With Europe on edge, this portfolio emphasizes the two best sectors in a volatile market—and also includes two innovative bond funds. By Steven Goldberg, Contributing Columnist June 22, 2010 Over long periods, stocks have always beaten bonds and money in the bank by wide margins. But Europe’s sovereign-debt crisis imperils the bull market in U.S. stocks. Europe could well suffer the dreaded double-dip recession, which in turn would hamper the U.S. economic recovery. I think the odds are still with the bulls, but Europe is a wild card.With that backdrop in mind, I offer my seven top mutual fund picks for the second half of 2010, as well as the percentage of your assets I recommend investing in each of them. If your time horizon is long and your taste for risk great, you may want to raise the percentage of your assets in the stock funds (and lower your allocation to bond funds). If your horizon is short or your tolerance for risk low, you may want to do the opposite. The portfolio puts a lot of money into two areas: large-company growth stocks and emerging-markets stocks. It also employs a market-timing fund, as well as two unusual bond funds. I’m loath just now to own many so-called value stocks or shares of small companies. Most of these stocks will be vulnerable if the U.S. economy falters. (For a different take on small-company stocks, read James Glassman’s Micro Stocks’ Big Payoff.) Large-company growth stocks are the sweet spot in the current market. They’re cheap relative to historical valuations, and the companies hold record amounts of cash on their balance sheets and can grow even as the world’s developed economies stagnate. Most do a lot of business in fast-growing emerging markets. Advertisement I’m talking about stocks such as Amgen (symbol AMGN), Google (GOOG) and Eli Lilly (LLY)—three of the largest holdings in Primecap Odyssey Growth (POGRX). Over the past five years through June 21, the fund returned an annualized 4.2%, while Standard & Poor’s 500-stock index returned 0.4%. You should put 20% of your money in Primecap. I’d invest 15% in Fidelity Contrafund (FCNTX). Will Danoff is one of the few managers who has thrived for decades in Fidelity’s cutthroat environment. Contrafund owns the same kinds of stocks that Primecap owns but is positioned slightly more conservatively. Over the past 15 years, Danoff has steered Contrafund to an annualized 9.4% return, compared with 6.8% for the S&P 500. If you want a more compact portfolio, put 35% of your money into either Primecap or Contrafund. Emerging markets are maturing rapidly. Yes, they face enormous problems in corporate governance and in their political systems. Surely, some of them will implode. But emerging nations are growing more quickly than developing countries, and their fiscal houses are largely in order. The developed world, by contrast, remains awash in debt. Over the past ten years, the MSCI Emerging Markets index has returned an annualized 11%. I think stocks in emerging markets will continue to outperform developed-markets stocks. So I’m recommending that you allocate 15% of your investments to emerging-markets stocks and another 5% to emerging-markets bonds (more about the bonds later). Investing in all the diversified funds in this portfolio, in the percentages I recommend, will get you an emerging-markets-stock allocation of 10%. Put an additional 5% of your money in Matthews Asia Dividend (MAPIX), which has returned an annualized 7.5% over the past three years with about the same volatility as the U.S. stock market. Advertisement A big part of this portfolio’s emerging-markets exposure comes from Harbor International (HAINX). Lead manager Hakan Castegren, 75, and his longtime co-managers have stashed 21% of fund assets in emerging markets. The fund returned an annualized 6.7% over the past ten years, roughly six percentage points per year better than the MSCI EAFE index. Castegren looks for large, growing companies selling at reasonable prices. Put 20% of your money into this superb fund. Another slug of the portfolio’s emerging-markets holdings comes via, of all things, a fund that practices market timing. At last word, Leuthold Asset Allocation (LAALX) had 25% of its assets in emerging markets. Lead manager Steven Leuthold, who has been researching markets for more than 40 years, is best known as an investment strategist. This fund employs number-driven techniques to invest between 30% and 70% of assets in stocks; the remainder goes into bonds and cash. Currently, Leuthold remains bullish, so the fund is about 60% in stocks. The Leuthold fund lost an annualized 2.5% over the past three years. But a similar fund, Leuthold Core Investment (LCORX), which is closed to new investors, returned an annualized 7.7% over the past ten years. In uncertain times, I think Leuthold Asset Allocation will prove its worth. Put 20% of your money here. Bill Gross is a renowned big-picture thinker and longtime star manager of Pimco Total Return (PTTDX). This fund, however, is limited in the size of the bets it can make, both by its prospectus and by its $228-billion girth. It’s the largest fund in the world. Advertisement Pimco Unconstrained Bond (PUBDX) faces no such limitations. It’s a relatively new fund that makes large wagers based on the thinking of Pimco’s top strategists. It can potentially profit even when bond yields are rising (bond prices move inversely with yields). Put 15% of your money here. Another bond fund seeks to profit from the economic growth and fiscal strength of emerging markets. DoubleLine Emerging Markets Income N (DLENX) makes sense for 5% of your money. This fledgling fund comes from a new firm started by the group of bond professionals who left TCW after the company forced out chief investment officer Jeffrey Gundlach. Lead manager Luz Padilla ran a similar fund successfully for several years at TCW. Steven T. Goldberg (bio) is an investment adviser.