Find Fiscal Cliff Safety in Pepsi, Varian Medical

NEW YORK ( TheStreet) -- The looming fiscal cliff should have investors seeking safety in high-quality stocks like Pepsi ( PEP) and Varian Medical Systems ( VAR), says Rob McIver, portfolio manager for the Jensen Quality Growth Fund ( JENSX).

The $4 billion fund, which garners four stars from fund rater Morningstar, has returned 13% in the past year, outpacing two-thirds of its rivals in the firm's large-cap growth category.

Welcome to TheStreet's Fund Manager Five Spot, where top fund managers give their best stock picks and views on the market in a five-question format.

What is your view of the economy?

McIver: We are optimistic on the long-term outlook for the U.S. economy, but more cautious in the short term. The U.S. unemployment rate has been too high for a robust recovery to take hold and the ongoing Eurozone economic problems remain a significant headwind and the recession in Europe has been a major theme of the third quarter's earning's season.

As the looming U.S. fiscal cliff is less than two months away, we favor high-quality growth companies that are able to deliver consistently high returns on equity. We are demanding investors and we'll only invest in a company if it has been able to post a return on equity of at least 15% each year for 10 years. Fewer than 200 US companies meet this hurdle but the average return on equity of our portfolio companies today is over 28%, so despite the challenging economic conditions, these are incredibly profitable businesses.

What is your top stock pick?

McIver: We are impressed with the long-term business performance delivered by Pepsi, a global market dominator in the snacks and beverage markets. Pepsi accounts for 40% of the worldwide market in salty snacks, making it 10 times larger than its next closest competitor. The company owns 19 brands that generate sales of more than $1 billion per year and the company's daily net income is more than $17 million.

Pepsi is heavily focused on growing overseas revenues that now account for nearly 50% of its total and the faster growing emerging markets account for about 31% of sales. We also believe that the management team is stockholder-friendly, returning over $25 billion to shareholders in the form of dividends and share buybacks over the five years ended December 2011, but the share price does not appear expensive to us.

What is your top "sleeper" or "under the radar" stock pick?

McIver: We have a few in the Jensen Quality Growth Fund and one of the more interesting is the healthcare company Varian Medical Systems, a fast growing company that manufactures x-ray technology applications. The company is a technological leader in its field, and it enjoys a leading 60% global market share of radiation therapy equipment.

The emerging markets are a small portion of its business but they represent a rapidly growing element of the company's sales that offsets pricing pressures in the more developed countries. Switching costs in this business are high and customer's need for service provides the company with an annuity-like stream of earnings. Over the past five years Varian's average annual growth in earnings per share has been 14% and last year the company's return on equity was an impressive 32%.

What stocks or sector would your sell or avoid right now?

McIver: We prize "all weather business models" with consistency and sustainability in earnings and cash flows so we avoid companies where the market, not the business, sets the price of the finished product. So we don't own any commodity-based companies nor are we invested in utilities that are generally too highly regulated to meet Jensen's basic investment requirement of a 15% return on equity.

What is your outlook for 2013?

McIver: Much will depend on how our government chooses to address the fiscal cliff's expiring tax cuts and sequestration provisions. Regardless of who is in power, we believe it is important that investors recognize the homegrown challenges that will face the U.S. economy next year, including the urgent need for the next administration and Congress to reduce federal spending and raise revenues.

Both of these issues have the potential to reintroduce uncertainty and volatility into the economy, which we believe highlights the attractiveness of high-quality growth companies with durable competitive advantages, regardless of the economic backdrop.

-- Written by Gregg Greenberg in New York.

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

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