From the manual:
The HSI in this aircraft can be controlled by the NAV1 receiver source (VLOC), the NAV1 GPS signal (GPS), or the RNAV source. The RNAV source is selected with the switch located above the autopilot auxiliary mode annunciator panel.
The switch might not do what you expect it to. When set to RNAV, the HSI is controlled by the KNS-81 unit only.
The reason why you get the barber pole flag, when set to RNAV, is because no valid signal is received in the KNS-81.
You might be looking for the GPS/VLOC button, to the left of that switch.