Regional Funds Put Eggs in Fewer Baskets

People around the country now can invest in a mutual fund that is placing its bets almost exclusively on companies with a big stake in California.

The new Growth Fund of California soon will start buying shares in companies that are either headquartered in the nation’s most populous state or have substantial operations here.

It’s the latest wrinkle in regional stock funds, which invest mostly in companies of a single state or group of states.

“California as a region is economically equivalent to the sixth-largest country in the world, behind France and ahead of Britain,” said Dick Ollen, president of Monarch Investment Services Co. of Springfield, Mass., which will manage the fund. “We think there are outstanding opportunities here.”

Sounds good, but how will such a fund perform? This one is untested, so no one can predict. But the history of regional stock funds isn’t encouraging. As a group, they haven’t fared especially well.

Critics complain of self-imposed limitations, usually spelled out in the prospectus, that hamstring portfolio managers by reducing the number of stocks they can purchase. “They all impose some geographic restrictions that could impair performance,” said Sheldon Jacobs, publisher of the No-Load Fund Investor newsletter in Hastings-on-Hudson, N.Y. “This is another case of funds probably started for marketing reasons more than anything else.”

Proponents counter that the funds, when run well, have an inherent advantage in that the portfolio manager can really get to know the companies in his or her back yard. Certainly, this has been the case with Bing Carlin, who runs the IAI Regional Fund out of Minneapolis.

IAI Regional concentrates on Minnesota, Wisconsin and five less-populous states in the surrounding area. Carlin says he has about 300 stocks from which to choose and knows top managers at many of these corporations as neighbors.

For example, Carlin says he served in the Naval Reserves during the 1960s with Michael Sullivan, president and chief executive of International Dairy Queen, and played Pee-Wee football with Michael W. Wright, chairman of Super Valu Stores Inc. “And I grew up having snowball fights on Humboldt Avenue in southeast Minneapolis with Lloyd Johnson, now the head of Norwest Corp.,” Carlin added.

In this respect, an astute regional portfolio manager often can be the first to recognize promising stocks. “We try to find companies before Wall Street finds them,” says Carlin, whose fund has outperformed the Standard & Poor’s 500 index since its debut in 1980.

Mark Byl, senior portfolio manager of the Seattle-based Composite Northwest Select 50 Fund, agrees that regional portfolios have a research edge, even in an era when information flows faster than ever. “Telecommunication advances allow you to follow other U.S. companies, and even international firms, as easily as those in your back yard. However, we get insights others won’t get simply by picking up a phone and calling a company once a quarter.”

Byl doesn’t consider the geographical limitation to be a problem--even though his fund emphasizes stocks in Washington, Oregon, Alaska, Montana and Idaho, hardly a region with an excessive number of corporations. In Byl’s view, having a smaller “universe” of stocks forces a portfolio manager to diversify in other ways, particularly by industry and type of company.

Of course, even a well-diversified regional fund can falter if the local economy gets into serious trouble. Consider what happened to the Fund of the Southwest, part of the Houston-based Capstone Group. For the 15 years ended March 31, the portfolio showed a total return of 776%, according to Lipper Analytical Services. But over the last five years of that period, it rose just 58%. Fund of the Southwest concentrates on companies based or doing a large chunk of their business in Texas, Louisiana, Oklahoma, Arkansas, New Mexico and Arizona. When energy prices slumped in the mid-1980s, the fund did, too.

Another portfolio, USAA Mutual Sunbelt Era, last year changed its name to USAA Mutual Aggressive Growth and abandoned its geographic orientation after posting below-average returns for the previous six years. With roughly $140 million in assets, it had been one of the largest regional stock funds.

In recent months, three funds that focus on companies in the Washington, D.C., area have lagged the market. This list includes the Growth Fund of Washington, which is not open to California investors.

Costa Mesa is the headquarters of another struggling regional, the Orange County Growth Fund. Newport Securities Corp. launched this portfolio in March, 1988, in hopes of capitalizing on what has become one of the more economically diverse urban areas in the United States. “Orange County’s gross county product amounts to $55 billion, and it’s growing twice as fast as the national average,” says Jeffrey L. Kilpatrick, president of Newport Securities and portfolio manager of the fund.

Orange County Growth Fund invests at least 65% of its assets in companies headquartered in the county. Kilpatrick says he can choose from among 300 corporations in more than 80 industries, ranging from Fluor Corp. (engineering) to Community Psychiatric Centers (hospitals) to Carl Karcher Enterprises Inc. (fast-food).

Despite the geographic concentration of stocks, the fund’s holdings aren’t especially vulnerable to a slowdown in the local economy, Kilpatrick says. “Very few of the companies do more than 5% of their business in Orange County. It’s not like we’re buying a mom-and-pop doughnut shop that will only grow if Orange County grows.”

At any rate, Orange County Growth Fund has had trouble getting its message across. The portfolio counts just 175 or so shareholders and $1 million in assets--minuscule amounts for a mutual fund. In a bid to attract investors, Newport Securities has suspended the fund’s 5.75% up-front sales load and has abolished its annual 12b-1 fee.

Kilpatrick argues that Orange County Growth’s problems are shared by many smaller mutual funds, not just those with a geographic focus. But as a group, regional funds have had a hard time gaining the attention of investors. Combined, these portfolios account for well under 1% of all equity-fund assets, according to Lipper.

Apparently, investors prefer to spread their money around the country, rather than park it in anybody’s back yard.

HOW MUTUAL FUNDS PERFORMED

Average total return, including dividends, in percent for periods ended Thursday, April 26

TOP 10

Fund Type Notes 12 mos. Yr.-to-date Week ISI Growth Fund G +4.06% +0.71% +1.88% Sherman, Dean Fund CA NL +5.92 -15.33 +1.73 Dreyfus Strategic World Rev. WI LL -4.87 -5.54 +1.51 Equity Strategies S NL +25.72 +12.84 +1.25 CGM Capital Development G NL +10.85 +1.14 +1.20 Schield Port.: CA LL +5.65 +2.66 +1.10 Aggressive Growth Merger Fund CA NL +1.17 -0.49 +1.07 Strategic Gold/Minerals AU -5.05 +9.84 +0.98 Founders: Frontier Fund SG NL +9.53 -5.03 +0.98 AIM High Yield Securities FI -10.03 -4.89 +0.96

BOTTOM 10

Fund Type Notes 12 mos. Yr.-to-date Week Strategic Investments AU -3.59% -35.09% -9.30% U.S. Gold Shares AU NL +11.94 -21.47 -8.15 International Investors AU +12.71 -19.63 -7.36 Keystone Precious Metals AU NL,R -1.77 -19.26 -6.36 USAA Inv. Trust: Gold Fund AU NL -2.86 -17.28 -6.29 Van Eck: Gold/Resources Fund AU -3.18 -15.20 -5.83 Thom. McKinnon: Prec. Metals AU NL,R -3.60 -17.03 -5.79 Benham Equity: Gold Eq. Index AU NL +9.56 -14.95 -5.77 U.S. New Prospector Fund AU NL -2.67 -17.56 -5.74 Rushmore: Precious Metal Index AU NL * -16.60 -5.60

TYPE: AU=gold, B=balanced, CA=capital appreciation, CV=convertible securities, EI=equity income, EU=European regional, FI=fixed income, FS=financial securities, FX=flexible portfolio, G=growth, GI=growth and income, GL=global-international and U.S. stocks, GX=global flexible portfolio, H=health/biotechnology, I=income, IF=international, MI=mixed income, NR=natural resources, OI=option income, PC=Pacific regional, RE=real estate, S=specialty/misc., SG=small company, TK=science and technology, UT=utility, WI=world income.

NOTES: NL means no sales charge, LL means sales charge of 4 1/2% or less; L means sales charge of greater than 4 1/2%; R means redemption fee may apply.

Source: Lipper Analytical Services

A SAMPLER OF REGIONAL FUNDS

Fund Name: Composite Northwest Select 50 Phone: (800) 462-7228 Regional focus: Five Pacific Northwest states, including Alaska Minimum investment: $1,000 1-year return (3/89-3/90): +29.7% 5-year return (3/85-3/90): -- Sales fee: 4.5% (+0.25% 12b-1)

Fund Name: Fund of the Southwest Phone: (800) 262-6631 Regional focus: Texas and five other Southwestern States Minimum investment: $ 200 1-year return (3/89-3/90): +17.9% 5-year return (3/85-3/90): +57.8% Sales fee: 4.75%

Fund Name: Growth Fund of California Phone: (805) 525-9645 Regional focus: California Minimum investment: $1,000 1-year return (3/89-3/90): -- 5-year return (3/85-3/90): -- Sales fee: 5% (+0.25% 12b-1)

Fund Name: IAI Regional Phone: (612) 371-2884 Regional focus: Minnesota, Wisconsin, five neighboring states Minimum investment: $2,500 1-year return (3/89-3/90): +21.7% 5-year return (3/85-3/90): +154.7% Sales fee: None

Fund Name: Morgan Keegan Southern Capital Phone: (800) 366-7426 Regional focus: 14 Southern states from West Virginia to Texas Minimum investment: $1,000 1-year return (3/89-3/90): +6.0% 5-year return (3/85-3/90): -- Sales fee: 3% (+0.5% 12b-1)

Fund Name: Orange County Growth Phone: (714) 957-1217 Regional focus: Orange County Minimum investment: $2,000 1-year return (3/89-3/90): -4.5% 5-year return (3/85-3/90): -- Sales fee: None*

Fund Name: SFT New Jersey Pride Phone: (800) 523-2044 Regional focus: New Jersey Minimum investment: $500 1-year return (3/89-3/90): -0.1% 5-year return (3/85-3/90): -- Sales fee: 5% (+0.35% 12b-1)

Fund Name: Southeastern Growth Phone: (800) 999-4328 Regional focus: 12 Southern states, plus Washington, D.C. Minimum investment: $1,000 1-year return (3/89-3/90): +4.9% 5-year return (3/85-3/90): -- Sales fee: No (1% 12b-1)

Fund Name: Transamerica Sunbelt Growth Phone: (800) 999-3863 Regional focus: 18 Sun Belt states, including California Minimum investment: $100 1-year return (3/89-3/90): +12.3% 5-year return (3/85-3/90): +59.3% Sales fee: 4.75% (+0.25% 12b-1)

Fund Name: Washington Area Growth Phone: (800) 368-2748 Regional focus: Maryland, Virginia, Washington, D.C. Minimum investment: $2,000 1-year return (3/89-3/90): -0.6% 5-year return (3/85-3/90): -- Sales fee: 4.5%** (1.25% 12b-1)

* Temporary suspension of upfront fee

** Currently closed to new investors

Notes: Orange County Growth Fund is waiving its 5.75% sales fee until assets reach $5 million. Washington Area Growth Fund is closed to new accounts until July 5, 1990. Minimum investment amounts are often smaller for IRA and other tax-sheltered accounts. The 12b-1 fee is an annual expense charged to shareholders.

Source for total return numbers: Lipper Analytical Services.