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Victor Niederhoffer, tireless critic of Benjamin Graham, Graham’s investment idea, and Warren Buffett, is blown up once again —to the tune of some 75% losses for his funds —as reported for a story in this week’s The New Yorker. Whereas Niederhoffer’s latest catastrophic losses might serve as schadenfreude for some students of value investing, this self-described Ayn Rand Objectivist is a living testament to the lethal nature of some spectacularly subjective biases, including a disdain for anything resembling a margin of safety.

The New Yorker article is a bit heavy on Niederhoffer's personal life, but is still worth a read. Here’s the link:

http://www.newyorker.com/reporting/2007/10/15/071015fa_fact_cassidy

Several years ago, Victor Niederhoffer was questioned during a radio interview about his rejection of the value investment paradigm as espoused by Benjamin Graham. The interviewer asked Niederhoffer how he might then explain the half-century success of Graham students such as Walter Schloss and others, given his rejection of Graham’s ideas. Niederhoffer replied that such success was “random.”

In Niederhoffer’s book, Practical Speculation, an entire chapter is devoted to refuting Graham’s pursuit of bargain issues. Only Niederhoffer hardly gets around to doing so. Instead, this sophisticated statistician attempts to stigmatize Graham and dwells on a small, essentially anecdotal sampling to prove his points about the lameness of value investing. One fellow Niederhoffer knew bought a stock below book value and watched as the stock proceeded to trade lower.

See? Graham’s ideas are useless.

When he is done expounding on the value investment discipline’s futility and ineffectualness, Niederhoffer allows as how he is troubled by the discipline’s ostensibly cynical premise: a dollar bought for fifty cents means that the seller is exploited. It seems odd that this cultivated observer of free-enterprise fails to recognize a couple of cold, hard facts: the business that fails to sell at half-price is likely to be sold for even less, and buyers of these ailing businesses are, in effect, upholding a competitive counterpoint to stronger businesses that might otherwise have a stranglehold in a capitalist system.

“Random”, the quality that Niederhoffer attributes to successful value investors and any successful value investments as defined by Benjamin Graham, might more aptly be attributed to Niederhoffer’s own quest for an intellectually sound speculative framework. This tendency is displayed in living color by Niederhoffer and other participants on dailyspeculations.com, the website Niederhoffer hosts, as these traders engage in frothy examinations of the parallels between non-related phenomena, such as the evolved habits of exotic animals seen while on safari, and “trading”. Niederhoffer himself is especially fond of drawing wisdom from Captain Jack Aubrey, the main hero in Patrick O’Brian’s 18th century British Navy epics, as that wisdom might pertain to the markets. But after reading Practical Speculation, it is painfully obvious that if Captain Aubrey ever sashays into Niederhoffer’s trading-room and hands him a copy of The Intelligent Investor, Niederhoffer will politely accept the book, and promptly throw it overboard when the good Captain is out of site.

It’s easy to take potshots at this outspoken speculator gone off his trolley. But in the spirit of inquiry that Niederhoffer offers in his book, MSN articles and website, it seems reasonable to ask whether two catastrophic losses and one near-catastrophic loss offered to investors over a 10 year investment period —nearly 4 years of which were spent on hiatus— are more or less “random” than the market-beating investment success that Schloss, et al, offered to investors for over 50 years using a value framework. In any case, the simple fact is that the alternatives to a value framework in the securities markets frequently lead to misery, and by all accounts, Victor Niederhoffer is currently altogether miserable. In the manner that Walter Schloss' 50-plus years of risk-averse investment returns are "random", it may be safely said that Victor Niederhoffer's self-inflicted misery is also randomly rendered.
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It’s easy to take potshots at this outspoken speculator gone off his trolley. But in the spirit of inquiry that Niederhoffer offers in his book, MSN articles and website, it seems reasonable to ask whether two catastrophic losses and one near-catastrophic loss offered to investors over a 10 year investment period —nearly 4 years of which were spent on hiatus— are more or less “random” than the market-beating investment success that Schloss, et al, offered to investors for over 50 years using a value framework. In any case, the simple fact is that the alternatives to a value framework in the securities markets frequently lead to misery, and by all accounts, Victor Niederhoffer is currently altogether miserable. In the manner that Walter Schloss' 50-plus years of risk-averse investment returns are "random", it may be safely said that Victor Niederhoffer's self-inflicted misery is also randomly rendered.

I'm no fan of Niederhoffer and I continue to be amazed at how much respect he gets in the "speculative trader" community. His criticisms of value investing are beyond absurd, and given his failures it is amazing he has the chutzpah to criticize a methodology that has produced so much success.

Having said that, IMO his blowups are less about the superiority of value investing versus speculating and more about the utter insanity of super-leveraged positions and blatant ignorance of risk control. He blew up twice on pretty much the exact same scenario which was selling options against way too small a capital base.

Alot of option sellers like selling options on futures because the margin requirements are minimal (I think Niederhoffer was putting up something like 2% margin). A small move against your position wipes you out, because either you put up more capital (he couldn't get anymore) or your positions are forcibly closed out on you. It is amazing to me that he didn't learn his lesson from the first time it happened.

A value investor could just as easily blow up *IF* it were possible to use that level of margin buying and somebody was stupid enough to actually do it. With stocks you have to put up at least 50%, but if you could purchase stocks with 5% capital, you could easily go broke and blow up because the market may very well take your investments lower and you'll get a margin call and be forced to liquidate your stocks before the value ultimately gets recognized.

The real lesson is leverage is very dangerous if you aren't very careful. Interestingly, a large part of Buffett's success at Berkshire was from leverage through the insurance float, but the brilliance of that is that he was never subject to a margin call from outside parties.
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I suspect Niederhoffer is a Neanderthal, just my opinion, however.

Kahuna,CFA


now now...dont insult the Neanderthals.....

Dave
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Niederhoffer gets so much respect from speculators because his schemes allow "get rich overnight". This is the greatest allure to all greedy speculators, especially those ignorant rookies. It's even better if it is done with OPMs.
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It's almost always done with OPMs.
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An off-topic aside. Charlie Munger used Niederhoffer as an example of gaming the system at the Harvard Economics Department:

http://thinkorthwim.com/2006/12/05/niederhoffering-the-curriculum/

"Niederhoffer was the son of a police lieutenant, and he needed to get A’s at Harvard. But he didn’t want to do any serious work at Harvard ..."

The process is now known as "Niederhoffering the Curriculum".

-Rubic
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its been a couple of years since i visited this area of Victor Niederhoffer's site called the Nebraska Chronicles, a place devoted to to the debunking of the Buffett Myth... its still there, even while Niederhoffer & his own Trading Leagacy goes up in smoke. i used to go there for a laugh but the joke got old.

http://www.dailyspeculations.com/buffett/buffett.html

but i'm sure he meant well.

may his high-minded intentions out last his own delusions of grandeur.

RSIP, victor!

better luck next time.
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The process is now known as "Niederhoffering the Curriculum".

I don't know anything about the guy, but his gaming of the system was absolutely brilliant.
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See? Graham’s ideas are useless.

What page did he say that on again? I apologize if I missed it.

“The idea that you can make a lot of wealth ... with no great gyrations, is a canard,” he said to me. “If you are going to try and make forty or fifty per cent a year, tremendous variations are inevitable.”


It’s easy to take potshots at this outspoken speculator gone off his trolley.


Yes, it is. I don't have VN's full stats for this fund but --

Matador Performance given in article:
+40%
+40
+56
flat
+35%
-75%

= +7% return. Less than cash, but perfectly in line with what he said above. I've seen plenty of great investors have similar periods of bad to flat performance.
In addition, any money manager who practices rebalancing would have shown a much, much higher overall return, whether annually or more often. [That does not include his positive performance of this fund in years before the +40% above, which would improve things.]

I, of course, agree that his misery is 100% self-inflicted.

However, many market commentators, mavens and fund managers similarly made sport of Julian Robertson when he closed up shop at the bottom of the market for his style of investing, with many of his holdings down 40-50% as those stocks bottomed. They've done extremely well since then last I checked.

It's as reasonable to believe the common man can make money using Graham and Dodd methods, as it is unreasonable to believe professional commodities traders cannot make money in their fashion.

sincerely,
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Matador Performance given in article:
+40%
+40
+56
flat
+35%
-75%

lets see if that works out to 7%

100
140
206
321
flat321
428
107

this is assuming that you have no payouts...and it is compounded.....

it is not hardly 7% per year....but about 1% compounded over 6 years.........

what am I doing wrong???? OR IS IT THE VN curse???

Dave
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I, of course, agree that his misery is 100% self-inflicted.

VN is a very very bright guy......wooopdeedooo.......

eventually he only loses.......he is all ego......

Could there ever be performance-enhancing drugs for investing?
http://tinyurl.com/2h6ooo

The above article may state why VN loses money more than any other reason......

Dave
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Interesting...

shows mathematically how you can have great performance several years running but one really bad year can wash it away.

Rule 1, "Don't lose money."
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what am I doing wrong???? OR IS IT THE VN curse???

I don't know, but I do know that 1.4 times 1.4 is not 2.06.

I get these as the cumulative returns:

40%
96%
206%
206%
313%
3.2%

So it's more like 0.5% compounded over 6 years. Then again, those two 40% return years are stated in the article as "more than 40%", so this level of precision might not be called for, and his returns are probably slightly higher than the numbers I give in this post.

Niederhoffer's defenders might remember that not all of his clients joined him at time zero of the above. Anyone who joined after the start of the given data got creamed. The investment experience of someone who joined after the first year was -26.3% after 5 years, or -5% annualized. Someone who joined after the second year got returns of -47.3% after 4 years, or -10.14% annualized. Joining after the third year earned that person -66.25% after three years, or -16.56% annualized.

By comparison, for the 5 year period the S&P has roughly doubled, for the four year period it's up roughly 50%, and for the three year period up roughly 40%. (And for completeness, it's up roughly 40% for the 6 year period that covers the given Niederhoffer data.)

Smart guy, interesting guy, but very dangerous to your wealth.

UsuallyReasonable
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By the way, lowrisktaker's post showing VN's returns, several excellent years followed by one bad one that negates the prior performance, is precisely why many of us are still pretty comfortable with BRK.

We are not looking for spectacular performance for a few years running at the risk of a big loss of capital.

In terms of the S&P 500 outperforming BRK recently, there's nothing wrong with investing in an index if that floats your boat and in fact WEB recommends same if you don't have time to research individual stock investments.

On the other hand, if someone invests in the index, they're not doing so based on having evaluated all the stocks individually.

One of the good things about BRK is that you can invest in it with not so much insight and still not do too bad over a period of time. So although it's good if you can buy BRK cheap, if you don't, and you hold for a long enough time, you'll still probably do O.K. You really don't have a big risk of actually losing money, the risk is perceived opportunity cost of not having made a better investment.
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Niederhoffer's defenders might remember that not all of his clients joined him at time zero of the above. Anyone who joined after the start of the given data got creamed. The investment experience of someone who joined after the first year was -26.3% after 5 years, or -5% annualized. Someone who joined after the second year got returns of -47.3% after 4 years, or -10.14% annualized. Joining after the third year earned that person -66.25% after three years, or -16.56% annualized.

**************************

Additionally VN's returns are probably not dollar-weighted. Presumably the big early returns were made on a relatively smaller capital base; the good news caused much more money to flow in.
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The investment experience of someone who joined after the first year was -26.3% after 5 years, or -5% annualized. Someone who joined after the second year got returns of -47.3% after 4 years, or -10.14% annualized. Joining after the third year earned that person -66.25% after three years, or -16.56% annualized.

I miscalculated the "annualized"s above . . . they are worse than what I gave.

Corrected:

The investment experience of someone who joined after the first year was -26.3% after 5 years, or -5.92% annualized. Someone who joined after the second year got returns of -47.3% after 4 years, or -14.82% annualized. Joining after the third year earned that person -66.25% after three years, or -30.38% annualized.

I hope that's correct now . . .

UsuallyReasonable
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I know very little of Niederhoff, but based on what I've read/seen, it sounds like I'm not missing much.

As for the performance of his, my calculation seems to be a bit different.

Amount Annualized Return
Year 0 $10,000.00
Year 1 $14,000.00 40.00%
Year 2 $19,600.00 48.00%
Year 3 $30,576.00 68.59%
Year 4 $30,576.00 51.44%
Year 5 $41,277.60 62.56%
Year 6 $10,319.40 0.53%

Doesn't sound like a great investment to me... unless you got in earlier and was lucky enough to get out.
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I don't know, but I do know that 1.4 times 1.4 is not 2.06.

I get these as the cumulative returns...Niederhoffer's defenders might remember that not all of his clients joined him at time zero of the above


Absolutely! [others are reporting he lost 70%, which would be a 24% cum return, not including his gains prior to the years the NYer gave.]

His attackers, if intellectually rigorous, should note that with regular annual or quarterly rebalancing - recommended by any asset manager or person with knowledge of portfolio & asset allocation theory - the results were much better. Almost no HF investor or manager writes a check on Day 1 and goes away, permanently. Professional investors reallocate, withdraw, and spend money frequently.

Since this takes more effort, it is much easier for the nay-sayers to point and laugh at someone in a down year they don't like, rather than actually do any analysis that may prove them in error.

For assumption's sake, let's take a HNW portfolio of $100m, and allocate 1%, or $1m to Matador at the beginning of the return series given by the NYMag.
Also assume, the overall portfolio makes 10% per year [high, but conservative given the exercise we are going to do.]

We rebalance annually [even though we have option of doing it at least 2-4x per year.] This is very standard. Most of you probably do the same.

Year one, Matador gets $1mm, we make 10% overall, he makes 40%, we take out $300k and reallocate it.
Year 2, we make 10%, he makes 40%, we take out $330k and re-allocate it.
Year 3, Matador makes 56%, we take out $557k and reallocate it.

At this point, we have given Matador $1mm and actually taken out $1.19mm to give to other managers.

Year 4, Matador is flat, we put in $133k during our re-allocation.
Year 5, Matador up 35%, we take out $336k at end of year.

At this point, we have given Matador $1.13m and taken out $1.55m.

Year 6, assume Matador loses 75% ytd. We get a check for $403k. The fund ends on an extremely poor month.

Final results with annual rebalancing:
Quick n Dirty--
~6 Years, Matador was given $1.13mm, we ended with $1.96mm.
Using 6 full years to be conservative, and 8% discount rate, PVing each stream back individually, we get a Present Value of $1.41mm at the time Matador shuts down.

But, we didn't add in our add'tl investment earnings that were generated through the money we took from Matador and rebalanced - which earned 10% annually. When we took out $300k at end of Year 1, we re-invested it and earned $30k per year in our portfolio. These gains from rebalancing sprung from Matador's prowess in Year 1, and so on.

More Accurate Analysis--
The 10% compounded return earned on each annual rebalanced amount came to a Future Value of $557k. We must add these gains to the 'principal' portion of Matador's returns for an accurate view of all gains and losses, since these excess gains came from Matador's outsized early performance.

Then we compare that number to the $1.77m our initial investment would have made at 10% for 6 years.

Year 1 is the same of course, but our new total after PVing each individual stream of cash flows back at 8% is $1.80m. Better than 10% per annum, a perfect illustration of why you should always rebalance, particularly with volatile managers/asset classes.

To sum up, using NYMag data and rebalancing assumptions given:

Investor who doesn't rebalance made <1% per annum,

1-stage quick n dirty rebalanced analysis = 6% per annum,

More accurate, multi-stage rebalancing analysis = 10%+ per annum.

I apologize in advance for any math errors in my spreadsheet, but I think this has all been done correctly. Obvs one can tweak the overall portfolio return and PV rate and get slightly different numbers. The key takeaway is the importance of rebalancing your portfolio at least annually.
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The key takeaway is the importance of rebalancing your portfolio at least annually.

What if you opened your position the year Niederhoffer lost 75%? How do you rebalance your way out of that?

The problem is that if an investment has a substantial likelihood of losing three quarters of its value in a given year, it's not a good investment, even if its median returns look stellar.

Rebalancing and portfolio allocation are a poor substitute from making wise investment choices. In my opinion, it's much better to have an unbalanced portfolio of good investments than a balanced portfolio of bad ones.
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Rebalancing and portfolio allocation are a poor substitute from making wise investment choices. In my opinion, it's much better to have an unbalanced portfolio of good investments than a balanced portfolio of bad ones.

Yup. Tough to make a silk purse from a sow’s ear.

In any case, some type of overall portfolio approach with respect to a fund of hedge funds and rebalancing across various managers really doesn't have anything to do with evaluating the success of 1 particular manager on a stand alone basis.

One of Buffett's expressions that I think is particularly applicable to Niederhoffer is the "anything times zero is zero". Doesn't matter how many 20 to 40% years you string together if there is a strong possibility that your management process results in a 70 to 80% blowup every 5-10 years.
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What if you opened your position the year Niederhoffer lost 75%? How do you rebalance your way out of that?

The problem is that if an investment has a substantial likelihood of losing three quarters of its value in a given year, it's not a good investment, even if its median returns look stellar.


While Niederhoffer's performance is an extreme example, I don't think that generalize the point being made here is particularly obviously true. If you don't believe Niederhoff knows what he's doing, well that's fine and you shouldn't invest. That's certainly easy to agree with.

However, say a hypothetical investor has a portfolio of stocks they think are all pretty good, all at roughly similar discounts to estimated values. One day, one of them drops a lot, while another one goes way up. What is the "right" (TM) thing to do?

I don't think there is an obvious "right" answer. Personally I would sell some of the one that went up and buy some of the one that went down. Lower average cost wins. On the other hand, you may not want to make more than 5 trades a year, or you may insist on keeping all positions for 5 years and never incur short-term capital gains taxes. That's OK too.

-Mike
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the moral of the story of VN....it is a simple moral....

it works till it does not work.....and then it crashes and burns....that goes for many many hedge funds....

D'uh!!

Dave
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...I don't think that generalize the point being made here is particularly obviously true...

I was making two points:

1) That rebalancing cannot protect one from bad investment choices, and,

2) Rebalancing (especially formulaic exercises to buy and sell positions to maintain a fixed allocation ratio) is of much less significance than choosing good investments... that asset selection is far more important than asset allocation.


However, say a hypothetical investor has a portfolio of stocks they think are all pretty good, all at roughly similar discounts to estimated values. One day, one of them drops a lot, while another one goes way up. What is the "right" (TM) thing to do?

I don't think there is an obvious "right" answer.


Don't get me wrong. I'm not against moving things around when it makes sense. What I do take issue with is some professional money managers who charge fees to sell 5% of your holdings in crappy fund X so you can buy 5% more of crappy fund Y -- the ones which focus more on asset allocation than asset selection.

That's a far different scenario than what you suggest. Certainly if one stock becomes a better value because its price dropped it may well be time to reload... and if it's a good enough value increase its allocation in your portfolio. Likewise, if a stock becomes overpriced, one might want to liquidate some or even all of it. Your comment that "it depends" is to my point: one needs to understand the fundamentals of one's investmens and not simply what percentage of assets are in what class.

The differentiation I am making is between accuracy and precision -- "it's better to be approximately right than exactly wrong". An unbalanced portfolio of good investments is "approximately right" in my opinion, whereas a diligently maintained and balanced portfolio of bad investments is "exactly wrong".
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However, say a hypothetical investor has a portfolio of stocks they think are all pretty good, all at roughly similar discounts to estimated values. One day, one of them drops a lot, while another one goes way up. What is the "right" (TM) thing to do?


mindshar unwittingly parroted Will Rogers by saying if a stock goes down don't buy the 'bad' investment already.

Nobody seeks to have a portfolio of 'bad' investments, what a silly thing to say.

To act like only fools were ever invested in 'bad' stocks like:
Parmalat
MCI
EF Hutton
Continental Illinois
Penn Central
Pan Am
Beth Steel
ad infinitum

is the height of absurdity. Anyone looking at their portfolio doesn't know ex ante which stocks will be the 'good' ones and which ones the 'bad' ones, or they wouldn't own the latter names.

Any, ANY portfolio needs to be rebalanced, if only due to an investors changing opinion on the markets, risk tolerance, and the ravages of time on said investor over the years.
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