Roy Niederhoffer loves a good crisis.
The 54-year-old hedge fund manager’s firm, R.G. Niederhoffer Capital, which manages about $350 million in assets currently, often does best when the stock market is at its worst.
His Manhattan-based firm was one of the industry’s top performers during the past decade’s global financial crisis, and it is once again leading many of its peers in the market turmoil caused by the coronavirus pandemic.
So far, his company’s flagship diversified fund, which invests in stocks, bonds, commodities, and currencies, is up 27% for the year, after fees, at a time when the overall U.S. stock market is down 30%. Its second fund, which trades only currencies and bonds, is up almost 18% after fees.
“In a crisis, investors are behaving instinctually in ways that are not always optimal for trading,” Niederhoffer says, speaking from his ski house in Vermont, where he’s fled to escape the coronavirus pandemic.
Founded in 1993, the firm missed out on finding a way to play the 1997 Asian financial crisis, but it has managed to make money in most of the big market swoons since then.
Niederhoffer studied computational neuroscience at Harvard University, and his fund’s investment strategies are based around spotting situations in which human cognitive and behavioral biases—things like loss aversion or anchoring to previous high prices—are likely to cause other investors to make poor decisions. The fund uses computer-driven algorithms to search for those situations.
Usually, these bias-driven market disparities are short-lived. The firm’s trades are typically in place for only a few hours or a few days, Niederhoffer says, not the weeks or months some of the other multi-asset hedge funds prefer.
The fund’s performance often tracks market volatility, he says. And the past month has been one of the most volatile on record: The VIX index, which tracks investor expectations of the volatility over the next 30 days hit an all time high, at 82.69, on March 16.
Of course, that same correlation with volatility also means that Niederhoffer’s fund is coming off a very weak 2019, in which it lost almost 30%. The fund has also seen its assets under management shrink considerably in the years since the global financial crisis, as trend-following and momentum strategies triumphed in the long bull run.
“2019 was one of the least volatile years on record,” Niederhoffer says, noting that average daily volatility for U.S. stocks was just 0.4%, compared with 4% over the past month.
Still, R.G. Niederhoffer’s recent gains are all the more remarkable because they come in conditions that have humbled many other hedge funds.
Some of the best-known computer-driven funds have turned in their worst two months in years. In some cases, these funds have still outperformed the overall market. But, for firms that touted their algorithms’ abilities to generate positive returns for investors in almost any market condition, March has been a reckoning.
D. E. Shaw, one of the earliest computer-driven hedge funds, has seen its exclusive Valence fund, which has more than $6 billion under management, lose more than 9% in the first part of the month, according to a report in the Financial Times. Renaissance Technologies, the hedge fund known for complex quantitative strategies, founded by mathematician and billionaire investor Jim Simons, also reportedly suffered declines in March, after enduring a 7% decline in February.
Ray Dalio, the billionaire investor who founded Bridgewater Associates, one of the world’s largest hedge funds, has also said that his flagship fund blundered during the pandemic-induced market crash. The fund suffered double-digit declines in the first half of the month, according to Reuters.
Bridgewater is an example of a hedge fund that did well during the 2008 financial crisis but has been unable to navigate the massive declines across many different asset classes that has characterized the current market turmoil.
Part of the issue is that many hedge funds, including Bridgewater, use a trading strategy known as “risk parity,” which tries to balance the risk across a portfolio by finding baskets of uncorrelated assets. These funds then often use large amounts of borrowed money—leverage—to increase returns across that basket.
The baskets are adjusted to keep risk levels stable in any market condition. But in recent weeks, that balancing act has failed, according to many traders, with declines seen across asset classes, such as stocks and some sovereign debt, which have not been correlated in the past.
Niederhoffer says that many other hedge funds have made the mistake of trying to play the current pandemic-induced market crash in exactly the same way as the global financial crisis. “The trade that worked in 2008 was being long fixed income,” he says. “This time, rates were already so low, there’s no demand for fixed income, so a flight to quality trade won’t work.”
He also says that many investors are betting on a sharp, V-shaped recovery, similar to what occurred after 2008, and as a result have spent the past week trying to figure out how to place bets on rising equities or commodities. But Niederhoffer isn’t so sure the recovery will happen so quickly this time around.
He says central banks don’t necessarily have tools capable of buoying the economy this time around. And he thinks the pandemic could alter some of our habits and behaviors permanently, with potentially big impacts for industries such as airlines, business travel and hospitality.
“I think it is really important to consider what will happen if a V-shaped recovery doesn’t occur,” he says.
A period of hyperinflation caused by the vast amount of cash central banks and governments are pumping into the economy is one possible future scenario. Such a scenario, Niederhoffer says, might cause stocks and bonds to drop in unison.
Another possible scenario though, he says, is the opposite: a steep deflationary spiral, as occurred during the Great Depression and as almost happened in the 2008 crisis. Yet another scenario might see markets continue to bounce along, with a lot of daily volatility, but no fundamental direction until it becomes clear that a vaccine and treatment for COVID-19 will be widely available.
One way to play this, he says, is to simply be diversified: It isn’t clear what will perform best, so it would be wise to spread bets across many different types of assets. Another strategy, he says, would be to bet on volatility itself. “We believe there is no reason for volatility to fall back to one-tenth of where it is now,” he says.
More must-read stories from Fortune:
—Everything you need to know about the coronavirus stimulus checks
—The quickest way to boost the economy isn’t even being considered. Why?
—How does America pay for the coronavirus relief bill? With two shiny coins
—Will the “Great Cessation” be worse than the Great Recession?
—Listen to Leadership Next, a Fortune podcast examining the evolving role of CEOs
—WATCH: The U.S. tax deadline has been moved from April 15 to July 15
Subscribe to Fortune’s Bull Sheet for no-nonsense finance news and analysis daily.
