Polyalanine expansions in transcription factors have been associated with eight distinct congenital human diseases. It is thought that in each case the polyalanine expansion causes misfolding of the protein that abrogates protein function. Misfolded proteins form aggregates when expressed in vitro; however, it is less clear whether aggregation is of relevance to these diseases in vivo. To investigate this issue, we used targeted mutagenesis of embryonic stem (ES) cells to generate mice with a polyalanine expansion mutation in Sox3 (Sox3-26ala) that is associated with X-linked Hypopituitarism (XH) in humans. By investigating both ES cells and chimeric mice, we show that endogenous polyalanine expanded SOX3 does not form protein aggregates in vivo but rather is present at dramatically reduced levels within the nucleus of mutant cells. Importantly, the residual mutant protein of chimeric embryos is able to rescue a block in gastrulation but is not sufficient for normal development of the hypothalamus, a region that is functionally compromised in Sox3 null embryos and individuals with XH. Together, these data provide the first definitive example of a disease-relevant PA mutant protein that is both nuclear and functional, thereby manifesting as a partial loss-of-function allele.