Lacy B. Herrmann has relied on a simple formula to carve out a niche in the mutual fund business: "Get in fast, get in early, and partner up with the strongest bank money manager in the area."

That's the tack his firm, Aquila Management Corp., took when it helped Bancorp Hawaii start its first municipal bond fund in 1985. The fund, which Aquila launched with $100,000, has grown to more than $670 million today, and is Hawaii's largest municipal fund.

Mr. Herrmann, Aquila's president, soon discovered that there were other banks in out-of-the-way regions that wanted support in launching their own home-state versions of the tax-free funds.

What started as a experiment in the middle of the Pacific Ocean has turned into a nationwide success story. Aquila now serves as fund administrator and distributor to $1.9 billion worth of state-specific municipal bond fund assets.

As banks have stormed into the mutual fund business in recent years, many have launched state muni funds in an effort to meet perceived demand for tax-sheltered investments.

Indeed, the number of single-state muni bond funds managed by banks has increased tenfold - to 310 - since 1990, according to Lipper Analytical Services, Summit, N.J.

Aquila's boutique business caters exclusively to regional banking companies, such as Banc One Corp., First Security Corp., and U.S. Bancorp. The company administers and distributes seven tax-free funds on behalf of its clients.

Aquila prides itself on taking a more aggressive role than other administrators, picking and choosing the banks it wants to work with and urging them to consider starting tax-free funds. The company also procures the seed money to start its funds, instead of depending on a bank to convert trust assets.

Because it lacks the marketing muscle of muni fund giants like John Nuveen & Co. and Franklin Resources, Aquila depends on the brand name recognition of its client banks to push the funds.

"Often times the largest bank in a region is also the biggest muni player in the state you're working in," said Mr. Herrmann, during an interview in his spartan offices on New York's otherwise posh Madison Avenue.

Mr. Herrmann, a large man with a ruddy complexion, has a reputation for frugality. His company spends little on advertising and insists that its fund managers pinch pennies in order to give investors more bang for their buck.

Much of Aquila's marketing budget goes toward the annual fund shareholder meetings, which pull in hundreds of people. They can take on a carnival-like atmosphere, with balloons and lemonade.

"Annual meetings usually just focus on the performance of the fund and voting, but Aquila has a very strong goal of trying to draw the shareholders into a feeling that they're investing in their backyard," said Timothy J. Leach, president of U.S. Bancorp's Qualivest Capital Management.

But while many in the industry regard Mr. Herrmann as a pioneer in promoting banks as viable managers of mutual funds, it's not clear that he can hold on to his niche.

A scarcity of quality bonds to invest in, coupled with weak investor interest, has prompted some fund companies to fold their single-state muni funds into national tax-free funds or multistate muni funds.

Mr. Herrmann said Aquila, which also administers six money market funds, has started diversifying. The company added the Aquila Rocky Mountain Equity Fund last year, and there are plans to start more stock funds. "We've got a good niche that we plan to expand upon," Mr. Herrmann said. "I don't think we're going to get knocked out of the sandbox just yet."

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