Hedge funds are becoming increasingly cautious about wagering against UK stocks, following a series of takeover bids that have caught short sellers off guard.
Among those affected are Millennium Management, GLG, and Gladstone Capital Management, as they found themselves on the losing end as stocks like Hargreaves Lansdown, Darktrace, and Keywords Studios surged after attracting acquisition offers.
According to hedge fund managers, despite recent struggles faced by these companies, their reduced share prices are attracting interest from foreign competitors or private equity buyers. This dynamic is making it increasingly risky to bet on declines in share prices.
“Shorting any UK mid-cap is insane, literally insane,” remarked one hedge fund executive who specializes in shorting stocks. “The numbers [valuations] are just so low in the vast majority of cases that a $2bn UK company is peanuts for any mid-sized American company. Your sell case has to be unbelievably compelling and feature the stock going down at least 50 per cent,” the individual added, highlighting the substantial risk of losing if the stock attracts a bid.
Shorting involves borrowing shares and selling them in the market, aiming to buy them back at a lower price later.
Mergers and acquisitions involving UK targets have surged by 84 per cent this year compared to the same period in 2023, according to data from the London Stock Exchange Group, based on deal value. “The UK public-to-private market is especially busy right now,” noted Stefan Arnold-Soulby, a partner at law firm Paul Weiss.
This wave of deal-making is a response to the significant valuation gap between UK stocks and other markets, particularly the US. London’s FTSE 100 index trades at 12 times the estimated earnings of its members for the coming year, while Wall Street’s S&P 500 index trades at about 21.8 times forward earnings, according to Bloomberg data.
Josh Jones, a portfolio manager at Boston Partners, revealed that his bets against UK stocks were at near-record lows relative to his bets on rising prices. “We bet against two types of companies: extremely overvalued stocks with a low risk of being bought, but there are not many of them in the UK market right now; or against businesses with fundamental issues or bad balance sheets,” Jones explained.
Recent events have shown the vulnerability of hedge funds like Millennium, Kintbury Capital, and the Canada Pension Plan Investment Board, which were shorting Hargreaves Lansdown when it rejected a £4.67bn bid by private equity firms. Similarly, London-based hedge funds Gladstone, Marble Bar, and GLG found themselves in a similar situation with Keywords Studios when its shares surged after discussions of acquisition by private equity group EQT.
Man Group, owner of GLG; CPPIB, Gladstone, and Kintbury, declined to comment. Millennium and Marble Bar did not respond to requests for comment.
These losses add to the challenges faced by equity long-short funds, a well-established hedge fund strategy that has been experiencing client withdrawals and lackluster returns.
Expressing concern, the manager of a small London-based equity long-short hedge fund highlighted the approximately $1.2tn of “dry powder”, or unallocated capital, held by private equity firms eager to engage in deals.
