Hegde funds closing positions

Wednesday December 1, 12:34 pm Eastern Time 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.

-- Bill P (porterwn@one.net), December 01, 1999

Answers

It looks like Y2K will start early due to implementation of contingency plans. Add this to the planned halt of Foreign Exchange trading and it looks like economic activity in late-December will be much lower. Add in the planned short term (???) outages on 12/31/1999 by manufacturing and pipelines and economic activity slows some more.

I doubt this is like a spigot that is just shutoff and reopened.

This is what the WTO should be discussing in Seattle - how to conduct international trade at a reduced systems capacity.

-- Bill P (porterwn@one.net), December 01, 1999.

My cousin who does investment banking in Boston said that they have essentially stopped doing business already (T-day). No one is taking chances with deals before the rollover.

Hold your breath everyone.

-- nothere nothere (notherethere@hotmail.com), December 01, 1999.

I just heard an expert on CNBC who claims he's rarely wrong, state that the DOW will be up over 12,000 by the end of January. Everything is hunky dory and not worried about the feds raising interest rates. Now, don't you all feel better?

-- ~~~~~ (~~~~~@~~~.com), December 01, 1999.

Excellent Y2K related post. A lot of people are having difficulty recognizing what is and isn't related to Y2K.

-- Guy Daley (guydaley@bwn.net), December 01, 1999.