Morningstar Advisor - December/January 2010 - 18

Investment Briefs Mainstream Funds for Going Hybrid With investors still fearful of risk and yet also afraid of missing a rally, Arijit Dutta, an associate director of mutual fund analysis with Morningstar, recently suggested one possibility: Take the middle ground offered by preferred stocks and convertible bonds. Dutta offers some examples of managers who have made hybrids an important part of their strategy: Calamos Growth & Income CVTRX The fund is close to being a poster child for hybrid investing. The portfolio is split between common stocks and hybrids and is designed to provide a balance between upside potential and protection from sudden downswings. Fidelity Strategic Dividend & Income FSDIX Lead managers Joanna Bewick and Chris Sharpe allocate assets into stocks, real estate investment trusts, convertibles, and preferred stocks according to their bottom-up assessment of where they see the best value to grow income. Franklin Equity Income FISEX This fund’s focus on hybrid securities is fairly recent, timely, and makes a lot of sense based on management’s competitive advantage. Comanagers Alan Muschott and Ed Perks gave the portfolio a makeover in 2008, incorporating a heavy role for preferreds and convertibles in the strategy. Thornburg Global Opportunities THOAX Lot of aspects of this offering suggest that it is one of the most aggressive world-stock funds. So it’s particularly interesting that managers Brian McMahon and Vinson Walden have found compelling opportunities in corporate bonds and preferreds. Nuveen Tradewinds Value Opportunities NVOAX securities are also a permanent feature of Iben’s strategy. We would like the fund even more if expenses were to come down. Three Stock Picks Keep It Simple Paul Larson, editor of Morningstar StockInvestor newsletter, offered portfolio strategy pointers and shared his latest stock picks Nov. 5 at the 2009 Morningstar Stocks Forum. Larson’s central criteria is finding stocks with wide moats, and he stressed the competitive advantage of having a long-term focus. He said that he’s OK with concentrated positions as long as investors are confident in the company. In his words: “Fewer baskets, closer watching of eggs.” Larson’s picks: r Exelon EXC is composed of two utility companies, ComEd and PECO; and a nuclear power generation business, Exelon Generation. The utilities are only narrow-moat businesses, but they are relatively stable. Exelon Generation, however, is a wide-moat business. Exelon is the largest nuclear power operator in the country, with 17 reactors. Exelon’s valuation is compelling. It should earn a little over $4 a share in 2009, about 12 times earnings, and Larson said that he thinks that the company can earn at least $7 per share in 2012 as rate caps expire. r Enterprise GP Holdings EPE, a pipeline investment MLP, is also attractive. It receives royalties from operations of various companies it owns. They provide a minimal amount of incremental capital but get a disproportionate amount of growth. It’s a stable, wide-moat business. Taxable accounts are the preferred vehicle for MLPs. r Lowe’s LOW doesn’t have the widest moat, but it has advantages stemming from economies of scale and a national brand, and its currently low valuation makes it really attractive. Lowe’s has had a rough go of it during the housing struggles. Same-store sales have been weak, and operating margin has fallen. But Larson thinks that same-store sales will go up 1% next year and grow at 5% for the next few years. Post-Reform Health-Care Picks The exact outcome of health-care reform is uncertain, but speaking Nov. 5 at the 2009 Morningstar Stock Forum, analysts Bill Buhr, Debbie Wang, and Karen Andersen said that some companies stand out by being able to weather the possible outcomes. More-diversified pharmaceutical companies are most attractive in the face of uncertainty. Some favorites include: r Novartis NVS has a large exposure to generics, which the analysts said they think will be a winner from reform. r Abbott ABT has done a good job making smart acquisitions. It has a strong product portfolio and less exposure to patent expirations than many pharmaceutical companies. Its diagnostics business should also buffer it from volatility in the drug market. r Johnson & Johnson JNJ also has a strong pipeline of drugs. It also has great free cash flow and device and over-the-counter businesses, which offer downside protection. Biotech as a whole isn’t as undervalued as pharmaceuticals, but the analysts said that they like Genzyme GENZ. Genzyme has had manufacturing issues that have opened the door to competitors, but the analysts said that they think the competitive concerns are overblown. In terms of devices, the analysts said that new developments that demonstrate a clinical benefit will be able to command pricing. For example, Medtronic MDT is working on an MRI-compatible pacemaker. Since 50% to 75% of pacemaker patients eventually will need an MRI, such a device should be able to fetch higher prices. Manager Dave Iben will place massive bets against the benchmark if he sees great long-term prospects elsewhere. Hybrid 18 Morningstar Advisor December/January 2010

Morningstar Advisor - December/January 2010

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