You might think that an investment fund that sticks close to the state of Minnesota would produce a portfolio of hometown favorites, but not many stock standouts. You would be wrong.

To the uninitiated, Minnesota means the Twins baseball franchise, the singer Prince and too many Garrison Keillor jokes to count. But the state has much to recommend it. It is blessed with good schools, pristine wilderness lakes-and an entrepreneurial spirit responsible for creating some of the country's premier growth companies.

That provides ample opportunity for Mairs and Power Growth Fund managers William Frels and Mark Henneman to find promising issues for their locally grown portfolio. Although the $1.9 billion fund can venture afield in search of stocks, Frels believes that the quality of firms in the Midwest is nonpareil. "I don't mean to disparage places like Detroit or Cleveland, but they don't have the technology companies and the new company launches to the extent that the Midwest does," says Frels, who is the company's chairman and CEO. The fund also stays small, with just 45 holdings.

The strategy has yielded strong results for the St. Paul firm since George Mairs Jr. founded it 1931, when the Great Depression was casting its long shadow over the investment world. Today Mairs and Power Growth is up an annualized 2.4% over the last five years through Nov. 26, landing in the large-blend category's top 18%, according to Morningstar. Over the past 10 years, the fund is up 6.5% a year annualized, in the category's top 2%.



Of course it's not enough to be from Minnesota to make it as a holding in the growth fund. Frels is looking for companies with consistent growth-but he's not willing to pay too much for it. In the late 1990s, he and Mairs held hardly any technology names; they couldn't countenance the stocks' sky-high prices and minuscule or nonexistent earnings. The two chose to stay with slower-growing stocks, confident that those firms' growth trajectories were sustainable.

"We had to undergo a self-examination a number of times to see if what we were doing would hold us in good stead," Frels recounts. It did. By the early 2000s, Mairs and Power was outperforming competitors with weaker value disciplines.

The fund again showed its mettle during the most recent downturn, largely because Frels favors companies with strong management teams and the competitive advantage known as a "wide moat." These businesses can weather tough economic times and also make strategic acquisitions when the price is right.

One example is hometown favorite Target. Unlike Walmart, which strives for rock-bottom pricing, Target was seen as vulnerable as shoppers began to pinch their pennies in the recession. "But historically Target has had better returns and a somewhat better growth rate," Frels notes. "Over the years they've become e a superior merchandiser."

Now Target is back. Although it is trading near its 52-week high-up 20.1% in 2010 on top of its 42% gain in 2009-Target still sports a reasonable 12.8 forward price-to-earnings (P/E) ratio, in the middle of its historical average. And at $56, Target is about 20% below its five-year high.

Another stock for the rebound is Walt Disney, a new position from distant California. "We just felt that with an improving economy, there will be more discretionary spending," which would benefit an entertainment giant like Disney, Frels says.

He also likes that the House of Mickey has diverse revenue streams. Disney's trailing P/E of 18 is higher than the entertainment sector as a whole, but its premier properties are worth a lot, Frels insists. "Walt Disney is kind of a world unto itself, with its theme parks and movies and ESPN," he says. "There really isn't a lot of competition."

The stake in Disney is an unusual move for Mairs and Power, since portfolio changes are infrequent. The fund has just a 3% turnover.



About half of Mair and Power's assets are invested in industrial companies, which have aided performance significantly in recent years. Landscape maintenance equipment manufacturer Toro of Bloomington, Minn., for example, is up 40.7% in 2010 on top of a 28.6% advance in 2009.

"The company really took off 10 to 12 years ago, and management became more focused on profitability and the bottom line," Frels explains. "That dramatically increased the profitability of the enterprise."

As Toro's fortunes-and that of its investors-rose, Frels trimmed the fund's stake, but not to zero. "We typically don't sell out of company just because of valuation," he says. With an average holding period of 20 years, a stock must truly be troubled for the managers to abandon it. "We would only sell if we felt that the growth dynamics of a company had changed," Frels adds.

Not all industrial names have been as successful as Toro. Milwaukee-based Briggs & Stratton, maker of gasoline engines for lawn mowers, has struggled recently after its acquisition of a manufacturer of snow blowers. Briggs is down 3.7% this year, although analysts expect next year's earnings to increase by 13.7%.



One area that hasn't helped the fund is healthcare, as investors worry how new healthcare legislation will affect companies. But Frels likes the sector because of the aging population.

Case in point is Medtronic, the medical devices outfit. The stock has been in the portfolio "forever" Frels says. "It's the finest medical technology company, with leadership positions in pacemakers, defibrillators and other devices, all of which we feel have superior growth prospects."

But Medtronic, which is based in Fridley, Minn., has been hobbled recently. It's down 20.3% in 2010, badly trailing the S&P 500 and the medical devices industry. Medtronic reported a 35% profit decline for the second quarter, ended Oct. 29, the result of lackluster sales and a charge in connection with a lawsuit over recalled defibrillator wires. The company's multiple of nine times projected 2011 earnings is well below the market and the medical devices industry's valuation multiples.

Still, Frels believes that an improvement in the economy will mean healthier results for Medtronic. As the unemployment rate drops and more people are again insured through their employers, he says, they will be covered for Medtronic's pacemakers and bone grafts. Then the firm could be heading back to fast growth. "Investors will come back quickly once Medtronic can show that it's a double-digit grower."

Johnson & Johnson (another rare out-of-state holding located in New Brunswick, N.J.) has a similar story. "It's a very well-managed company that's had some bumps in the road recently in the manufacturing area," Frels says, referring to recalls of Children's Tylenol and other over-the-counter drugs, along with hip replacement devices and contact lenses. JNJ is working on improving its manufacturing facilities.

Nonetheless, Frels believes that JNJ's activity in Asia-where population and economic growth are faster than the United States or Europe-will provide the firm with increased demand in coming years. For the time being, JNJ trades at a higher valuation than Medtronic, although it too has taken its lumps in 2010. The stock is up just 0.70% this year, giving it a 12.3 forward P/E.

Globetrotters take note: Investing the Minnesota way pays off.


Ilana Polyak is a regular contributor to Financial Planning.


William Frels

Mairs and Power Growth Fund

Age: 71


BBA in finance, University of Wisconsin, Madison

Experience: Chairman, CEO and director, Mairs and Power (2000-present); portfolio manager, Mairs and Power Growth Fund and Mairs and Power Balanced Fund (1992-present); senior investment officer, American National Bank of St. Paul (1990-1992); portfolio manager, First Trust Co. of St. Paul (1972-1990); analyst and research director, First National Bank of Minneapolis (1962-1972)


Ticker: MPGFX


Inception of fund: November 1958


Style: Large-cap blend


Assets under management:

$1.9 billion


Three-year performance as of Nov. 26, 2010: 0.29%


Five-year performance as of Nov. 26, 2010: 2.39%


Expense ratio: 0.71%


Front load: None


Minimum investment:




3.75% vs. S&P 500