Finding stocks to sell short is like “shooting fish in a barrel,” according to Harry Rady, chief executive and portfolio manager at Rady Asset Management LLC.
Mr. Rady, who manages $250 million in long-short strategies in both mutual funds and hedge funds, said the stock market is nearing a tipping point where many of the companies that performed the best last year will become vulnerable.
“We believe the stock market is making a top here, and we're gradually easing into some short positions,” he said.
The Rady Contrarian Long/Short Fund (RADIX), which was launched in October, is currently 80% net long, which is slightly offset by an 8% short position. The fund is also holding a 20% cash weighting.
But those percentages will be shifting over the next few months to include more short exposure, he explained.
“To me, the opportunities are pretty clear,” he said. “We just went through a beta rally over the past six months, where the poorest-quality companies rallied the most, and I think that's coming to an end.”
As larger companies with stronger balance sheets start to lead the next stage of the rally, Mr. Rady anticipates vulnerability among the “second- and third-tier companies.”
The transition to higher-quality names, he said, could be triggered by a major market catalyst or it could come through basic market efficiencies.
“In the short term, the market can be inefficient at times, but in the long term, it is a pretty efficient machine,” he said.
Among the catalysts Mr. Rady expects will lure investors toward higher-quality equities is a reduction in the amount of liquidity the federal government has been pouring into the system.
“Low interest rates and massive liquidity have backstopped the markets,” he said. “Because of everything the Fed did last year to eliminate the downside, investors went to the riskiest assets.”
Even as a long-short hedge-style manager, Mr. Rady saw no advantage in fighting the direction of the market in 2009, during which he maintained mostly net long exposure.
“We believe that the trend is your friend,” he said.
As the market shifts to favor higher-quality names, Mr. Rady is expecting to see specific opportunities in both the health care and utility sectors.
One example of a stock he likes is NRG Energy Inc. (NRG).
“This is one of the safest blue-chip steady performers,” he said.
Mr. Rady added that NRG is currently a good value with a price-to-earnings ratio of 10, which compares with a historical average P/E of more than 15.
Portfolio Manager Perspectives are regular interviews with some of the most respected and influential fund managers in the investment industry. For more information, please visit InvestmentNews.com/pmperspectives .