Britain 1, Speculators 0

BBC business editor Robert Peston on the recent performance of hedge funds

It has been a lousy three months for hedge funds.

I hope I didn't hear you say "diddums" - because it is possible, you know, that a bit of your wealth is being managed by a hedge fund, via your pension scheme.

According to Hedge Fund Research's HFRX Global Hedge Fund Index, funds fell 0.94% on average in June and 2.79% in the three months ended June. This was, apparently, the worst second-quarter performance since 2000 when the industry lost 3.42%.

Now I'll admit that there is one aspect of this poor performance that gives me the kind of unworthy pleasure I enjoy when seeing a football team that I despise being thrashed (I think we all know which team I am referring to here - as it happens, its players receive hedge-fund-size wages and it is supported by a disproportionate number of hedgies).

What warmed my cockles were the significant losses incurred by those who bet large over the past few months on a collapse in the pound and in the price of gilts.

Because as someone who lives and works in the UK, I have no serious option but to be a supporter of team sterling. If the pound were to career downward in an uncontrolled way, if investors were to refuse to lend to Her Majesty's government, well that would be a fairly significant problem for the more financially immobile among us.

Of course, hedge funds are the definition of financially mobile institutions. So when the opinion polls before the election were predicting that the UK was heading for a hung parliament, a number of them bet that this would lead to paralysis in government and an inability to take serious measures to reduce the UK's record 11% public-sector deficit.

They weren't alone of course. You'll probably remember those telephone calls I received on the eve of the election from Sir Philip Green and Sir Martin Sorrell putting on record their fears that a hung parliament would result in dangerously ineffectual government (see my note Tory-backed business letter flops).

So for some hedge funds, the formula "hung parliament = fiscal deterioration = collapse in the pound and gilts" looked like a law of nature. And they placed their bets accordingly.

They discounted the possibility that a strong coalition - forged by a determination to cut the deficit - could be created.

And what adds to my amusement about their chronic miscalculation is that they had no understanding at all that a coalition could actually tackle the deficit faster and more credibly than a party with a working majority - because they failed to apply the portfolio theory of investment management to politics, on this rare occasion where it would have been a useful tool.

Here's the point: a government of Tories and Lib Dems could (and will) cut deeper and speedier than the Tories alone would have done (almost certainly), because the reputational risks can be distributed across two parties rather than focussed just on the one.

There's a wider point to be made here about what a confusing and difficult world it has become for hedge funds and short-term investors in general - largely because of the eurozone's financial instability (see my note Eurozone stress tests stress investors).

Right now the eurozone is a raging, boiling ocean of governments pushing and pulling each other over what to do about their members' excessive deficits and their weaker banks, coupled with powerful currents of liquidity added and then suddenly and dangerously withdrawn.

Discerning anything other than the big waves colliding is tricky - and predicting when it will all calm down is well-nigh impossible.

In the middle of all that, even a multi-billion dollar hedge fund looks like a vulnerable small craft.

You can keep up with the latest from business editor Robert Peston by visiting his blog on the BBC News website.