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The Wherefores of Regional Investing

September 29, 1996|RUSS WILES | Russ Wiles, a financial writer for the Arizona Republic, specializes in mutual funds

Conrad Herrmann might succeed in doing with regional mutual funds what nobody has done before: Put them, so to speak, on the map.

Herrmann is senior manager of the Franklin California Growth Fund, one of a dozen or so funds that invest in a single state or region of the country.

Under him and co-manager Nicholas Moore, Franklin California Growth has performed impressively well, placing in the top quartile of growth-stock funds in each of the last three years, according to researcher Morningstar Inc. of Chicago.

"No other fund in the growth objective can currently claim this one's nearly perfect combination of risk and reward over the past three years," wrote Morningstar analyst Kevin Kresnicka in a recent report.

If any genre of mutual funds needed a standard-bearer, it's the regional one. The idea behind these investments is a sound one: Stake out an area of the United States or a particular state, get to know the stocks within its boundaries really well, then make lots of money.

But it's never caught on in a big way. Of the 3,500 or so stock funds now available, little more than a dozen take a narrow geographic slant. These portfolios barely top $1 billion in combined assets, a mere drop in the mutual fund bucket. Even Franklin California Growth counts just $120 million, although that's triple its level at the start of 1996.

Although a regional format would seem to be a great way for a fund company to distinguish itself from the crowd, it's also a way to limit shareholder returns and the audience of potential investors.

Many fund groups simply don't want to restrict themselves from buying the best stocks they can find anywhere in the country--or the world, for that matter. Besides, there's the danger of getting pulled down in a regional recession.

"There's not enough diversification for our tastes," says Brian Mattes, a spokesman for the Vanguard Group. The Valley Forge, Pa., firm offers 92 mutual funds but not a single regional-stock product.

Fund companies probably also figure it would be a tough sell to get investors in, say, California excited about a fund that buys Tennessee stocks. It's no coincidence that most regional products are sold through the brokers with a load attached. Fund groups rely on sales people to get the word out.

The two largest regional funds are IAI Regional ([800] 945-3863, no load), a Minneapolis-based fund that targets Upper Midwest companies from Illinois to Montana, and Composite Northwest ([800] 543-8072, 4.5% load), a Seattle fund that focuses on firms in the Pacific corridor from Oregon to Alaska.

Franklin California Growth may help change the perception of regional funds as investment afterthoughts. The product, launched in 1991 as an index fund, has never had a down year. Since switching to an actively managed format in July 1993, it has consistently beaten the Standard & Poor's 500 benchmark.

There's no certainty that that will continue, of course. But with California's economy finally on the mend, the fund presumably will have the wind at its back--although Herrmann is quick to point out that with so many multinational firms based in the state, the fund was never really anchored to the regional economy.

"With 1,300 companies headquartered in California, there's no paucity of investment opportunities," he says.

Current leading holdings include Computer Sciences Corp., PacifiCare Health Systems, Bay Apartment Communities, Amgen and Granite Construction. The fund has traditionally maintained a hefty weighting in technology stocks, which helps to explain its good performance over the last few years. Tech stocks currently account for about 30% of the portfolio.

If California were a country, it's economy would rank as the world's seventh-largest, ahead of even China's, Herrmann says. In terms of corporate capitalization, California companies could form the globe's fourth-largest stock market, behind those of the United States, Japan and Britain.

Mutual funds targeting smaller states or regions might not enjoy wide diversification, but they could benefit from a research advantage in being close to their selections. In fact, Herrmann believes many managers of widely diversified funds actually do favor stocks in their own backyards, even if they don't admit to it.

As with most other regional portfolios, Franklin California Growth ([800] 342-5236, 4.5% load) does levy a front-end sales charge. But there's currently a short-term window available for people wanting to invest on a no-load basis. As a result of Franklin's pending merger with the Mutual Series fund family of Short Hills, N.J., shareholders in the latter group can switch money commission-free into any Franklin fund after a six-month wait. This only applies to current Mutual Series investors or shareholders who buy shares before the deal closes, which is scheduled for about Oct. 31. After that date, the Mutual Series funds will also be sold on a commissioned basis.

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