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June/July 2010 Picks

Four offerings deemed to be right for right now.

Morningstar Analysts, 06/14/2010

Mutual Fund: Aston/Montag Caldwell Growth N MCGFX
This fund proves the old saw that quality never goes out of style. Its debt/capital ratio and P/E are lower than the S&P 500 Index's, but its net profit margin and return on equity are much higher. In short: It owns firms with minimal debt and superior profitability, yet it paid less than average for them. That's always a winning combination, but it looks especially attractive now in an environment of a shaky economic recovery and volatile markets.

Its top holdings include such proven firms as 3M MMM and Wal-Mart WMT, whose stable market positions and strong balance sheets give them an edge in uncertain times. (Michael Breen)

Separate Account: FPA Small/Mid-Cap Absolute Value
This quirky separate account's mantra is that a good defense is the best offense.

It's run by a talented team from First Pacific Advisors--investing legend Bob Rodriguez's firm. It has more than a fourth of its assets in cash, and more than half its equity portfolio is in energy-related stocks. The former not only acts as ballast in choppy markets, but it gives the managers plenty of dry powder to quickly jump on opportunities that arise in a market reversal. The latter gives the separate account a much better chance than most to handle the rising inflation the managers think is inevitable as a result of massive increases in government debt. (Michael Breen)

Exchange-Traded Fund: iPath S&P 500 VIX Short-Tm Futures ETN VXX
Sophisticated investors with a long-term view could use this fund to partially guard their portfolios against future downturns, but they must first understand the unusual risks and returns of this exotic asset class. Volatility jumps in sync with stock price crashes, spiking whenever the S&P 500 collapses. This behavior makes sense, as expected volatility serves as a proxy for the amount of uncertainty in the market. This relationship between volatility and price makes the VIX one of the best diversifiers for an equity portfolio. Unfortunately, it is also a strongly mean-reverting asset class, so it produces zero long-term return. There is always a cost for decent insurance, but the payoff can be large when disaster strikes. (Paul Justice)

Stock: ExxonMobil XOM
In regard to ExxonMobil's moat, the entire oil industry benefits from the presence of OPEC. Members of the cartel control roughly 45% of the world's oil production, but approximately 75% of its reserves. Beyond having a cartel providing a pricing floor under the key commodity it produces, ExxonMobil also benefits from superior operational efficiency. Moreover, its size and financial strength give it an advantage when negotiating for new projects.

Because of its expertise and ability to deploy tens of billions worth of capital from internal sources alone, Exxon is an attractive partner for governments looking to exploit their resources. It is no accident that Exxon has the highest profitability in the industry.

As Paul Larson, the editor of Morningstar StockInvestor, wrote in his most recent issue: "I happen to believe that oil prices in the future are going to be higher, perhaps much higher, than in the past as we reach 'peak oil.' ExxonMobil will certainly benefit from this. If governments around the world resort to quantitative easing (printing money) to resolve the sovereign debt problems currently outstanding, higher rates of inflation will also ensue. Exxon is not a bad hedge against this scenario. Looking at valuation, despite refining profit margins currently being in the tank (pun intended), Exxon is still expected to earn about $6 per share in 2010, putting the stock at roughly 11-times forward earnings, a very inexpensive price to pay for such a high quality company." (Haywood Kelly)

Hindsight: April/May 2009
Our picks from April/May 2009 have done well. The best performer has been manufacturer 3M MMM, which is up nearly 60%. It's the same wide-moat, financially sound firm we recommended, but it's now closer to Morningstar's estimate of fair value. We still like its prospects, but it's not the bargain it was a year ago, trading at 85% of Morningstar's estimate of fair value. Mutual fund Longleaf Partners LLPFX has also been on a tear. Simply put, most of its holdings that tanked in 2008 roared back in force. Despite the huge runup, the fund is largely standing pat--most of its names still trade for less than 60 cents on the dollar. The fund remains a favorite for long-term investors. Based on its sibling mutual funds' returns, separate account Keeley Corp. Restructuring Sm-Cap has also been a winner. Our ETF pick, BLDRS Developed Markets 100 ADR ADRD Index, has lagged a bit but has cranked out a solid absolute gain. It still looks like a great way to load up on international blue chips, helping diversify a U.S.-based portfolio. (Michael Breen)

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