In this podcast, Dan Kelley, portfolio manager, Fidelity Investments, discusses how investing in founder-led companies has historically translated in higher returns.
As a high school student, one of Dan Kelley's first jobs was working in a supermarket. At a young age he was interested in how businesses worked, how they were run. In high school he was inspired by legendary investor, Peter Lynch, after reading "One Up On Wall Street." Dan went on to work for two Wall Street firms, as an analyst, until the opportunity to work at Fidelity Investments came along, in 2007. This turned out to be the fulfillment of his long-time desire to work on the buy-side, for one of the great investment management firms.
Prior to joining Fidelity, Dan never imagined that he would one day be mentored by, and earn a place alongside investing greats Will Danoff and Joel Tillinghast, nor that he would be having regular conversations with Peter Lynch.
Dan Kelley manages Fidelity Founders Class Fund for Canadian investors. He also manages the Fidelity Trend Fund and the Fidelity Advisor Diversified Stock Fund for U.S. investors.
Podcast Transcript
AA: Today, it's our pleasure to talk with Dan Kelley. Dan Kelley is a portfolio manager at Fidelity Investments. He manages the Fidelity Founders Class Fund for Canadian investors. He also manages Fidelity Trend Fund, and Fidelity Advisor Diversified Stock Fund for US investors.
Dan, thanks so much for joining us today.
Dan Kelley: Thank you for having me, happy to be here.
AA: Dan, why don't we begin with your personal story we all have a story of how we ended up in the investment industry. Some of us just love numbers, Some of us got here by accident. So when, and how did you develop an interest in investments?
Dan Kelley: It's interesting I've always had a passion for businesses, ever since I think, I was 14 years old, and had my first job stocking shelves at a supermarket. I always wondered why certain products were priced the way they are, how things were marketed differently, what things were on the endcaps, at the supermarket, how the supermarket was run, and that started me pursuing and reading about investing, and I read a lot of the classic investment books.
And, in high school, unfortunately, I never really had any money, when I was in high school, I had a mock investing account, and took an investments class in high school and that really just kind of lit a fire underneath me, in terms of pursuing why stocks are behaving the way they are, relative to the fundamentals of a business.
It's kind of ironic now that Peter Lynch is someone I talk to, and he's one of my mentors. I talk to him regularly and here I was, a 16-year-old kid in high school, just starting to look at the investment world, and reading some of his books, like "One Up On Wall Street."
Now, I do a quarterly call with him, where he's kind of, checking to see where I'm excited about certain areas of the market, and it's a lot of fun. So it's been a pretty interesting journey,
AA: So Dan, tell us about your professional journey. How did you become a portfolio manager at one of the biggest investment firms in the world?
Dan Kelley: So it's probably an atypical path actually, relative to most analysts here at Fidelity. I started my career on the sell side. I was at Goldman Sachs and Morgan Stanley for about four years out of college, where I was based on the institutional brokerage side. I was a stock analyst for the the institutional brokers desk, and Fidelity was one of our largest clients, at both of those firms.
So I got to talk to a lot of people here at Fidelity, analysts and fund managers, in terms of where I was finding value within the the research platforms at Goldman Sachs and Morgan Stanley, and two of my former colleagues at Goldman Sachs had come over to Fidelity as analysts on the real estate team, so it was ironic, I had just taken a job offer at Morgan Stanley.
I always thought at some point in my career I would go to the buy-side, but it was an opportunity for more responsibility at Morgan Stanley and about a month or two into it one of my clients, here at Fidelity, said I need your resume.
"I know you've always wanted to be a an analyst on the buy-side. I need your resume." I'm like, "Man, I just accepted this offer, things are going pretty well."
But he knew what I wanted to do long-term. I knew what I want to do long-term.
I actually had to take a pay cut. A pretty big pay cut, to come here, because I wanted it that bad, and it's worked out. It couldn't have been a better decision. I started as a real estate analyst, and, talk about jumping right in feet first in the flames. I covered all different areas of real estate which have a lot of different operating area, like hotels, and office companies and residential companies; and then I became our housing analyst. I was the firm's housing analyst. I got that assignment in May of 2007, right as Lehman Brothers and Bear Stearns melted down, and obviously housing was at the epicenter of the credit crisis.
So what was fantastic about that experience, being the housing analyst from from 2007 through 2011, was, I actually had to become a fixed income analyst as well, where I had to basically look at every area of the capital structure.
A lot of these businesses like housing and real estate were very capital intensive. Access to the capital markets was closed, and so you had to look at their ability to fund their business for a long period of time. I think that that will forever be a learning experience that hopefully will help me over the rest of my investment career, because it was a fascinating time. The beauty of it was - we were able to make a lot of money as a firm, for our shareholders, when everyone was running to the exits.
In late 2008, we were finding a lot of value in housing and I think that afforded me the opportunity to do more exciting things within the organization, given we were able to do relatively well during that period of time.
AA: I can imagine your fundamental research background, and then subsequently the credit research background that you developed, must have been invaluable?
Dan Kelley: So important. One of the things I originally was thinking, maybe I'll do a stint in high-yield or something.
In that three or four year period, I basically was a high yield analyst, fixed income analyst, and equity analyst, and it was great because I also got to leverage the power of Fidelity's platform, where we have such reputable people, in our fixed income organization, in our high-yield department, and again you get mentored by these tremendous investors, and so it just really helps you, develop as an investor, and just get up the learning curve even faster, which is great.
AA: So Dan, you've been in the industry, looking at markets for roughly 20 years. What lessons have you learned?
Dan Kelley: Wow, unfortunately we'd be here for days if you want me to list them all. Let's see, a few of the powerful lessons...
I think that the crux of my approach to investing is, I think, the market often underestimates the rate, or the sustainability of a company's growth rate.
So I tend to actually be, kind of lumped into this Growth-at-a-Reasonable-Price (GARP) type of investor.
I think there's growth fund managers who tend to focus on getting the fastest growth for the cheapest price, or for a reasonable price, and there's value investors who care about how mispriced the asset is, and, they worry about when it will be normalized, over time.
I actually think that the market tends to often mis-price the growth trajectory of a company, and if you look at a lot of these fast growing companies there's often a big fade in the growth rate, priced into the market, in terms of consensus expectations. I think the market the consensus gets kind of lazy – they can say, for example, okay this company's growing fast, and it's probably not going to be able sustain that rate, and, you know, we'll have it growing 40%, we'll have it grow 20% next year, and normalized to 10%, and so it becomes a mature company, and then it's much lower.
That's where fundamental research, is so important, and leveraging the breadth and depth of a firm like Fidelity and, and, just doing the work during the credit crisis, was a great example.
There are a lot of times where the market just hasn't done the work, and that's what's so exciting. That you can find mis-pricings in any kind of market environment.
I've actually been kind of excited by the recent volatility because the dispersion of returns has been increasing, which is great for stock picking, and I'm finding some tremendous or some exciting opportunities.
So, in terms of lessons learned, I actually keep a list. So I could get very granular for you. I'm opening a word document, if you really want to go into it, but that's because I'm always trying to get better, and unfortunately, I'm making, I think every investor makes mistakes every day, and you're just, you're you're playing, for hopefully, a solid batting average.
But at the end of the day, I think the one lesson learned, I'll really reiterate to you, right now, is, don't invest with sleazy management teams.
Because if you don't trust the people you're investing alongside of, to have the interests of your shareholders, and delivering on the fundamental performance of the company, and, if they're more focused on themselves, or if they're not ethical, or, or they're cutting corners, it's a recipe for disaster, and losing a lot of money, which I never enjoy doing.
Dan Kelley: Just make sure you're investing with people that are that are above board.
So I think underwriting the people you're investing with, is why I'm actually so excited about The Founders Class, because you really are focused on the people that are leading the organization, that founded the company, that have the long term vision. Can they execute on, the vision. Are they the type of people you want to invest alongside of?
AA: I have to say, it's the first time that I think I've ever heard a fund manager, portfolio manager, put it quite that way, and I have to say, I have a great deal of respect for that idea. I think it's an underestimated subject, in terms of valuing companies, and looking businesses from the bottom up.
AA: Will Danoff and Mark Schmehl are growth investors. Joel Tillinghast and Dan DuPont are value investors. How would you describe your investment style?
Dan Kelley: It's funny. In a nutshell I would say I'm in between, with a slight tilt towards Will and Mark, so no, I'm on the growth-ier side, so I'm definitely closer to Will and Mark.
Unlike most growth fund managers, I may have mentioned this earlier, I am less focused on the absolute rate of growth.
I'm more focused on the price-per-pound and and how mispriced is the security over a multi-year view of a company's growth rate. So I tend to, my guess is, my funds would screen a little bit cheaper than Will and Mark's, and not as growthy, but they're still much growth-ier than Joel and Dan's.
Sometimes the best investment opportunities are when the market thinks that a company is going to have negative growth for a couple years, and you think it's going to be flat to positive, with a chance of being really positive. I mean those stocks are usually multi baggers, and so I think Will and Mark might wait to catch the inflection, and maybe, in particular, Will would wait till the earnings revisions are really taking hold.
I might be a little earlier because the long-term risk/reward is so powerful.
I think of housing as a great example, during the credit crisis, where the earnings revisions weren't really starting to hit yet, but they weren't there – the negative earnings revisions were stopping. The companies had written down all their land books, so they were generating reasonable returns, and they had liquidated a lot of their inventory, so their balance sheets were in better shape, so they could survive, and so then it was just a recipe because all the kindling was there, and you see the match to be lit on demand, and that happened as the economy recovered in the ensuing years.
I think you can find terrific investment opportunities that aren't necessarily fast-growing. I do have a bias towards companies where I think the market is under appreciating the sustainability of growth.
I think this fund is a great example of that where I think these companies can compound. They're usually disrupting some area of the marketplace, and there's some innovative new idea, e.g. a better way to provide a product to customers or service to customers and so they can often garner a lot of market share and mind share, with with consumers that can usually lead to higher growth for longer, and so if you have a three-year plus time horizon, you look at some of these stocks and they're ridiculously cheap, relative to the potential.
So that's kind of the heart of what I do.
AA: There are always aspects that are below the surface, that aren't necessarily visible, [or obvious] but if you know where to look...
Dan Kelley: ...Just to reiterate that point, I think Peter Lynch, he's kind of viewed as a famous growth investor but but he always viewed you know investing like a poker game, and the question is, "Is the next card getting better or worse?", and I think to put up the returns he did over such a long period of time it wasn't all growth companies, it was occasionally seeing a cycle that was getting better and tightening, whtehr it be energy or whether it be you know something else were all of sudden, things were getting better, and the stocks were on sale.
AA: Absolutely. Let's now talk about your new fund, Fidelity Founders Class. Can you describe the fund in simple terms?
Dan Kelley: Sure. In a nutshell, we back-tested, years and years of data, and the conclusion is that founder-led companies, or our definition of founded-led companies, founder-led companies have significantly outperformed non-founder-led companies, going back over the last few decades.
If you can pick stocks, and add traditional fundamental analysis, and leverage our breadth and depth of research here at Fidelity, you can add even more value from picking stocks within this sandbox which is fruitful for our performance.
Our data shows that the founder-led companies have generated about 200 basis points of out-performance versus the Russell 3000, in our analysis.
Other analysis using the S&P 500 found about a similar amount of out-performance
AA: Where did the idea for Founders Class Fund come from?
Dan Kelley: It's actually a great story. You mentioned earlier, Will Danoff and Joel Tillinghast. They're two of my mentors. I've worked with both of them for many years.
A few years ago we were all talking about some of the common traits of out-performers over time that they've invested with in their multiple decades of investing, and both of them highlighted that founder-led companies tended to be highly correlated with long-term out-performance, and so it led to a discussion where we decided to delve into the issue further to see if there's any empirical data that supports that.
So, I worked very closely with our quantitative research team here at Fidelity. I actually have a quant analyst that works very closely with me on this fund, and we did lots of backtests, we took out the survivorship bias, we turned over the data every which way from Sunday, and we found the same thing.
We found this to be a fruitful area to invest in, and so then, fortunately being at a place like Fidelity, I think one thing that I'm looking for and Founder-led companies is kind of this founders mindset that differentiates the companies – they're bold, they're willing to take risk, they see calculated risks, they see a long-term vision that could disrupt an area of the market or could solve a problem for people.
I think it's kind of ironic that this idea was so embraced here because I think we embody, Fidelity Investments embodies this mindset that I'm looking for.
We're still a family led company, the granddaughter of our original founder is the CEO, and we have thrived for many decades by having this bold vision, thinking longer-term, staying laser-focused on providing the best products, and methods for people to save for retirement. For that very reason Fidelity invested a few million dollars of our own money, to really launch this product a few years ago and see if the empirical data of us running this product could deliver superior returns, and so far the performance has been quite strong.
AA: Is the Founders Class a tech fund?
Dan Kelley: It's a good question, so Pierre these companies just by the definition of the founder typically being involved, unless it's an heir that keeps the key tenets of what I'm looking for in a founder, which I can discuss if you're interested.
It tends to lead to newer-economy companies.
And, what do I mean by that?
Obviously, with older economy companies, you think back to the Industrial Revolution, and you think back to financial regulation, and where a lot of financial companies came about, and unfortunately a lot of those founders have long since passed, and an unfortunately a lot of those companies. If they're still around, perhaps the culture is different, maybe the long-term vision is more based on their scale, and what their priorities are.
And so, it tends to lead to newer-economy areas of the market, which I would call technology and healthcare as being two very large sectors in that new economy part of the market.
Right now the fund is about 40% technology so I would in a simple answer, I would say, no it's not a tech fund.
Now, 40% is large, but I actually think most of the innovation I'm seeing right now, a lot of the innovation, or the most powerful innovation, is really related to the fact we have a supercomputer in our pocket right now.
And it's really changing and permeating people's lives. It's changing the way they do a lot of different things.
So basically, I'm following the innovation. I'm going where the the greatest mispricings are, and I don't think this will be a tech fund. I'm seeing a lot of innovation outside of technology.
I'm seeing really interesting things, like, I'll give you a crazy example: I own a water utility. I can't talk specific stocks, I don't think, but that [company] is doing a lot of water purification, and delivering water to areas of the world where water is scarce, and earning strong returns, as a result. So you find innovation everywhere.
I do think we're in this multi-decade period where, since people have a supercomputer in the pocket, I would think that this this fund will tend to be heavy [on] tech for quite a while.
AA: Tech has been making a lot of headlines these days and we're seeing some volatility is this a challenge or an opportunity for you as an active manager?
Dan Kelley: I think hands down an opportunity. Volatility is my friend. I'm trying to embrace volatility for the better good of my shareholders, and again dispersion of returns is a good thing, because the market sometimes has a broad-brush during periods of volatility, that is really not paying attention to any of the underlying fundamentals of a company in many cases.
It's kind of derating everything.
Facebook as an example, regulatory risk, and people concerned about privacy, and obviously, that's going to be pervasive in terms of other companies like Facebook. But, the beauty of that is not every model is like each other, and so you can find other models within technology that have been discounted for maybe the wrong reasons, and that's a great opportunity again for longer-term shareholders that are looking to embrace powerful disruptive trends in the marketplace, like this fund is really geared towards.
We want that because, ultimately, that's going to be enhancing to our long term return profile.
AA: Dan, what are some of the sectors and regions that you're finding attractive in today's environment? Tell us about some of the tailwinds that you like.
Dan Kelley: Okay, so generally, as I mentioned, I'm very excited about certain areas of Technology.
I think, for example, cloud computing. That's going to be a powerful secular trend for a while because it lowers compute costs for of a lot of businesses.
It leverages the scale of some of these cloud infrastructure providers, and it also enables tremendous data analysis, and being able to leverage all these tremendous reams of data that all these digital devices create on a day to day basis, and all these transactions.
So I think that's a powerful tailwind but I want to really emphasize to you that I'm finding innovation across every area of the economy. I'm finding tremendous innovation in healthcare. We're seeing new innovative platforms to treat a lot of different diseases. Cell therapy is a very interesting area of the marketplace where some of the companies are leveraging off the shelf T-cells, where you can manufacture them, to then put them back into the body to treat people that have autoimmune diseases, and even treat various cancers. So that's exciting. I mentioned the education space is an area where I think is ripe for disruption, and I am looking, and I own some exposure there.
I think, in general, the smartphone is a tremendous tailwind, but I think you're seeing just a lot of new innovation across other areas of the economy, including financials. I'm seeing some interesting things, and even in some of the, what would be considered old economy sectors, like industrials. There's some relatively newer companies that I think are doing some very exciting and creative things in that marketplace.
So that would be kind of just emphasizing that there's a lot of, although its tech heavy, there's a lot of great founder-led companies in all sectors.
I mentioned tailwinds – I mean in terms of tailwinds, I think technology as a powerful tailwind. I think it's it's lowering costs the many people. It's giving access to consumers that they've never really had before to all sorts of products and services. So there's an emerging economy associated with that.
I think diversity, I guess geographically is a tailwind, so I know everyone thinks of technology in the U.S. I think I'm finding a lot of interesting founder-led companies outside of the U.S.
There are about 700 founder-led companies in the US. There's about 1,800 outside the US that meet my founder-led, or our founder-led definition. There's lots of innovation outside the US, so what's great about that is if you find founder-led companies that have some sort of special sauce, in terms of a product or service or a way of doing business, they're exposed to also economic tailwinds, like rising middle class, like in China or India, it can be kind of a dual win-win, or powerful trend, where not only is this a new product or a new way of doing business, but it's also the consumers ability to consume that, or the end customers ability to consume that is going up as well, so yes, that would be another thing I would highlight.
AA: Dan, it's really exciting to contemplate the idea that technology itself is fostering even more innovation, and thank you so much for this this conversation, it's been really great to talk to you, and thank you so much for joining us today.
Dan Kelley: Great well Pierre thank you for having me and I really look forward to keeping a dialogue going forward. This is a product I'm really excited about because I think it exposes shareholders to a lot of really exciting, both technological trends, and just innovation like I mentioned so again thank you for having me.
