Black box traders shut up shop early due to Y2K
By Andrew Priest
LONDON, Dec 1 (Reuters) - So-called black box funds, which base trading strategies on complex computer programmes, said on Wednesday they were shutting up shop early this year amid fears that rising volatility could undermine their market bets.
Concern about the impact of the date change on computer systems, the so-called millennium bug, is likely to cause liquidity to dry up earlier than usual as the yearend approaches, leaving investors exposed to erratic price changes, fund managers said.
They also noted there was still a risk, though small, that the millennium bug could cause their computer trading systems to malfunction or even shut down which could cause heavy disruption and big losses.
``A lot of these specialist funds have liquidated their positions, believing the risk of getting out of the markets as worth taking relative to the risk of holding large positions over the yearend,' said one black box fund manager.
``It's not just in currencies, it's in all markets and reflects growing uncertainty in the run up to the millennium,' he said.
Black box funds, the most infamous of which was Long-Term Capital Management (LTCM) which almost collapsed last year amid multi-billion dollar losses, use historical market data and statistical analysis to underpin their investment decisions.
If volatility, a key component in pricing, rises beyond usual historical levels due to a fall off in trading it could cause erratic movements in prices which would not be predictable using historic information, fund managers said.
The last time there was a sudden and massive increase in asset price volatility was after the Russian financial crisis last August, an event which caused heavy losses at many specialist funds like LTCM as well as major banks.
``Anytime liquidity is reduced it makes market manipulation a lot easier and you don't want to be exposed to that sort of uncertain risk,' said Christopher Cruden, managing director at Tamiso and Co. which trades currencies using computer models.
``We're in the business of taking risk but when the market is not true this is offset by risks we don't want to take.'
Cruden declined to say whether his fund had stopped trading yet but said in a normal year he would close positions well ahead of the Christmas holiday break to avoid heavy volatility.
Programme trading is one strategy used by specialist and highly secretive hedge funds, which pool money from wealthy individuals and institutions to make bets across financial markets.
These funds often use derivative instruments such as futures and options, which are priced off underlying assets, to boost the magnitude of their market bets.
Such instruments are priced using volatility measures and tend to move very erratically in illiquid markets leaving investors exposed to losses even higher than the size of original investments. |
