Convinced that many financial stocks are undervalued, a Washington-based investment banking and advisory firm is launching a hedge fund to invest in small banks and thrifts.

Hovde Financial Inc., which primarily works with banks and thrifts having less than $10 billion of assets, said it expects to finish raising $40 million for the fund today. The fund, to be called Financial Institutions Partners LP III, also is to invest in electronic finance companies that have yet to go public.

Steve Hovde, executive vice president at the investment bank, said he is betting that investors will return to bank and thrift stocks once merger and acquisition activity heats up, or after high-flying technology stocks come back to earth.

"We want to take advantage of the beat-up bank stock market," said Mr. Hovde. "There are plenty of well-run banks trading at very low price-to-earning multiples."

One small-cap bank investor said the new Hovde fund should help to redirect money into bank stocks and bring them some liquidity.

"I'm elated to hear that new money is coming into the sector," said David Harvey, founder of Everest Managers LLC, a Gardnerville, Nev., fund that invests in micro-cap banks. "This is good for all of us."

Hovde operates four other funds that invest in community banks. Financial Institutions I, for instance, was begun in 1994 to invest in dozens of fledging California banks that had been bruised by the recession.

The strategy has paid off handsomely. One of its investments, Escondido, Calif.-based North County Bancorp agreed in September to be bought by Wells Fargo & Co. for $112 million, or 3.4 times book value. The fund owns 11.4% of North County's shares outstanding.

The Financial Institutions I fund has posted a net return of 83.30% since 1996, and a companion fund, Financial Institutions II, had a net return of 51.50% in 1999, according to data compiled by SNL Securities in Charlottesville, Va.

Hovde's other two funds are Western Acquisition Partners LP, which owns a 45% stake in Sunwest Bank, a $180.4 million-asset bank in Tustin, Calif., and Hancock Park Acquisition LP, which has investments in a dozen banks and thrifts. In all, the firm has invested about $250 million in community banks since 1994.

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