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 that 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 80% net long, which is slightly offset by an 8% short position. The fund holds a 20% cash weighting.
But those percentages will shift over the next few months to include more short exposure, Mr. Rady said.
“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,” Mr. Rady said.
Among the catalysts that he expects will lure investors toward higher-quality equities is a reduction in the amount of liquidity that the federal government has been pouring into the system.
“Low interest rates and massive liquidity have backstopped the markets,” Mr. Rady 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 last year, 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 expects 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 a good value with a price-earnings ratio of 10, which compares with a historical average P/E of more than 15.