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Ford Draper Jr., Kalmar Investments

Inspired by a vessel that brought Swedes to the New World, Draper has built a firm that emphasizes results over renown.

Dan Culloton, 12/14/2009

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Ford Draper Jr. doesn't own a yacht, was never in the Navy, and owns farmland. He has spent enough time on the water, however, to know a useful nautical allusion when he hears one.

Nearly 30 years ago, when Draper's wife suggested that he name his new investment boutique after a 400-year-old ship that few people outside of Delaware and Sweden knew ever existed, he got it right away. The Kalmar Nyckel wasn't the most famous vessel that ferried settlers to the New World during the 17th century, but the ship, named for its Swedish home port and the fortress that guarded it, was among the most successful. In 1638, the armed merchant ship carried inhabitants to the colony of New Sweden, the first permanent European settlement in Delaware Valley. The Kalmar Nyckel made four round-trip voyages between the old world and new, more than any other craft before the American Revolution, including the more heralded Mayflower. It also outlived more than one captain.

The Kalmar Nyckel embodied a lot of the values Draper wanted to undergird his firm: an emphasis on results over renown, crew over captain, and repeatable rather than unreliable returns. "The name resonated from an organizational standpoint," Draper says. "There was a good story behind it."  The story has been good at Kalmar Investments, too. The firm, founded in 1982, has delivered strong returns for investors over time. Anyone who put $10,000 in Kalmar's Growth-with-Value-Small-Cap separate account when it opened on June 30, 1982, would now 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-at-a-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.PAGEBREAK

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.

Colonial Culture
Kalmar's culture is relaxed and natural. Upon entering the former Quaker barley miller's home where the firm resides, the first voice a visitor hears floating down from the second story is the founder's. Draper's office is at the top of the narrow staircase, so anyone who drops in is as apt to be greeted by him as by a receptionist. The analysts and managers work in framed glass offices that try to preserve the character of their abode.

Employees tend to stick around at Kalmar. Draper says no one has ever left the firm for a competitor, though some have departed for personal reasons. Lifestyle has something to do with it. Wilmington, with a population of about 73,000, is a compromise community for those who want to live surrounded by the pastoral landscapes of an Andrew Wyeth painting yet still have access to the amenities and opportunities of commercial hubs like New York, Philadelphia, and Baltimore. Those cities are tolerable drives or train rides from Kalmar's door. So are lakes, rivers, ocean-front beaches, and narrow lanes lined by low stone walls that curve through the undulating estates and horse farms around Wyeth's (and Draper's) hometown of Chadds Ford, Pa.

Ownership-eight of the 13 investment professionals have stakes in the firm-and the chance to grow with a small firm keeps people around, too. So does the ability to work for a team-oriented, unbureaucratic organization. Kalmar's staff members specialize in certain sectors, but they are free to pursue ideas where they find them, on their own or in collaboration with their colleagues. There are no stars or prima donnas. If the 10-member research and portfolio-management team doesn't think a recommendation makes sense, it doesn't get into the portfolios. Once in, the analyst who sponsored the stock is responsible for monitoring and managing the position.

"You're really very much in charge of the position in the portfolio," says manager and analyst Leonard Sanders.

Kalmar's Style
As Draper and his partners like to say, "here's a for instance" of the Kalmar process at work.

In early 2009, Sanders resolved to take a hard look at companies he had long wanted to own but that had been too expensive. He has an engineering degree and experience working in the electronics industry, and he got together with fellow analyst Gregory Travers to investigate analog semiconductor maker Monolithic Power Systems MPWR. Things were looking grim, and valuations were compressed for chipmakers; economic forecasts were dire. He and Travers scoured the company's fundamentals and met with competitors, customers, and suppliers. They concluded that Monolithic's new product pipeline and proprietary process for producing small power management chips for ever-tinier consumer electronics could help it grow by 15% to 20% annually when technology spending rebounds. They bought the stock when it was trading in the low teens in February. In October, even after the shares had appreciated to the low $20s, Sanders saw more upside because consensus earnings forecasts still looked low to him.PAGEBREAK

There are risks with Kalmar's style. Quality and competitive advantages can be in the eye of the beholder. Where Sanders sees in Mono­lithic a design and manufacturing process that stands out and gives the company a defensible beachhead in the competitive semiconductor industry, others, such as Morningstar's stock analysts, see a promising company whose moat may not be wide or deep enough to fend off established players with more scale, such as National Semiconductor NSM.

Indeed, because Kalmar endeavors to find companies before their advantages are apparent to other investors or in trailing financial measures, its portfolios' earnings growth, quality, and valuation metrics often aren't much different than their peers'. The firm still has delivered better returns than the Russell 2000 Growth with less volatility over the long term, indicating that it's done a pretty good job of spotting quality growth stocks before others. Its continued investment success will depend on keeping it up.

Business success, however, will continue to rely on referrals rather than overt marketing. The firm, though, has gotten some free advertising. A foundation launched a replica of the Kalmar Nyckel in 1998 to promote Delaware and its history. The firm has no official connection to the ship or the foundation, but the firm is often linked in conversations. The firm also hasn't been shy about using the boat's image.

"It's fun to have this thing out there sailing around," Draper says. "It makes for good Christmas cards."

Dan Culloton is an associate director of fund analysis with Morningstar.

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