewicz says. ``He'd just have to throw out a few
looks and the deal was signed.''
Niederhoffer broke into commodities trading in 1979,
starting in gold and silver and eventually moving into fixed
income and foreign exchange.
He hired college kids to input historical market prices into
12 Radio Shack TRS-80 computers that he'd wired together.
Niederhoffer, an empiricist like Galton, wanted to base his
trades on hard data, not just hunches. He used his jury-rigged
mainframe to find predictive relationships between markets.
`Overenthusiastic'
Zeckhauser, now a professor at Harvard's John F. Kennedy
School of Government, says he became uneasy with Niederhoffer's
risk taking. He quit the firm in 1983 to pursue a full-time
academic career. Cross died in the '80s.
``Victor's failing was that he got overenthusiastic about
things,'' Zeckhauser says. ``No matter what your edge, you can
lose everything. You hope and believe he will learn his lesson.''
Through much of the 1980s, Niederhoffer went from success to
success. Soros entrusted him with a separate account to manage in
1981. Niederhoffer says he returned that money in 1993 because he
felt he'd temporarily lost his edge.
``He made good money while the markets were sloshing around
aimlessly,'' Soros wrote of the episode. ``Then he started losing
money, and he had the integrity to close out the account. We came
out ahead.''
Bangkok Brothels
By the mid-1990s, Niederhoffer's returns -- which had
averaged 35 percent annually for 15 years -- ranked him among the
country's top futures traders. In 1994, Business Week magazine
named him the best U.S. commodities fund manager.
Niederhoffer soon reached for more. Emerging markets were on
fire. He began betting on stocks in Mexico and Turkey.
He hired Steve ``Bo'' Keeley, a veterinarian-turned-hobo, to
travel the world and provide a worm's-eye view of developing
economies.
Keeley went to Thailand and reported that the economy looked
sound. His evidence? The management of Bangkok brothels had
improved.
``I'm a good point man, willing to go to the heights and
depths to acquire accurate data,'' says Keeley, who now lives in
a buried trailer in the Southern California desert.
Based in part on Keeley's reports, Niederhoffer made a trade
that was to prove disastrous. In early 1997, he bet heavily on
Thai stocks.
Spreading Crisis
By then, the tremors had already started in Thailand. Its
economy, one of the fastest growing in the world, was becoming
overbuilt, overheated and overleveraged. Thai banks had trouble
collecting money on property loans, which caused investor
confidence to wane and put pressure on the baht, then pegged to
the dollar.
On July 2, the Bank of Thailand abandoned the peg, and the
baht plunged more than 19 percent against the dollar in a day. By
August, Niederhoffer faced potential losses of $50 million.
``I was very successful for many years, and I figured I
could apply my techniques that worked in the most-liquid markets
to emerging markets,'' Niederhoffer says now. ``I made a
qualitative inductive leap rather than a quantitative empirical
leap.''
By October, the financial crisis had spread to Brazil and
Russia and had begun to shake U.S. markets. Still bullish,
Niederhoffer used options to bet that the S&P 500 would rally.
The end came on Oct. 27, 1997. That day, the Dow Jones
Industrial Average plunged 554 points, prompting the New York
Stock Exchange to halt trading at 3:30 p.m., 30 minutes early.
When his broker, Refco, called in his margin loans, Niederhoffer
didn't have the money.
Suicide Watch
Niederhoffer was left owing Refco $2 million. He mortgaged
his house and called Sotheby's to sell his silver. His colleagues
deserted him. Niederhoffer says he didn't know what to do. He was
so used to having things done for him, getting whatever he wanted
whenever he wanted it, that he had trouble finding his own
kitchen, he says.
His sister, Diane, a psychiatrist, sent him a list of 10
symptoms of clinical depression. Niederhoffer says he had shown
every one: weight loss, impotence, fatigue -- on and on. He says
his family put him on suicide watch and made sure someone checked
on him whenever he was left alone.
Niederhoffer says he escaped into novels. He read ``Gone
With the Wind,'' ``Les Miserables'' and ``Master and Commander.''
He tinkered with electronics and invented a device that raised
and lowered his toilet seat.
``It would have saved a lot of marriages,'' he jokes.
Writing Columns
To help him get back on his feet, Al Hallac, a friend who
runs Weston Capital Management LLC in nearby Westport, set up a
small hedge fund, Wimbledon Fund Ltd., for Niederhoffer to
manage. Niederhoffer says brokers were reluctant to handle his
trades. Some, worried that they'd be on the hook for his losses
if he crashed again, forced him to put up double or triple the
usual margin, he says.
``Brokerage houses were loath to open an account with me,
not only because of their own fear of being involved in a debacle
but also reputation risk,'' Niederhoffer says.
In 2000, Niederhoffer and Laurel Kenner, a former editor at
Bloomberg News, began writing columns together for Web sites such
as thestreet.com. Later, they began posting musings on the
markets on their own site, dailyspeculations.com.
And so it went until July 2001, when one of Niederhoffer's
old investors, Mustafa Zaidi, called with the offer Niederhoffer
had been waiting for. Zaidi, 39, asked Niederhoffer to become the
trading adviser for Matador, an offshore fund Zaidi had set up
for institutional investors in Europe and South Africa.
`Learned His Lesson'
Niederhoffer jumped at the chance. When Matador began
trading, in February 2002, it had a mere $2 million in assets.
Zaidi, a money manager who had met Niederhoffer in 1994 at
Junto, a monthly salon that Niederhoffer hosts for investors,
thinkers and executives in New York, says his one worry was that
Niederhoffer might once again stray into unfamiliar markets. He
says he gave him specific instructions: Matador would invest only
in S&P 500 futures and options.
``There was hubris involved in 1997,'' Zaidi says of
Niederhoffer. ``He's definitely learned his lesson.''
Since then, Matador's assets have ballooned. The fund
charges an annual management fee equal to 2.5 percent of its
assets and takes a 22 percent cut of any profit. In February,
Niederhoffer and Zaidi began marketing the fund to other
investors.
New Fund
Niederhoffer has also started a second hedge fund,
Manchester Partners LLC, which, unlike Matador, is open to U.S.
investors. Niederhoffer named the fund after the one silver
trophy he'd managed to keep: the Manchester Cup, given to the
winner of the Steeple Chase in Manchester, England, in 1904.
Wisdom, who has known Niederhoffer since 1983, defends his
boss's investment strategy.
``You need to take risks if you are going to have
consistent returns of 25 percent or more,'' Wisdom says.
All the same, Wisdom calls Niederhoffer a changed man. ``He
realized he was fallible,'' he says. ``He wants to leave a
legacy.''
It's Wisdom's job to ensure that Niederhoffer doesn't get
carried away again. Matador has a history of volatile returns.
The fund plunged 30 percent in July 2002 as U.S. equities sank.
Matador lost 12.7 percent in April 2005, and it was down 5.42
percent in October 2005.
``I am the fail-safe,'' Wisdom says. ``I've gotten good at
keeping us one step ahead of the bill collector.'' Wisdom says
he's willing to take losses of 15 percent to 20 percent a month.
`Obsessive and Focused'
Niederhoffer and Wisdom use Niederhoffer's database, now run
from servers in Weston and nearby Norwalk, to spot potential
trades.
Niederhoffer says he's added new options pricing programs to
his predictive database. Unlike derivatives traders who use
theoretical models, Niederhoffer says he has created empirical
models of where derivatives should be priced based on historical
data of market movements.
``The reason for his success as an athlete was his obsessive
and focused mind,'' says his daughter Galt, 30. ``The same with
his trading.'' An award-winning film producer, Galt Niederhoffer
recently published ``Taxonomy of Barnacles'' (St. Martin's Press,
2005), a novel about six sisters -- Bell, Bridget, Beth, Belinda,
Beryl and Benita Barnacle -- and their eccentric father, Barry, a
New York pantyhose tycoon, who longs for a male heir.
High Hopes
Niederhoffer has high hopes for Manchester, which charges a
1 percent management fee and takes a 20 percent cut of profits.
Jamie Fee, who markets Manchester, says Niederhoffer might be
able to manage as much as $400 million in the fund. ``We need
investors who are prepared for volatility,'' Fee, 51, says. As of
May 1, Manchester had $28 million in assets.
Niederhoffer is already eyeing markets beyond S&P 500
futures and options. Unlike Matador, Manchester isn't limited to
trading stock index futures and options.
When Wisdom starts to answer a question about areas
Manchester might explore, Niederhoffer cuts him off.
``We are going to have to improve our abilities to trade
fixed-income markets,'' Niederhoffer says. ``We hope to be able
to compete in foreign exchange in the future.'' For now, both
funds make the same investments.
As Niederhoffer builds his funds, his personal life is
taking a new turn, too. His seventh child -- at long last, a son
-- was born on April 3. Niederhoffer named him Aubrey, after the
sea captain hero of Patrick O'Brian's novel ``Master and
Commander.''
Seventh Child
On April 5, Niederhoffer took 2-day-old Aubrey to dinner at
the Four Seasons. Niederhoffer and Kenner, 52, plan to raise the
child together. Niederhoffer and his second wife, Susan, are in
the midst of a divorce.
In the music room of Niederhoffer's mansion, above the grand
piano, hangs another painting. This one is of the Essex, a 19th-
century whaler. There's a story behind it, one Niederhoffer tells
again and again. The tale is a reminder of what he now has at
stake.
In August 1819, the Essex set sail from Nantucket, bound for
the whaling grounds of the South Pacific. There, in a stroke of
bad luck, the ship was rammed by a sperm whale. At sea in three
whaleboats, Captain George Pollard and his crew of 19 struggled
eastward toward the coast of Peru.
The food ran out; the men began to die. Several crew members
were eaten by their shipmates. After three months adrift, eight
survivors were rescued. The story inspired Herman Melville to
write ``Moby Dick.''
Pollard sailed only once more from Nantucket, as captain of
the whaler Two Brothers. In February 1823, that ship, too, went
down, wrecked on a coral reef. Pollard returned to Nantucket a
pariah. He had failed not once, but twice. He ended his days as
the town night watchman.
``In America, people get a second chance,'' Niederhoffer
says. ``They don't get a third.''
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gérés qu'avant. Bo a donné de sa personne pour acquérir des données fiables.
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Le futur marché amha.
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