Tips To Identify Best-Of-Breed Investments

OCEAN CITY – If you are considering adding growth to your portfolio, it’s important to make choices that can help you weather current economic conditions and take advantage of any stronger markets. Step one: Recognize the characteristics that position certain companies and sectors for growth.

In the 1990s, when Michael Hartnett, Co-Head of International Investment Strategy at Banc of America Securities–Merrill Lynch Research, used the phrase “best of breed,” he was referring to Japanese companies that escaped the decade-long bear market in the world’s second-largest economy. “Japan was facing something similar to what is going on in the U.S. today — a credit-fed boom followed by a deflationary bust,” says Hartnett. Yet, in sharp contrast to the plight of most Japanese stocks, a basket of 15 top-performing Japanese blue chips rose 330% during that decade, versus a 40% decline for the broader market.

Today “best of breed” applies to the kinds of companies that tend to weather downturns and are more likely to provide long-term opportunity for investors. Such companies have healthy balance sheets, strong management, consistent earnings histories and forecasts with bright future prospects, plenty of cash as a percentage of overall assets, and clear growth strategies. Now, as investors look for signs of recovery in the global economy and markets, searching for companies with these best-of-breed attributes could help identify stocks that have the potential to rise even if market benchmarks don’t.

Where should an investor look for such companies? One fruitful area might be markets that are primed to outperform. Hartnett is especially optimistic about the prospects for some emerging markets in Asia and Latin America. What makes certain countries in these regions attractive is that they have current account surpluses, they have stronger domestic demand prospects in 2009 and beyond, and their banking sectors are relatively healthy.

As far as U.S. investments are concerned, investors may consider globally oriented brand-name companies that export to high-growth countries such as India and Brazil, which have burgeoning consumer markets.

While it makes sense to invest in sectors poised for growth, even hard-hit industries such as U.S. banking and real estate may offer best-of-breed candidates. “The commercial real estate sector is one of the main beneficiaries of U.S. government intervention, so there are opportunities to invest in REITs [real estate investment trusts], not only on the equity side but also in fixed income,” says Doll. Best-of-breed investors will want to identify the real estate companies that are best positioned to benefit from government spending — which will tend to be those with strong management, high growth prospects, a solid plan going forward and enough cash to implement the plan.

Although the best-of-breed approach is tailored toward equities, there are fixed income investments with similar high-quality attributes — and which can offer a desirable balance between safety and growth. According to Martin Mauro, Fixed Income Specialist at Bank of America Securities–Merrill Lynch Research, “economic growth will be lethargic enough to pose financial challenges to many corporations and municipalities.” Expecting a rising default rate for high-yield corporate bonds, he believes the best value lies in munis with a five- to 15-year maturity range.

(A Merrill Lynch Senior Financial Advisor. She can be reached at 410-213-8520.)