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Hedge funds are increasingly wary of betting against British stocks after being burned by a wave of takeover bids for companies targeted by short sellers.
Millennium Management, GLG and Gladstone Capital Management are among the funds that have been snapped up in recent weeks as shares such as fund supermarket Hargreaves Lansdown, cyber security provider Darktrace and video game services company Keywords Studios surged after attracting bids.
Hedge fund managers say that while all three companies have struggled recently, the depressed share prices are attracting interest from the groups’ foreign rivals or private equity buyers, making it risky to bet on share price declines.
“Shorting any UK mid-cap is crazy, literally crazy,” said one hedge fund manager who specializes in shorting stocks.
“Numbers [valuations] they are, in the vast majority of cases, so low that a $2 billion British company is a piece of cake for any medium-sized American company. Your sell case has to be incredibly compelling and include the stock falling at least 50 percent,” or risk losing 50 percent if the stock gets bid, the person added.
Shorting involves borrowing shares and then selling them on the market in hopes of buying them back at a lower price.
M&A involving a UK target is 84 percent higher this year than in the same period in 2023, according to London Stock Exchange Group data based on deal value. “The UK public-private market is particularly busy right now,” said Stefan Arnold-Soulby, partner at law firm Paul Weiss.
The wave of deals came in response to a gaping gap in valuations between UK shares and markets elsewhere – particularly in the US. London’s FTSE 100 is trading at 12 times its members’ estimated earnings for the coming year, according to Bloomberg data. By comparison, Wall Street’s benchmark S&P 500 is trading at about 21.8 times forward earnings.
Josh Jones, a portfolio manager at Boston Partners, said his bets against UK stocks are at near record lows compared to his bets on rising prices.
“We are betting against two types of companies: extremely overvalued stocks with low buy risk but not many in the UK market at the moment; or against businesses with fundamental problems or bad balance sheets.
“You hope that the probability of acquisition is lower [for the latter type of business]but sometimes businesses with problems are fixed by someone else.”
Millennium, Kintbury Capital and the Canada Pension Plan Investment Board were among the funds shorting Hargreaves Lansdown when it announced on May 23 that it had rejected a £4.67bn offer from a group of private equity firms. The stock price rose 20 percent in the two weeks before the rejection.
According to the investor, Kintbury covered its short position – meaning it bought back shares – in the firm. The hedge fund had bet against the investment platform for five years, during which its share price had halved, so overall it was still making good money from the position, the investor added.
London hedge funds Gladstone, Marble Bar and GLG were all short Keyword Studios when shares soared 55 percent after the Financial Times reported it was being acquired by private equity group EQT.
Man Group, which owns GLG; CPPIB, Gladstone and Kintbury declined to comment. Millennium and Marble Bar did not respond to requests for comment.
The losses are the latest blow to equity long-short funds, one of the oldest and best-known hedge fund strategies, many of which have suffered client withdrawals and lackluster returns.
The manager of one small London equity long-short hedge fund said he was nervous about the roughly 1.2tn of “dry powder”, or unallocated capital, held by private equity firms looking to do deals.
“The valuation is cheap and there’s a lot of cash around,” the hedge fund manager said. “On the short side of the book, it’s a definite risk.”
Some managers said they were expanding their short positions to a wider range of UK stocks to reduce the damage if one of their short targets received a takeover bid.
“You either short it or you shrink it,” said the long-short hedge fund manager, who is taking smaller bets with new positions. “It’s all about sizing and control [the risk].”
Additional reporting by Harriet Agnew, Ivan Levingston, George Steer and Will Louch