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Hedge fund short sellers burnt by flurry of UK takeover bids

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Hedge funds are increasingly wary of betting against UK stocks after being burnt by a wave of takeover bids at companies targeted by short sellers.

Millennium Management, GLG and Gladstone Capital Management are among funds to have been caught out in recent weeks as stocks such as fund supermarket Hargreaves Lansdown, cyber security provider Darktrace and video game services company Keywords Studios soared after attracting offers.

Hedge fund managers say that while all three companies have had difficulties recently, knockdown share prices are piquing the interest of these groups’ foreign rivals or private equity buyers, making it a risky business to bet on share price declines.

“Shorting any UK mid-cap is insane, literally insane,” said one hedge fund executive who specialises 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” or there is a risk you lose 50 per cent if the stock gets bid for, the person added.

Shorting involves borrowing shares and then selling them in the market, in the hope of buying them back at a lower price.

M&A involving a UK target is 84 per cent higher this year than it was during the same period in 2023, according to data from London Stock Exchange Group, based on value of deals. “The UK public-to-private market is especially busy right now,” said Stefan Arnold-Soulby, partner at law firm Paul Weiss.

The wave of dealmaking has come in response to a yawning valuation gap between UK stocks and markets elsewhere — particularly the US. London’s FTSE 100 index trades at 12 times the estimated earnings of its members for the coming year, according to Bloomberg data. Wall Street’s benchmark S&P 500 index, in comparison, trades at about 21.8 times forward earnings.

Josh Jones, a portfolio manager at Boston Partners, said 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.

“You hope the probability of an acquisition is lower [for the latter type of business], but sometimes businesses with issues are fixable 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 it had rejected a £4.67bn bid by a group of private equity firms. The share price had risen 20 per cent in the two weeks before the rejection.

Kintbury has covered its short position — meaning it has bought back the shares — in the firm, according to an investor. The hedge fund had been betting against the investment platform for five years, during which time its share price halved, so overall it has still made good money from the position, the investor added.

London-based hedge funds Gladstone, Marble Bar and GLG were all short Keyword Studios when the shares soared 55 per cent after the Financial Times reported it was in discussions to be acquired by private equity group EQT.

Man Group, which owns GLG; CPPIB, Millennium, Gladstone and Kintbury declined to comment. Marble Bar did not respond to a request 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 lacklustre returns.

The manager of one small London-based 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 keen to do deals.

“Valuations are cheap and there is plenty of cash around,” said the hedge fund manager. “It’s a definite risk on the short side of the book.”

Some managers said they were spreading their short positions across a wider range of UK stocks in order to reduce the damage if one of their short targets received a takeover offer.

“Either you cut the short or make it smaller,” said a long-short hedge fund manager who is taking smaller bets with new positions. “It’s all about sizing and controlling [the risk].”

Additional reporting by Harriet Agnew, Ivan Levingston, George Steer and Will Louch

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