Morningstar Advisor - December/January 2010 - 49

have more than $418,000. That 14.7% annualized return is more than twice the Russell 2000 Growth Index’s during the same stretch. Similarly, $10,000 plunked into Kalmar’s open-end mutual fund of the same name when it opened on April 11, 1997, would now be worth $22,322—a 6.6% annualized gain versus a 3.5% yearly gain from the Russell 2000 Growth. Not Speculators The Kalmar Nyckel analogy only goes so far, however. Investing in the New Sweden Company, which underwrote the Kalmar Nyckel’s first voyage, was a wildly speculative affair. The success of a midwinter sea journey and a settlement in the North American wilderness was far from certain. Draper and his colleagues aren’t speculators. They fancy themselves fractional, long-term owners of businesses. So, they prefer to rely on original fundamental research to find and buy shares of small-growth companies with durable competitive advantages in large and growing markets. Such firms, if well managed, have the earnings, cash flow, and reinvestment opportunities to fuel growth for a long time. If bought at the right price, they can also produce good long-term returns with low risk. Though Draper and his team coined the phrase “growth-with-value” to encapsulate the approach, they are not value or even growth-ata-reasonable-price investors. Indeed, some of the firm’s portfolio holdings, such as business software firm Cybersource CYBS, can look rather pricey by traditional measures such as price/earnings. Rather, the Kalmar crew thinks that its original, bottom-up research can uncover companies with growth prospects or positive developments that the market has overlooked. Such stocks may not be traditional value stocks, but they can still be inefficiently valued, Draper argues. It’s a strategy Draper developed out of practicality early in his career while working for Baker Fentress & Co., a closed-end fund that traced its corporate history to 1891. When he started at Baker Fentress in the 1970s, capital gains tax rates were high—nearly 40%. The fund needed rejuvenation, Draper says. It owned a lot of large, former growth companies that were beginning to gather moss. To justify selling one of these behemoths and taking a tax hit, Draper and his colleagues had to find replacements that were capable of making up for the tax haircut by generating more sales and earnings growth than the market expected over a long term. “It didn’t make sense at the time to sell IBM and buy Eastman Kodak” Draper says. Draper moved down the market-cap ladder and plowed sale proceeds into smaller companies that could be bought at prices that didn’t reflect their profitability and future prospects and that the fund could hold as they grew faster than the economy. Draper found this to be a tax-efficient, rewarding way to invest. “We had a real money mind-set as opposed to a relative performance mind-set,” he says. Beyond tax management, small companies attracted Draper. A dapper and self-effacing man with manners and speech reminiscent of Jimmy Stewart, Draper sits up on the edge of his seat and gets more animated when he talks about small-cap investing. Small caps aren’t as widely followed as other stocks. Early on in his career, it was possible to develop a significant research edge on Wall Street just by paying attention to the firms and managers who were often starved for attention. Even in more recent years, after regulators began requiring all public companies to disclose financial information and company news to all investors at once, Draper contends that attentive sleuthing can still uncover overlooked small-cap growth companies. More importantly, though, is the thrill of the hunt. Just as he admired the colonists who endured an unforgiving ocean to start new lives in the Delaware Valley, Draper harbors a deep respect and fascination for capitalism’s pioneers. He loves meeting and talking with entrepreneurs who’re developing new shops, products, services, technologies, and business models. It offers the chance to meet inspiring and occasionally outrageous characters. It also affords the prospect of learning about potentially disruptive innovations in their early stages. With a combination of persistence, diligence, skill, and luck, Draper finds rewarding long-term investments in this fertile ground. Word of Mouth After refining the growth-with-value approach for about a dozen years, Draper struck out on his own with one partner and an associate who have since retired. If you’re a successful money manager in the Wilmington area, chances are you’ve managed money for a DuPont or someone connected to the family and its eponymous chemical company, founded on the banks of the nearby Brandywine River in 1802. Draper, whose father worked for DuPont, tapped that network for clients. Some of the wealthy families, individuals, and trusts that hired Draper employed consultants who then recommended him to other clients as his track record lengthened. The firm did very little marketing. “Effectively, Kalmar Investments was a firm that grew through word-of-mouth referrals and then through professional referrals,” Draper says. It was a slow process for a firm with no marquee name and no real desire to cultivate one. It took roughly a decade to move from primarily high-net-worth clients to the institutional market. That, however, has allowed the firm’s partners to scale up without compromising their values. They’ve hired gradually and selectively. The company now has about 25 employees, including 10 analyst/ managers and three traders. “We believe we’ve created something very natural, which is a focus on substance,” says partner Dana Walker, a manager and analyst who has been with the firm for 23 years. MorningstarAdvisor.com 49

http://www.MorningstarAdvisor.com

Morningstar Advisor - December/January 2010

Table of Contents for the Digital Edition of Morningstar Advisor - December/January 2010