When James Schmidt founded the country's first mutual fund to invest primarily in banks and thrifts, detractors told him the sector was dying.

More than a decade later, not much has changed: critics still predict banks' demise, and Mr. Schmidt, 45, still delivers solid returns for John Hancock Advisers Inc.

Since 1985, his funds have grown from $29 million to $3 billion in assets. And since 1990, his core fund is the No. 2 rated equity fund, according to Lipper Analytical Services Inc.

"People have been predicting for 10 years that the bank rally is over," he said in a recent interview. "Banking is eroding, but the rate of erosion is slower than people give it credit for.

Although the industry is shrinking, Mr. Schmidt insists that "it is not the crisis that some bears seem to think."

Banks have faced an increasing army of new competitors over the last decade, shriveling revenues and forcing the sector to consolidate.

But the elimination of many banks through acquisitions has meant sizable merger premiums for investors like Mr. Schmidt, who fully expects consolidation to continue.

A senior vice president at John Hancock who manages four funds and a staff of three, Mr. Schmidt favors midsize and community banks that trade at a discount.

As a result, in a year when investors swarmed to large capitalization banks - which accounted for the bulk of the year's record merger activity - Mr. Schmidt's 1995 return of 47% trailed the Standard & Poor's index of major banks' 56% average.

Part of that lag may be linked to his hefty stake in thrifts, which account for roughly 25% of the funds' invested holdings. Even more than banks, concerns with thrifts' viability have hammered returns.

"With rare exception, thrifts are an anachronism because they are not providing a financial service that isn't provided more efficiently elsewhere," said Russell Meyer, president of Metier Capital Group, a Los Angeles-based adviser to institutional investors.

Thrifts trade at a discount and offer takeover value, Mr. Schmidt countered. And he is not alone in that sentiment.

"In the long run his is probably a good strategy," said Scott Edgar, a bank analyst with SIFE Trust Fund, which invests primarily in financial services stocks. "These companies are labeled as thrifts, but they are acting like banks."

Mr. Schmidt may be flying solo, however, in his deliberate avoidance of banks that are considered trend setters.

His stake in First Interstate Bancorp recently converted to Wells Fargo & Co. shares after the banks' merger. But Mr. Schmidt hinted he could soon sell the stake in the pace-setting company, which is his portfolio's largest at 3% of invested assets.

"Wells is not my kind of stock," he said. "I am biased toward plain- vanilla banking with a strong traditional franchise.

"I am willing to accept a me-too bank," he added. "I don't think you get paid that much for being first. I have done well with a lot of plodding banks."

He indicated he may also shed his PNC Bank Corp. stake - the fifth- largest holding in his portfolio - which he assumed after the bank acquired Midlantic Corp.

He gravitates toward banks that are likely to be ignored by Wall Street and trade at a discount - "a Jim Schmidt kind of bank" as Thomas Finucane, a vice president in the fund, describes it.

On takeovers, Mr. Schmidt is not a table pounder. However, mergers are important to the funds' returns. Indeed, 27 of the funds' banks were acquired last year alone, including the top three.

"Most banks that are around now over the balance of my career will disappear. But I am trying to encourage people not to think of us as takeover speculators," he said.

Mr. Schmidt is not a shareholder activist, but he has voted with dissidents - like Harry Brock, who failed in an attempt to force the sale of Compass Bancshares in early 1995.

He cannot initiate shareholder actions, however, because federal law prevents his funds' corporate parent, the insurance giant John Hancock, from being more than a passive investor in banks.

Mr. Schmidt has come a long way from when he managed $150 million of pension money at the Hartford Group in the early 1980s.

In Hartford, he felt the company's bureaucracy distanced him from the direct contact with company managements he champions at John Hancock.

He still delegates investment decisions to his associates. Mr. Finucane covers community banks, Patricia E. Ouimet focuses on midsize banks, and James M. Boyd oversees thrifts that have recently converted from mutual to stock ownership.

Mr. Schmidt manages the $2.3 billion asset Regional Bank Fund, which has A and B shares, and two closed-end funds, the $640 million-asset Bank and Thrift Opportunity Fund and the $60 million-asset Southeastern thrift fund. In the last month he has added a financial services fund.

His other passion is tennis, attested to by the painting behind his desk of the Longwood Cricket Club in suburban Chestnut Hill, where he plays when he is not on the court he shares with a neighbor.

Unlike golf - the traditional bankers' game - tennis is intense, athletic, and very competitive, he said. And with some luck, he'll score a few more aces in both his passions.

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