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(Reuters) – Andrew Adams takes the Wall Street adage “invest in what you know” literally.

Adams, the Minneapolis-based manager of the tiny $62 million Mairs & Power Small Cap fund, invests all but a quarter of his portfolio in companies that are headquartered or do the majority of their businesses in the Upper Midwest. He estimates that there are about 500 small-cap companies that fit the bill in the six-state region that includes Minnesota, Wisconsin, Iowa, Illinois and North and South Dakota, compared with 2,000 companies in the total small-cap universe in the U.S.

“We like to invest in stocks in our backyard, because we know the history better than anyone else,” he said. “To me, it feels like a pretty big pool to fish from.”

It’s a quirky strategy that has nevertheless worked for the fund’s investors. Thanks to gains like a 53 percent jump in Nebraska-based hunting retailer Cabela’s and a 54 percent increase in Minnesota-based business services company Deluxe Corp, Adams’ fund gained 26.8 percent over the last year, making it the best performing small-cap fund among the 1,525 tracked by Lipper. The average fund in the category returned 10.7 percent over the same time frame.

Region alone isn’t enough to get into Adams’ portfolio of 44 stocks, of course. He looks for companies with durable competitive advantages that also have high returns on their invested capital. His portfolio ranges from commercial banks like Wisconsin-based Bank Mutual Corp to chemical makers like Minnesota-based Hawkins Inc. Adams aims to hold on to a company for 5 to 10 years, and emphasizes meeting with company management to get a sense of where the business is headed.

That long-term mentality makes Adams loathe to sell a stock, but he will do so if a company’s shares look extremely overpriced. He sold out of his position in 3-D printing company Stratasys last year, which recently moved its headquarter to Israel from Minnesota after a $1.4 billion merger with competitor Objet. The combined company’s stock is up 92 percent over the last 12 months and trades at 80 times earnings.

“We’re really excited about 3-D printing, but the valuation couldn’t justify holding onto it even assuming above average long-term growth potential,” Adams said.

He used the money from the sale – the stock returned 200 percent for the fund while Adams held it – to buy Minnesota customer parts maker Proto Labs Inc shortly after its February initial public offering. The company makes limited-run plastic or metals parts using 3-D printers and benefits from the 3-D printing trend by servicing commercial orders, while Stratasys focuses more on consumers, Adams said. Its shares are up 57 percent since the IPO and trade at 44 times earnings.

The fund’s Midwestern focus fits the philosophy of privately held Mairs and Power, which was founded in Minneapolis in 1931 and has long had a tilt toward investing in companies in the region. The small-cap fund, launched in 2011, is just the third fund offering from the firm and its first new fund since 1961. Its other funds are the $366 million Mairs and Power Balanced Fund, which is up 15.1 percent over the last year, and the $2.8 billion Mairs and Power Growth fund, which gained 19 percent over the same time period.

Adams’ own background also plays a role: he graduated with both a bachelors and masters in finance from the University of Wisconsin. Prior to Mairs and Power, he co-managed a small-cap fund at US Bancorp Asset Management in Minnesota.

Not every company he buys is headquartered in the Midwest. He bought shares in investment management software company Advent Software, which is based in San Francisco, because he couldn’t find a Midwestern company in the category that offered the same potential. And he recently increased his position in supercomputer maker Cray Inc, which has its headquarters in Seattle but has divisions based in Minnesota and Wisconsin.

Adams believes Cray has the potential to compete with International Business Machines in the so-called “Big Data” business of analyzing large and complex data sets. Already, its customer base includes the Mayo Clinic and the U.S. government. He began buying shares of Cray in February of last year; the company is up nearly 140 percent since then.

Adams also recently increased his position in one of last year’s underperformers, Minneapolis-based biotech Techne Corp. The company, which has fallen 4 percent over the last year, produces antibodies used in gene research.

The company’s shares were downgraded to underperform by Credit Agricole Securities and research firm CLSA in January. CLSA cut its target price to $70 from $77, in part because of the company’s ongoing search for a CEO after former chief executive Thomas Oland retired in November. The company trades at approximately $68 per share and a price to earnings ratio of 22.8.

Adams pins much of the stock’s underperformance to concerns that looming government spending cuts will mean fewer government-financed research studies – and fewer customers for Techne. “This is going to pass, and the long-term thesis is intact,” he said.

Investors in the Mairs and Power Small-Cap fund will pay $1.25 per $100 invested, a fee level that Lipper considers average. The fund yields 0.14 percent.

(Reporting by David Randall; Editing by Jennifer Merritt and Phil Berlowitz)