New Orange County Growth Fund Bets on Strength of Local Companies

If you’re worried about a major earthquake hitting Southern California anytime soon, the Orange County Growth Fund may not be for you.

The novel mutual fund, introduced last week by Newport Securities in Costa Mesa, plans to invest at least 65% of its assets in the stocks of Orange County companies, so an earthquake could quickly collapse its value.

As remote as it might seem, that possibility is not overlooked in the fund’s offering prospectus, which lists “possible physical disasters in Orange County” as one risk factor.

Earthquakes aside, the fund is an idea that might appeal to investors who have witnessed the county’s rapid pace of development.

“We see the fund as an alternative to Orange County real estate,” said Newport Securities president and founder Jeffrey Kilpatrick, who designed the fund. “It’s the economic strength of the county that created the land value in the first place, so why not just buy into the companies directly? The gold isn’t all in the land, it’s also in the factories and research plants sitting on top if it.”

Pooled Investment Vehicle

A mutual fund is a pooled investment vehicle established to achieve certain investment goals, such as allowing individual investors to acquire relatively small interests in large, diversified, professionally managed portfolios of stocks or other securities.

There are about 1,800 mutual funds in the country, with total assets of $774 billion. According to the Investment Company Institute, the majority of those assets are in bond and money-market funds, with only $179 billion invested in equity, or stock funds.

The Orange County Growth Fund, which opened for business last week, will purchase shares in as many as 50 companies once it gets up and running. The idea, said Kilpatrick, is to pick out the best of about 250 publicly traded Orange County companies, creating a diversified portfolio that will reflect the overall strength and growth of the county.

The fund is authorized to invest up to 100% of its assets in Orange County companies but will probably include several Southern California firms beyond the county line for the sake of diversity. “We see Orange County as a hub, but we should also take advantage of opportunities around Southern California,” Kilpatrick said. About 50% of the county’s public companies are manufacturers, with a heavy emphasis on computers and computer parts, according to the offering prospectus. Financial service firms make up another 35% of Orange County’s publicly traded companies.

Special Qualities Sought

Kilpatrick said he hopes to identify small, lesser-known companies, with sales ranging from $10 million to $200 million, that have recently issued shares to the public. There are 45,000 private companies in the county, of which 10 to 20 should go public each year, he said. Of those, some will have special qualities--like skillful management, a promising product, or creative financing--that will make their stocks a good buy.

The fund’s basic investment strategy will be to buy and hold shares for a minimum of six months, although up to 5% of the portfolio may be invested in companies subject to takeovers and other special situations expected to provide quicker investment returns.

By focusing on a relatively narrow universe of companies within one geographic area, Kilpatrick said his firm will be able to conduct more detailed research than is normally available through mutual funds. Kilpatrick has already developed a successful niche with Newport Securities, which specializes in designing portfolios of Orange County stocks for individual managed accounts.

Newport’s sales have grown 30% to 50% a year since its inception in 1980, and its clients have realized an average return of 15% to 20% annually, Kilpatrick said. Whether the Orange County mutual fund can do as well is uncertain, but Kilpatrick said he is optimistic.

“The fund will be a true local institution in Orange County to provide a vehicle for local residents to invest in local businesses,” said Kilpatrick, who expects to raise $50 million for the fund within three years.

Few Precedents

Despite the potential appeal of a regional fund to area residents, the concept has few precedents, according to William E. Donoghue, publisher of the Donoghue Money Letter, a biweekly mutual fund newsletter published in Holliston, Mass.

“This is a theme fund,” Donoghue said. “It should sell very well on the basis of civic pride. But I’d rather be invested in a fund built on economic fundamentals rather than on geographic considerations.”

“The idea sounds reasonable, but what the performance will be, who knows?” said Perrin Long of Lipper Analytical Services in New York. “Even though Orange County itself is growing rapidly, that’s no guarantee that companies in the fund will also do well.”

Still, Kilpatrick is banking on the management expertise of Orange County’s business community, which he said has spawned one of the most active and sophisticated retail investment communities in the country.

“The people I’ve met in Orange County that have made millions in the stock market are the presidents and senior managers of public companies,” Kilpatrick said. But you don’t need to be rich to buy into Orange County. Kilpatrick will take as little $2,000 for a regular account or $1,000 for an IRA investment. You do have to be willing to pay a fee of up to 5% to invest in the fund. And, you have to be willing to invest in a new idea with no track record, a risk that troubles some.

The fund’s biggest selling point is the county’s continued growth. Kilpatrick can easily tick off the statistics: Orange County, if a nation, would have the 35th largest economy in the world, and its gross product of $50 billion in 1987 ranked it 10th among all U.S. metropolitan areas, outpacing Dallas, Atlanta and other large cities.

Believes in Growth

The county’s economy has grown nearly twice as fast as the national economy in the 1980s. “We believe that growth pattern of Orange County is destined to continue,” Kilpatrick said.

But all that may be irrelevant if the stock market decides not to cooperate and takes a turn for the worse, always a distinct possibility. Kilpatrick agreed that stock prices of Orange County companies are not divorced from the overall market, but he said he believes that whatever the market does in the next year or so, Orange County companies will grow and prosper.

Kilpatrick plans to use up to 5% of the fund’s assets to purchase put options or portfolio insurance, either of which would help protect the fund against a decline in market value. It may also sell call options, enabling the fund to generate income on otherwise flat stocks.

Kilpatrick also expects to invest part of the fund’s assets in convertible corporate bonds, hybrid securities that are considered somewhat more speculative than traditional bonds but less risky than stocks.

“Over the long run, say five to 10 years, the economy will grow and give birth to strong companies. One of the ingredients of long-term investment success is patience,” said Kilpatrick, who expects to see a “more rational” market over the next year that values companies on performance and not speculation.

For some investors, though, 10 years may be too long. Said Donoghue: “This may turn out to be a hot fund, but I’d like to see some indication of its performance” before investing.