R. G. Niederhoffer Capital Management, Inc.

March 26, 2013 Dear Investor, February was another excellent month. Following on R. G. Niederhoffer Capital Management Performance our finalized +8.4% return for January, we estimate Fund iHedge Negative Trend- Optimal returns for the Diversified Program of +8.6% for Diversified Inflation Correlation Hedge Alpha February. Conditions since November continue to be Program Protection Program Program Program excellent for our strategy, and March looks to be our Program fifth consecutive profitable month for our flagship Investment goal Strong Positive Positive High stand- Positive program. performance performance performance + alone Sharpe performance + + downside + substantial protection from ratio; Low protection Our other funds also performed well in February, with protection. tail risk Macro/CTA correlation to during rising returns of +10.0% for TrendHedge, +5.1% for Negative protection. declines. equities/FOFs interest rates Correlation, +9.3% for Optimal Alpha, and +1.1% for . or asset prices iHedge. total $543M as of Program Assets $506 million $11 million $14 million $7 million $5 million today. Onshore/ Onshore/ Onshore/ Onshore/ Fund Domicile Onshore Performance was steady and well diversified Offshore Offshore Offshore Offshore Performance was extremely steady during the month, Fund Inception 1995 2003 2006 2004 2011 and the Diversified Program was up on 14 of the 20 2013 YTD (est. thru 22.2% 9.7% 10.2% 27.3% 10.5% trading days during the month. Only two days had losses 3/25) of 1% or more, reflecting continuing high accuracy by our models since November. Mar-13 (est. thru 3/25) 3.7% -0.6% 1.2% 3.9% -0.2%

We were profitable in all four sectors, with foreign Feb-13 8.6% 5.1% 10.0% 9.3% 1.1% exchange the biggest contributor. A strong trend reversal in $/Euro and Euro/Yen and choppy and Jan-13 8.4% 4.9% -1.0% 12.1% 9.5% volatile conditions in $/Yen were very beneficial to our short-term strategy, which as you know does not rely on Dec-12 1.5% 1.0% -0.5% 3.8% 1.8% long term market trends. In equities, higher volatility toward the end of the month was beneficial. In Nov-12 1.6% 0.7% 1.1% 2.7% 1.8% commodities, we were most successful in energies. 2012 -22.4% -28.5% -14.0% -13.7% -10.4% By strategy, our newer “core” models were a big contributor, particularly in the foreign exchange sector. 2011 -17% -15% -16% -27% -10% But no one particular strategy produced outsized profits, even when examined in individual sectors. Instead, it 2010 -7% -11% -11% 12% was a general lack of losses and a large number of moderate-sized profits that accounted for the strength of 2009 -16% -26% -6% -12% February performance. 2008 51% 55% 21% 19% The pattern of price movements has changed As I mentioned in my last letter, I believe the change in 2007 30% 20% 4% 21% market behavior is no coincidence. There has been a Annualized since 7.6% -3.2% -1.4% 1.5% “sea change” in markets in recent months, and the over- 2000/inception all level of accuracy of our trading strategy has been Correlation to -0.2 -0.7 -0.2 -0.0 approaching the levels of 2007-2008 when our largest S&P 500 Index funds were each up nearly 100% for the two years Correlation to HFRI -0.3 -0.6 -0.3 -0.1 combined. The image of the ocean is quite apt: The Fund of Funds Correlation to “tide” (long period oscillations), “swell” (medium +0.2 -0.1 -0.4 -0.1 period oscillations), “chop” (short period oscillations) Newedge CTA Correlation to MSCI and “foam” (high frequency oscillations), their shapes, -0.3 -0.6 -0.2 +0.0 relative sizes, and directions, and the resemblance of AC World Index Correlation to the these moves to those in historical market price data -0.2 -0.5 -0.1 -0.0 Nikkei 225 Index together dictate the performance of strategies like ours Annualized perf. as of 28 Feb-13. Asset estimates as of 25-Mar-13. Correlations monthly from strategy (and trend following as well). After more than three inception through Feb-13. Data source: HFR, Bloomberg, Barclays. Correlation data for iHedge is not shown due years of a very different look, since November all of to limited history. PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. these have shifted back to a more normal mode after PLEASE SEE ADDITIONAL NOTES AND DISCLAIMERS AT THE END OF THIS LETTER. several years of “QE-style” muted volatility.

1700 BROADWAY, 39TH FLOOR, NEW YORK, NY 10019 TEL: 212-245-0400 FAX: 212-245-4030 EMAIL: [email protected] WEB: www.niederhoffer.com

Years of QE from the Fed have made their mark – until now Why should this be the case? In the United States, it has a lot to do with reaction and anticipation of the Federal Reserve. Since 2009, each period of slowing US economic data has been met with a round of Fed asset purchasing in order to get the economy back on track. As a result, each decline in equities that accompanied the slowing data has been interpreted as a buying opportunity, rather than a time to panic as has been the case in prior years. Thus, bad news paradoxically makes investors more confident rather than less. On the other hand, when the US economy seems to improve, instead of generating irrational exuberance, each stock market rally is greeted by fears that the Fed will end or perhaps even reverse its QE policy. Unlike past decades, since 2009 fear begets confidence and greed begets fear. Market patterns changed, and equity volatility fell precipitously. The result was great difficulties for many managers like us who rely on decades of historical price data as a guide to creating trading strategies. Prolonging this process, from 2010 to 2012 the possibility that the Republicans would win and implement a more pro-business, lower spending, lower tax platform (whether they would have is another story) created an oppositional force to the more inflationary, higher-spending, higher-tax approach favored by Democrats. Republican challenger Mitt Romney even spoke of ending Bernanke’s term as Fed chairman. Had Romney triumphed in November 2012, there would likely have been some tempering of the free spending and money-printing that characterized Obama’s first term. However, his crushing defeat has given an effective mandate to the high deficit, anti-business, redistributionist policies of the Democrats. Without an oppositional force of restraint, there is now little to stop the growth of government in the US to levels that far exceed the 90% debt to GDP ratio that has historically led to inflationary disaster. At this point, however, interest rates are so low that future Fed asset purchases can have little impact. And at the same time, the US deficit will grow continuously. The die has been cast, and markets are now free to move with less hope that politics will intervene to reverse their path. In Europe, Cyprus is just the beginning In Europe, each round of bad news since 2009 has been met by assurance from the Troika (the EC, IMF and ECB) that “all measures will be taken to solve the problem.” But the problem cannot be solved, because it is structural. Overall, Euro Area economic growth was negative in 2011 and 2012, and only Germany of the largest economies is at all positive. The peripheral countries are in dire straits, and the most recent disaster, Cyprus, demonstrates that Germany is unwilling to provide unlimited bailout capital to salvage every other EU country (and they all will need bailouts eventually, not just the periphery). Cyprus is the first of what will be a continuing series of shocks that will serve to increase the overall level of volatility across all sectors in Europe. The recent big moves in $/Euro and Euro crosses as well as European equities reflect the deteriorating conditions in Europe and uncertainty about Cyprus. And the likelihood of future volatility caused by instability is high. Indeed, the list of potential flash points is so long that it is highly unlikely Cyprus is the last. Japan is in a death spiral The cost of Crude Oil in Yen has risen as the BOJ seeks inflation. In Japan, higher inflation via money printing is (1-Jan-00 to 28-Mar-13) now an explicit target. Unsurprisingly, the cost 16,000 of Crude Oil in Yen has risen to long term highs (and pretty much the highest ever save a few 12,000 months during 2008) as the Yen has fallen from 77Y/$ to 94Y/$ and Crude Oil in Yen has risen from 7000Y/barrel to 9000Y/barrel. The only 8,000 period in which energy was more expensive in Japan was in July 2008 when Crude Oil rose to 4,000 15000Y/barrel. Further devaluation of the Yen by Japan’s own version of Quantitative Easing will be counterproductive. Not only rising 0 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12 energy prices but the inherent confiscation of wealth from the middle class (via artificially Since its low in Sep-12, the Yen has fallen from 77Y/$ to 94Y/$. low interest rates on savings) will more than (1-Jan-00 to 28-Mar-13) offset any stimulative impact of even lower 140 Japanese interest rates. 130 Markets are returning to normal 120 Taken together, the shaky macroeconomic 110 conditions and enormous debt of Europe, the US, and Japan are overwhelming the ability of 100 governments to hold things together, and our 90 trading strategies are starting to succeed more consistently as emotional market responses to 80 these fundamentals become more violent and 70 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12 volatile. While the clear preference of the US and Japan, and to some extent Europe, is to take Source: Bloomberg.

the path of monetizing debt and printing money in an attempt to create economic growth, the future positive impact on growth will be minimal just as it has been so far. Eventually, just as in many historical examples, the strategy will become printing money for the sake of paying back debt in cheaper currency, rather than creating growth. And interest rates will begin to rise – indeed, we may already have seen the lows of interest rates in the US and Europe as expectations grow for future inflation. And the eventual rise in prices may not be slow and controllable. Inflation can happen fast US inflation appeared rapidly in 1917. It also happened quickly in the 70s. It’s worth pointing out that even in a historically Annualized US CPI Annualized US CPI price-stable country like the United States, inflation 20.4% can set in very rapidly. For example, in 1915 the 20% 20% inflation rate went from a stable 1-2% annualized to 20% in just 19 months (during World War I). And 15% 15% in peacetime, it went from 3% to 10% annualized in less than 14 months starting in late 1972. As writer 10.0% Amity Shlaes has pointed out, Krugman-esque 10% 10% critics of German policy in 1922 claimed that currency deflation was caused by too tight a 5% 5% 3.4% monetary policy (“Tight money in German Market: Causes of the Abnormally Rapid Currency 1.0% Deflation at Year-End, New York Times, January 0% 0% 2, 1922, p.32). Little did they know that inflation Nov 1915 Jun 1917 Dec 1972 Feb 1974

rates of 50-100% a day would soon ensue. Source: U.S. Department of Labor Bureau of Labor Statistics. As of yet, there is very little sign of inflation being signaled by the precious metals or commodities markets, at least in dollar terms. But one place there may already be a bubble forming is in the US equity markets, many of which are at all-time highs. As usual, managers of all types have piled into the long equity trade, just like in 2007. Biggest portfolio risk right now is the most “unlikely:” a drop in equities It’s interesting to examine how managers are positioned after the long, slow and very non-volatile increase in equity prices. Looking at the rolling six month correlation of hedge funds and CTAs to the S&P 500, we find that that CTAs and hedge funds are now almost at record levels of positive correlation to the S&P 500 compared to the last ten years. The prior record high correlation of hedge funds to equities occurred from February to July 2007, right before the first drop in August. Back then, however, the correlation of CTAs to equities was not as high as it has been for the last six months. Now, the higher long exposure of CTAs to equities via various “risk-on” trades means that a combined portfolio of hedge funds and CTAs (75% hedge funds, 25% CTAs, for example) has just about the highest rolling daily correlation to the S&P than ever. Regardless of whether this makes equities a “crowded trade” and is bearish by itself, it is likely that a sudden drop in equities would be quite damaging to /CTA portfolios and a portfolio risk worth addressing.

Hedge Fund correlation to Equities has risen to near records levels. CTA correlation to Equities has also risen significantly. 6-month rolling correlation of Hedge Funds (HFRXGL) to S&P 500 Index 6-month rolling correlation of Newedge CTA Index to S&P 500 Index

0.8 0.8

0.4 0.4

0.0 0.0

-0.4 -0.4

-0.8 -0.8 Oct-03 Apr-05 Oct-06 Apr-08 Oct-09 Apr-11 Oct-12 Jul-00 Jan-02 Jul-03 Jan-05 Jul-06 Jan-08 Jul-09 Jan-11 Jul-12

Source: HFRX and Bloomberg, since HFRX inception, 1-Apr-03 to 28-Mar-13. Source: Newedge and Bloomberg, since CTA Index inception, 1-Jan-00 to 28-Mar-13.

Looking at the extremely high correlation of both CTAs and hedge funds to equities, and the extremely low levels of both realized and implied volatility in the equity sector, it is hard not to be reminded of 2007, when after four years of declining volatility and Fed-driven reflation, the bubble suddenly burst. I don’t think it’s a coincidence that during the emotional year or two that followed, our trading strategy was more accurate than at any time in our history. Popping bubbles seem to drive short term trader performance Recently I was describing this to a colleague and it occurred to me that short term traders, particularly the less trend-following of them, seem to be especially good when bubbles pop. When I think back to my own career, my first trading success occurred during and after the crash of 1987. R. G. Niederhoffer Capital Management’s first particularly successful period of performance came in 1994, when interest rates rose suddenly after several years in which the Fed had attempted to bail America out of the Savings and Loan Crisis. Another period of excellent performance occurred in 1998 when Russia, the convergence trade bubble and Long Term Capital Management all imploded. In 2000-2002, the end of the internet bubble spurred three straight years of excellent returns. And as I mentioned, the 2007-08 implosion was outstanding too. In fairness, the periods in which those bubbles inflated (1995-1996, 1999, 2003-2005 and 2009-2012), were much more difficult for us. As I have discussed in our last few letters, our strategies have undergone a great deal of improvement lately, and one of our most important tasks has been to develop methods to succeed during extremely low volatility “bubble inflation” markets while maintaining our ability to profit from high realized volatility that typically accompanies bubble bursts. Our positive returns in equities for the last few months suggest that we are on the right track. It’s worth noting that every one of these bubbles was inflated intentionally by the Fed in its continuing attempts to “manage” markets, and that each successive burst created the need for even stronger measures. And each burst has been greater in magnitude and in volatility. When the interest rate bubble pops… The current bubble in and equities will burst too – and my feeling is that the first hint of a reversal in Fed policy will be met by an avalanche of selling. Anyone watching the markets for the last few years knows what Quantitative Easing did on the upside, and it won’t take trading brilliance for every discretionary Global Macro manager in the world to put on maximal short positions in fixed income that very day. This is the final bubble, for better or for worse. And when rates start to rise, the world of hedge funds will face a huge challenge. Watch out. In my next letter I’ll discuss why rising rates will pose a serious problem for all hedge fund and CTA portfolios, in contrast to the consensus view which seems to be that rising rates would be just as positive as falling rates. Rather than being a positioning problem, as is the current “risk-on” positioning of most managers, a world of rising rates would be a structural issue that may challenge the viability of the entire hedge fund community. I look forward to speaking with you again soon. If you’d like an update on what we’re seeing in markets, our plans on the strategy front, as well as a preview of our views on the fixed income market, it would be my pleasure to schedule a quick call.

Very truly yours, P.S. I want to call your attention to the recent meteoric rise of Bitcoin, an electronic currency

that combines the fungibility of cash with a fixed money supply (like gold). Because of its use to avoid capital controls in Cyprus and Argentina, as well as general money printing going on throughout the world, this new currency has begun to serve as a proxy for global financial Roy Niederhoffer tension. It is worth watching how this market evolves. I think that its recent rise has something [email protected] to do with the way our trading strategies perform as well, and it would not surprise me that ten years from now we do a study showing that our funds perform better in months when Bitcoin rises, just as they do when volatility rises. You can view a real time chart of Bitcoin here: http://TinyURL.com/RGNBitCoin

FOOTNOTES AND OTHER IMPORTANT DISCLAIMERS: Subject to the following paragraphs, Data for R. G. Niederhoffer Capital Management, Inc. (“RGNCM”) trading programs (the “Programs”) is calculated net of all actual organizational and initial offering fees and expenses of the underlying funds (the “Funds”), and the impact of ongoing operating fees and expenses. Because performance numbers and correlation numbers (“Data”) represent data on a composite basis, Data does not represent performance or correlation for any particular investor in any Program. Therefore, it is possible in any particular period that certain investors may have achieved better or worse results as a result of the timing of their investments and the payment or non-payment of incentive fees. Data for all current Programs is reported. To analyze Data in months other than the months listed, please refer to the complete track records for the Programs. All correlation data is from the Programs’ inception through February 2013. Comparisons to indices are for demonstrative purposes only. No representation is made that Data will track or otherwise reflect any particular index. Data sources: HFR, Bloomberg, Newedge and Barclays Group. For Diversified Program, Data is: (i) through June 2008, actual results for Roy G. Niederhoffer (Ireland) No. 1 Fund; and (ii) beginning July 2008, actual results for Roy G. Niederhoffer Diversified Fund (Offshore), Ltd. (“DFO”) class A. For Negative Correlation Program, Data is: (i) through Dec 2011, actual results for Roy G. Niederhoffer Negative Correlation Fund, Ltd. (“NCF Offshore”) class A; and (ii) beginning Jan 2012, actual results for NCF Offshore class B. For TrendHedge Program, Data is: (i) through Oct 2006, pro forma results for Roy G. Niederhoffer TrendHedge Fund, Ltd. (“TrendHedge Offshore”) class C, net of fees that would be charged to TrendHedge Offshore class A; (ii) from Nov 2006 through Sept 2008, actual results for TrendHedge Offshore class A; (iii) from Oct 2008 through Nov 2010, actual results for TrendHedge Offshore class B; (iv) from Dec 2010 through Dec 2011, pro forma results for Roy G. Niederhoffer TrendHedge Fund (Onshore) L.P. (“TrendHedge Onshore”), net of fees that would be charged to TrendHedge Offshore class B; and (v) beginning Jan 2012, pro forma results for the general partner's investment in TrendHedge Onshore, net of fees that would be charged to a TrendHedge Onshore limited partner. For Optimal Alpha Program, Data is: (i) through Dec 2004, actual results for Roy G. Niederhoffer Optimal Alpha Fund, Ltd. (“OA Offshore”) class A; (ii) from Jan 2005 through April 2009, actual results for OA Offshore class B; (iii) in May and June 2009, pro forma results for OA Offshore class C, net of fees that would be charged to OA Offshore class B; and (iv) from July 2009 through Dec 2012, pro forma results for Roy G. Niederhoffer Optimal Alpha Fund (Onshore) L.P., net of the fees that would be charged to OA Offshore class B; and (v) beginning Jan 2013, pro forma results for OA Offshore class C, net of the fees that would be charged to OA Offshore class B. For iHedge Inflation Protection Program, Data is pro forma results for Roy G. Niederhoffer iHedge Inflation Protection Fund (Onshore) L.P. (“iHedge Onshore”), net of fees that would be charged to Roy G. Niederhoffer iHedge Inflation Protection Fund, Ltd. (“iHedge Offshore”) class A. In addition, August and September 2011 results include pro forma adjustments made to reflect a 12% annualized volatility target, rather than the 22% annualized volatility that was actually targeted. Pro forma performance of iHedge Onshore does not include the impact of organizational and initial offering fees and expenses. As a result of a 0.50% higher administration fee carried by class B than class A and onshore funds (except in the case of iHedge Offshore), an investor in class B would have achieved slightly worse performance than the class A or onshore fund performance reported herein in the following circumstances: (i) since July 2008, an investor in DFO class B; (ii) through December 2011, an investor in the NCF Offshore class B; (iii) from June 2006 through Sept 2008 and then beginning Jan 2012, an investor in TrendHedge Offshore class B; and (iv) from Jan 2004 through Dec 2004, an investor in OA Offshore class B. An investment in the Funds is speculative and involves significant risks including, without limitation, those set forth herein. Such risks are more fully set forth in the applicable offering document for each Fund. An investor may lose some or all of its investment in the Funds. The Funds’ investments will be highly leveraged and the Funds’ performance may be volatile. Each of the Funds will engage in futures and options trading, both of which involve substantial risk of loss. RGNCM, has complete discretion over all investment decisions relating to the Funds. Shares in the Funds are subject to restrictions on transferability and no secondary market for such shares currently exists or is expected to develop. The fees and expenses of the Funds are high and may offset trading profits. A substantial portion of the Funds’ trades may take place on non-U.S. exchanges and markets which may be subject to less regulatory oversight than trades on U.S. exchanges and markets. THIS LETTER DOES NOT REPRESENT AN OFFER TO SELL SECURITIES. SUCH AN OFFER CAN ONLY BE MADE PURSUANT TO AN OFFERING DOCUMENT. ONLY QUALIFIED INVESTORS WHO MEET SUITABILITY STANDARDS WILL BE ENTITLED TO RECEIVE AN OFFERING DOCUMENT.

YOU SHOULD ALREADY HAVE RECEIVED A COPY OF AN OFFERING DOCUMENT FOR A FUND. IF YOU HAVE NOT RECEIVED AN OFFERING DOCUMENT, PLEASE CONTACT US AND WE WILL SEND YOU AN APPROPRIATE OFFERING DOCUMENT IMMEDIATELY. THE INFORMATION HERE SHOULD ONLY BE USED IN CONJUNCTION WITH OUR OFFERING DOCUMENTS, WHICH CONTAINS ADDITIONAL INFORMATION ABOUT OUR FIRM AND INFORMATION ABOUT THE RISKS OF INVESTING IN THE APPLICABLE FUND. PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.