One of London’s most successful hedge fund groups alerted clients to the dangers of “black box” hedge funds yesterday, arguing that their computer-driven strategies contained the seeds of their own destruction.

Fauchier Partners, which advises wealthy individuals and institutions, said that it shunned black box, or quantitative, funds because of what it regarded as weaknesses in their design.

The criticism came as it emerged this week that Morgan Stanley had lost $390 million (£192 million) in one day in August through its quantitative trading strategies. Also in August, Goldman Sachs injected an emergency $2 billion of its own capital into an in-house quantitative fund - Global Equity Opportunities – after its investors lost 32 per cent of their money in a few days. The fund has bounced back strongly.

In a letter to clients, Fauchier said it believed that pure quantitative funds, whose pre-programmed computers take all the investment decisions, were flawed because they bet that past patterns in securities prices would continue into the future. “Invariably, when correlations break down, these funds are exposed,” it said.

It also said that black box funds took on extra debt, and, therefore, risk, precisely when they should not. In benign environments they increased leverage to sustain the returns made in more volatile times. “This has always struck us as being perverse,” Fauchier said. “At an inflection point – when markets are shifting from low to high volatility – quantative funds tend to run much larger balance sheets than normal, thus compounding the problem.”

It was the leverage of many quantative funds that led to the implosion in August, when prime brokers demanded that they cut their gearing, either by paying back loans or meeting margin calls, making them forced sellers of equities. At this point many discovered that they had invested in the same shares, a consequence of Fauchier’s third criticism. Quantative funds, it said, came to the same conclusions about which shares to invest in and which to “short-sell”.

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