Hedge funds have become increasingly susceptible to hacks since the explosion of high frequency trading. Hedge fund trading has been assumed to be the domain of exclusive and wealthy investors, those with more than $1 million available to invest, but there’s more to the story. Institutional players like pension funds are increasingly exposed to uninsured hedge fund losses. That means if a hedge fund is hacked and your pension or 401K is invested you’re at risk for a loss.
Over the last few years stock trading by hedge funds has been increasingly dominated by high frequency electronic trading. That means that the trading is done not by humans but by computers that make money by taking advantage of price differentials made possible by trading stocks a micro second earlier or later than the next guy. It’s a tough concept to grasp, but speed is essential and it’s a speed the fraction of an eye blink. Michael Lewis’ new book Flash Boys, offers an incisive view of high frequency trading.
If you remember the so-called Flash Crash that hit Wall Street in 2013, you have some idea of what’s possible. In that crash an incorrect data entry resulted in a loss (and subsequent recovery) of more than 1,000 within minutes. Now, imagine what’s possible if it’s more than a data error, if someone intentionally hacks the system.
Hedge fund hacks are, unfortunately, more than just a subject of alarmist blog posts. CNBC’s Eamon Javers reports that, “Cybercriminals acting in late 2013 installed a malicious computer program on the servers of a large hedge fund, crippling its high-speed trading strategy and sending information about its trades to unknown offsite computers.” In this case, they were able to reap significant gains at the expense of legitimate investors.
The lesson here is that there is a risk inherent to investing, even in seemingly blue chip accounts, like your firm’s 401K plan. Those funds are not insured, unlike money that you have in your own bank account, which is federally insured by the FDIC. That’s not news, what is news is that the risk has been magnified by the behavior of some funds (i.e. high frequency trading) that has put them in the cross-hairs of financial hackers.
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