Portfolio Manager Perspectives

Jeff Benjamin

Too much market optimism, says Harry Rady

Money manager ups short exposure to 35%, from 8% in January; ‘tale of two markets’

Mar 9, 2010 @ 10:16 am

By Jeff Benjamin

After the stock market’s 68% rally from its March low last year, the problem now is misguided optimism, according to Harry Rady, chief executive and portfolio manager at Rady Asset Management LLC.

“It’s the tale of two markets,” he said. “You’ve got large-cap blue-chip stocks that have rallied very little, and you’ve got low-quality high-beta companies that have rallied too much.”

Mr. Rady, who manages $250 million in long-short strategies in both mutual funds and hedge funds, currently has 98% long exposure and 35% short exposure.

“We’re betting on there being too much optimism in the market,” he said of his short exposure, which was just 8% in January.

Some of that market optimism, Mr. Rady said, is reflected in huge, nonsensical rallies.

Steiner Leisure Ltd. Ticker:(STNR), for example, has seen it stock price climb 123% over the past 12 months. The company, which provides spa services aboard cruise ships, represents “pure consumer discretionary spending,” according to Mr. Rady.

“The stock is trading at the high end of its historical valuations, it’s seen a fair amount of insider selling, and it’s in an odd business,” he said. “We think it’s an attractive short candidate.”

Another of his short candidates is American Campus Communities Inc. Ticker:(ACC), a real estate investment trust specializing in housing for college students. The company’s stock is up 90% from the market’s low point last year, yet Mr. Rady does not like the firm’s debt levels or its reductions in capital expenditures that are required to maintain the properties.

The stock performance of Whirlpool Corp. Ticker:(WHR), which has gained 360% over the past 12 months, also defies simple logic, according to Mr. Rady. “This is a company that has done a good job with innovation and cutting expenses,” he said. “I just don’t think washers and driers are going to be the first thing on consumers’ lists of things to buy.”

Considering how far the market overreacted on the downside a year ago, it’s not surprising that stocks have rallied, Mr. Rady said. Now, however, he’s looking for companies that are currently overvalued.

“Some of the beta rally is justified because the market went down too far,” he said. “But in our bottom-up research, a company’s proximity to its 52-week high is the first thing we consider in a first-blush analysis.”

On the long side of the portfolio, Mr. Rady said he is “long utilities in a big way.”

One example is NRG Energy Inc. Ticker:(NRG). “We’re fans of the management team, and we like the company’s nuclear exposure,” he said. NRG shares have gained 31.6% over the past 12 months.

From a pure valuation perspective, Mr. Rady is positioning his portfolio for a reversion to the mean that he expects will close many of the market’s valuation gaps.

“It’s impossible to predict the reasons, but history has shown that reversion to the mean always happens,” he said. “When volatility picks up and there’s more uncertainty in the market, there will be flight to quality.”

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.


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