Fund Managers Tell Where to Invest Your Tax Refund

BOSTON ( TheStreet) -- If you're receiving a tax refund this year, congratulations! You just gave the U.S. government a generous interest-free loan over the past year while missing out on gains of 75% or more in stocks such as Netflix ( NFLX) and Caterpillar ( CAT).

With so much money about to be repaid to workers, investment advisors are right to note the stock-market returns that Americans could have enjoyed if their withholdings had been different. According to the Internal Revenue Service, more than 82 million tax returns were filed by March 25. Almost 70 million were due refunds, with the average refund checking in at $2,952. That means the IRS has already committed to paying out more than $206 billion, and the government still expects to receive another 59 million returns before the April 18 filing deadline. (The deadline is usually April 15.)

Those receiving tax refunds should think about opportunity costs, though. U.S. workers have an average annual salary of around $40,000, which means those due a refund are essentially loaning the government 7.4% of their income interest-free. By comparison, the S&P 500 rose more than 13% over the last year. While workers can't go back in time to change their withholdings, they can put that tax refund to work now.

"It's never a bad idea to put money into the market," says Greg Estes of Intrepid Capital Management, "but you need to be selective where you put it. Over the long term, if you want to protect your wealth, you need to be invested. The money market today isn't going to do you much good."

If someone is lucky enough to get a tax refund, that cash certainly could be used to pay down debt or credit cards instead of invested in stocks. And fund managers stress that a tax refund won't become an instant lottery ticket if invested in the market.

"Investors shouldn't think about the next three days, but where this money is going to be in the next three years," says Rich Werman, manager of the Neuberger Berman Select Equities Fund ( NBEAX). "It's about investing your tax return wisely."

The problem, though, is figuring out where to put their money now. The stock market has risen steadily and investors should ask whether there is more room to run or if they're buying in at the top. Thankfully, several mutual fund managers gave TheStreet their current investing strategy and have several stock picks that are worthy of tax refund dollars, which are detailed on the following pages.

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Kevin O'Brien, Prospector Opportunity Fund

The Prospector Opportunity Fund ( POPFX), which takes an extremely risk-averse, value-oriented strategy to investing, holds several large-cap companies, and it's no wonder why.

"A lot of the large caps -- almost confusingly so -- are trading at once-in-a-generation multiples," says O'Brien from his Guilford, Conn., office.

As of Dec. 31, the Prospector Opportunity Fund had lagged the Russell 2000 Total Return Index over the past year. However, the fund has easily outpaced the index over three years, returning 6% to the Russell 2000's total return of 2.2%. Since its inception in September 2007, the fund has an average annualized return of 5.6%, better than a return of 0.3% on the Russell 2000 Total Return Index.

The Prospector Opportunity Fund had 102 stocks as of Dec. 31 with an annual turnover of 45%. O'Brien says the fund's total net assets has climbed above $50 million from $37 million at the end of 2010 due to investor inflows. The fund has a heavy sector allocation to consumer staples, insurance, and information technology, each accounting for more than 10% of the portfolio.

For those potential investors with a tax return they're looking to invest, O'Brien offers some stocks for those looking to take a conservative approach.

First, O'Brien notes that while Newmont Mining ( NEM) has underperformed, it's the largest position in the Prospector Opportunity Fund as the company has several growth initiatives.

O'Brien also is happy to see Newmont has laid out a plan to allow investors in the company to participate in rising gold prices. Newmont's annual payout will increase at a rate of 20 cents per share for each $100 per ounce rise in the average realized gold price. At the current gold price, Newmont's annual dividend would be $1 per share.

In addition, O'Brien likes PepsiCo ( PEP), thanks to predictable growth over the next three to five years. Pepsi has a price-to-earnings ratio of 13, which has been compressed from the mid-20s in recent times.

"It's generating over $5 billion in free cash per year," O'Brien says. "They've been aggressively buying back shares and paying out dividends. It's a company you can count on returning capital in the form of buybacks and dividends. They also have nice exposure to international markets."

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Rich Werman, Neuberger Berman Select Equities Fund

Like other fund managers, Rich Werman and the management team of the Neuberger Berman Select Equities Fund ( NBEAX) favor large-cap value stocks.

As of March 31, institutional shares of the Neuberger Berman Select Equities Fund have beaten the benchmark S&P 500 Index in 2011 and over the past one- and three-year periods. The fund shielded investors during the market downturn in 2008, climbing 1.1% since its December 2007 inception to the S&P 500's decline of 0.7%.

The Neuberger Berman Select Equities Fund had 25 stocks as of Dec. 31 with an annual turnover of 126%. Werman says the fund's total net assets has climbed above $77 million from $68 million at the end of 2010. The fund has a heavy sector allocation to industrials, materials and energy, each accounting for more than 10% of the portfolio.

For those with tax returns in hand looking for ideas, Werman says his team owns and recently bought shares of Hewlett-Packard ( HPQ). Rather than the cost cutting that the company has done in the past under old management, Werman and his team expect the company to instead spend and reinvest back in the business.

"New management believes they'll be able to earn in excess of $7 per share in earnings," Werman says from his New York office. "They're generating in excess of $800 million per month in free cash flow, and we think they're doing the right thing by buying back stock. They're buying up companies that have higher growth and higher margins, and they're not paying exorbitant amounts."

Elsewhere, Werman says the portfolio has an investment in cell-tower operator American Tower ( AMT), which saw its share price decline on news of the potential AT&T ( T) merger with T-Mobile USA due to expectations there will be less of a need for more cell towers. Werman and his team, though, say the stock is attractive as the company transforms into a real estate investment trust, or REIT.

"If you follow the REIT index, this will be a top five REIT and all the REIT funds will go out and buy the stock. It's like when a company is added to the S&P 500," Werman says. "So you'll have the REIT status and they're still growing internationally. They just bought towers in India, Ghana and South Africa, where they can apply their expertise to grow that business there."

Lastly, Werman says he and his team have focused on Deere ( DE) because of its agriculture business, as well as Teck Resources ( TCK). Specifically, Werman notes that the company has a joint venture that will be an oilsands business, and it also is involved in metallurgical coal.

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Greg Estes, Intrepid All-Cap Fund

The Intrepid All-Cap Fund ( ICMCX) pursues value as it seeks long-term capital appreciation, but portfolio manager Greg Estes doesn't advocate being completely diversified and owning the market.

"For us, it's about selecting individual securities that through their cash flows or assets are worth more than what the market has priced them at," Estes says. "Where we're seeing more opportunity -- and we're looking across the entire capital range -- is in large caps. There is a discount in larger-cap stocks for value investors."

As of Dec. 31, the Intrepid All-Cap Fund outpaced the S&P 500 over the past one- and three-year time periods. Since its inception in October 2007, the fund has an average annualized return of 3.4%, better than a 4.2% decline on the S&P 500.

The $30 million Intrepid All-Cap Fund had 37 stocks as of Dec. 31 with an annual turnover of 86%. The fund has a heavy sector allocation to information technology, health care, financials and consumer discretionary, each accounting for more than 10% of the portfolio.

The fund takes a slightly contrarian stance, and one of the most contrarian names in the portfolio currently is Johnson & Johnson ( JNJ). Estes points out the company's recall problems, which range from its flagship Tylenol product to hip replacements.

"Certainly, J&J has made some missteps, but we think they'll get through their issues," Estes says. "If you take a longer-term view and you look at the cash flow the company produces, it's pretty attractive. It's a great company that typically gets priced along with the market. But there is a dislocation between what we think it is worth and what the market is pricing it at."

Similarly, Estes likes Dell ( DELL) as it is strictly a free cash flow story to him. Estes notes that the company has a net cash position and that founder Michael Dell has recently bought $250 million of the company's shares.

"That's a big move and it's a good signal, especially when someone who already had a big ownership position," Estes says. "People get overly fixated with the idea that they're no longer the top desktop manufacturer, but they don't make money off the desktops for personal computing. They make their money on their business relationships and now in storage and networking. It's all about improving the operating margin."

Estes also likes insurance companies, specifically Dow component Travelers Co. ( TRV).

"Travelers has a management team that is thorough and they explain what is on their books and what they're buying with their money," Estes says. "They did not experience the same issues that a lot of financial firms did when subprime was an issue. They're good at buying back shares and it's trading right at book value. For a financial, that's cheap."

Lastly, Estes is a fan of Gilead Sciences ( GILD) due to its leadership position in HIV drugs and good patent protection that extends out for an extended time period.

"In addition, the company has a decent pipeline," Estes says. "Gilead is cheaply priced, it has cash flows and a net cash position. Those are all very important things for a pharmaceutical business to have."

-- Written by Robert Holmes in Boston.

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Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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