Shorting stocks is now ‘high risk’

Shorting stocks is now ‘high risk’

An upward surge in share prices driven by a glut of corporate mergers has made it increasingly difficult to pick stocks to short, according to Henderson’s Luke Newman.

Mr Newman’s £561m UK Absolute Return fund can take short positions, which means it benefits from falls in share prices. But the manager has said selecting stocks he expects to fall has become particularly difficult at this stage in the market cycle.

This is, in part, thanks to the rising number of mergers and acquisitions, which he said can significantly propel stocks in a short space of time.

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He said a flurry of deals in rapid succession could cause strong movements in markets, making it “high risk when it comes to shorting stocks”.

To tackle the problem, Mr Newman said he is considering using a large amount of derivatives to short the UK index as a whole, which negates the need to choose single companies.

“In 2006, we saw the level of merger and acquisition activity surge and I increased my holding of index derivatives to its highest level ever – 50 per cent of the short book,” he said.

“I’d be prepared to return to that level if M&As [mergers and acquisitions] really start to take off.”

At the moment index derivatives make up about 30 per cent of his short portfolio, which translates to 11.2 per cent of the fund as a whole when the long book is taken into account.

However, Mr Newman hopes he will not have to add to his index derivatives weighting.

“Index derivatives are good in some ways, but if you want to make real money in the short book, you need to invest in single stocks,” he added.

Mr Newman said a rise in M&A was also being driven by the strength of the dollar, which made it more attractive for US-based companies to target European firms.

The greenback has staged a rapid rally against most other currencies. Last July, the pound was worth more than $1.70 but it’s now at $1.53, according to data from Thomson Reuters.

A strong dollar has, however, prompted changes in the manager’s long book of stocks; those he is backing to perform well.

He has added to his holdings of Reed Elsevier, a multinational publishing and information company, and Carnival Cruises, a cruise line operator.

The other big theme for Mr Newman’s investment strategy was the UK election last month.

Prior to the country going to the polls, the manager built up positions in UK housebuilders and challenger banks, which he believed would not be overly affected by a change of government and had “a degree of protection”.

He added to Taylor Wimpey, one of the UK’s largest housebuilders. The stock is now his fourth largest, making up 2.1 per cent of his portfolio.

The manager said: “The company was always likely to do well no matter which [party] won the election since [it] had a commitment to build new houses outside of London.”