Investing behemoth Fidelity just launched the first-ever fund for founder-led companies. Here's the 3-part 'secret sauce' its manager looks for when picking entrepreneurs.

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Investing behemoth Fidelity just launched the first-ever fund for founder-led companies. Here's the 3-part 'secret sauce' its manager looks for when picking entrepreneurs.

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  • On Wednesday, Fidelity launched its new Founders Fund, which exclusively invests in companies whose founders are still senior managers or board members.
  • Dan Kelley, the fund's lead porfolio manager, gave Business Insider an exclusive look at the three attributes he looks for when investing in an entrepreneur.

If you talk to enough portfolio managers, it will eventually become clear just how much they value companies whose founders are still heavily involved.

But Fidelity - the investment giant boasting more than $7.1 trillion in client assets - has taken it one step further.

On Wednesday, the firm launched the Fidelity Founders Fund (FIFNX), which is designed to invest solely in companies that still have their founders attached as either a senior manager or board member. The fund will be actively managed by Dan Kelley, a portfolio manager with more than a decade of stock-picking experience.

The epiphany that led to the fund's creation came after a meeting Kelley attended with Will Danoff and Joel Tillinghast, two legendary Fidelity managers.

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"They realized that during their multi-decade investment tenures that they tended to favor founder-led companies," Kelley told Business Insider by phone. "They found they were usually solid long-term outperformers versus the market. The light bulb went off and we decided to pursue the idea further."

The 3 attributes Fidelity looks for in a founder

"I want to find the secret sauce."

All of Kelley's efforts around identifying founders trace back to that single mandate. He wants to know what makes an entrepreneur stand out, and he's interested in transformational thinking that goes beyond conventional wisdom.

Here are the three main attributes Kelley looks for in a founder. All quotes in this section are attributable to him.

(1) A deep interest in the customer experience

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"A lot of the most successful companies I'm seeing on the founder-led front really start with the customer experience first, then work their way backward. It becomes kind of viral when a lot of customers are using a service or product, and they're talking about it on social media. You get these powerful network effects."

"In this day and age, if you come up with an idea and you focus on commercializing it without appreciating the customer's perspective, you're missing the big picture."

"These founders are customer-obsessed, they want feedback from the customer, they're thinking about the whole complete customer experience, and they really want to convert customers into advocates for their whole product, service, or brand."

(2) An innovative mindset

"Getting back to the long time horizon of this universe, I want founders that are seeing the world differently than it exists today. They're focused on being disruptive to the marketplace. They're leveraging the fact that they're creative and think differently to change the status quo. That usually involves and unmet need out there that they can fulfill."

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"Sometimes it's doing things differently, in a less cumbersome manner. There are numerous examples of companies that started with just a basic idea of how to make a product better, and then ends up drastically changing how business is done in whatever vertical."

"If you want to compound at a growth rate well above the market over time, you have to be doing something different."

(3) Skin in the game

"The best managers and leaders also have a lot of skin in the game. What I mean by that is they have a significant portion of their net worth in the stock."

"When you have that, interests are incredibly aligned with us as shareholders so that you do the right thing for the shareholder and you don't get caught up in the noise. You're worried about the value creation over a number of years."

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"When people aren't investing in you because of macro conditions, you're continuing to invest in yourself. You're doing what's right in the long term, because these are viewed as their babies. They want to see them grow and prosper."

Other methodology

By Kelley's count, there are more than 700 companies in the US that meet his core criteria for founder involvement. And there are multiples of that outside the US. So simply identifying them is just part of the battle.

Within that large universe of founder-led firms, Kelley then looks for high-growth opportunities that he thinks are being underappreciated by the market on a three- to five-year basis.

Now that the initial portfolio has been established, Kelley plans to build and reduce positions based on shifts in valuation that create dislocations - and future investing opportunities.

"You double down when there are drawdowns on some of these names, because they are high-growth and often times don't have near-term valuation support," he said. "You can make even more in terms of returns in the long-term."

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This is an approach that requires a high degree of conviction - one that Kelley has achieved through a rigorous diligence process that involves complex financial modeling and multiple in-person meetings with companies.

As for which stocks are in the portfolio, Fidelity won't disclose that until the end of April. But, according to Kelley, the group will go well beyond the tech and healthcare sectors - otherwise known as the areas one might initially look when pursuing founder-led companies.

"The index is between 40 and 50% tech and healthcare," Kelly said. "But I'm finding really interesting, innovative founder-led companies across all sectors."

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