Fitzpatrick and Elia also discussed their strategy for uncovering new opportunities and techniques for managing risk—especially during a volatile market—and what it’s like to manage the Wellington portion of Vanguard Explorer^TM Fund. Fitzpatrick and his team at Wellington are responsible for $8.3 billion of the $21.1 billion U.S. equity fund.*

*As of July 31, 2023, Wellington is one of five investment advisory firms that manage the fund.

Fitzpatrick: Absolutely. I grew up in the Northeast and went to Boston College. Once I got to Boston, I never left. I made my way to Wellington in 1998, so I’ve been here for 25 years. I was actually hired onto the team that manages Vanguard Explorer Fund by the prior portfolio manager, Kenny Abrams.

I’ve been a small- and mid-cap investor my entire career. I started on the team as an analyst, covering technology. Over time, I took on new sectors as the team grew. In 2020, I succeeded Kenny as the lead portfolio manager on the Wellington portion of Vanguard Explorer Fund.

Elia: I’m an analyst on the group, hired by D.J. about seven years ago. I grew up in northern New Jersey and then went to Carnegie Mellon University. From there, I worked for a Pittsburgh-based investment manager and then for a Philadelphia-based investment manager. I moved to Boston during the global financial crisis to be a founding partner of a small- and mid-cap value firm. That firm grew to about $1 billion in assets under management before I left to join Wellington. Those experiences made me a better investor over time. I now live in Boston with my family.

Fitzpatrick: In terms of team structure, we think sector coverage is most effective. It provides efficient idea generation but also broad coverage of the wide small- and mid-cap universe. Kenny Abrams still contributes health care ideas to Vanguard Explorer Fund. I cover technology and consumer financials, while Paul covers everything cyclical—energy, materials, industrials, and consumer cyclical durables. He also covers some financials that are cyclical. We have another full-time equity research analyst, Jessica Lebo Costello, who joined us in late 2021. Her initial mandate is to cover consumer services and business services. As she continues to ramp up as a member of the team, her coverage will expand.

Elia: In terms of how names get into the portfolio, it’s very much tied to our philosophy and process, where each of our analysts acts as a filter. To be more concrete, we go out to different investors at the firm and share the mandate of what we’re looking for, in terms of our ideas. Then we take their ideas and see how they overlap. Personally, I’m working with the five or six industrial analysts, plus the utility team, energy team, and materials analysts. I’ll bring back all their best ideas for our portfolio, and then we assess the respective appropriateness and reward-to-risk potential for each of them.

Fitzpatrick: In terms of philosophy, there are two key tenets. The first is that we’re opportunistic investors. We believe our approach benefits more than a pure growth strategy would from more sources of alpha and better diversification. By that, I mean there are times when you might see traditional growth investors focused on just a handful of sectors, in which certain stock ideas may be exploited quickly.

With our opportunistic approach, on the other hand, we don’t shy away from secular growth but we do want to sell at an appropriate valuation. We also believe you can find growth in less trafficked areas—which could be cyclical sectors or more stable sectors. This ability to generate growth through capital allocation in a typical or more stable sector is what provides that investment opportunity. So, it’s really just being opportunistic and trying to take advantage of as wide an opportunity set as we can.

The second tenet is our firm belief that a strong management team is a key driver of shareholder value creation. This is very important in the small- and mid-cap universe, where management quality varies greatly. We focus on teams that apply a coherent strategy and have been able to execute on and allocate capital to it.

Elia: While looking to uncover high-quality company management teams, we’ll ask questions like, “What is your competitive advantage?” We’re not just looking for the answer, per se; we’re also interested in how honest of an assessment they’re able to make about their own capabilities. We want to know how they envision their position within the marketplace and what they see as their opportunity set over time. In short, we are looking for their view on how they will create value for shareholders.

Some other questions that we ask include: “What opportunities are you exploiting in the marketplace?” “How do those opportunities build upon your strengths?” and “How are you fighting against some weaknesses or structural issues within your industry?” Essentially, we’re trying to get a handle on their vision for where they are and what they have the potential to do in the marketplace. 

Fitzpatrick: We’ve been covering the small- and mid-cap market for decades, so we’re able to apply long-term, collective investment experience. One advantage of that is we can meet with a manager at one company and then track that person through their career. We can see how managers develop competence and the ability to execute. And then, when they show up at a different company later in their career, our knowledge of their background benefits our research process. Additionally, we’re able to tap into a tremendous breadth of investors at Wellington who are also expert at evaluating management teams.

Elia: As small-/mid-cap managers, we believe that risk management is incredibly important when it comes to alpha generation. The volatility in this space is higher than in the larger-cap universe. We believe a diversified portfolio of 100-plus names can create a downside hedge, which gives us greater potential to generate sustainable, long-term alpha. That diversification, when coupled with the ability to identify great management teams, can give you an advantage over your peers, particularly if you’re able to sidestep or mitigate significant market downfalls.

Fitzpatrick: During the past year and a half, we have experienced a very macro-, top-down-driven market. Any long-term investor is going to encounter similar markets throughout the course of a career. The question is, how are you going to operate when you may not know what interest rates, inflation, or consumer spending trends are going to do? In the short term, those types of events can impact a stock price more than a company’s underlying fundamentals.

The environment has been challenging for many companies. They’ve managed COVID-19, supply-chain constraints, and rapid inflation. Our longevity in the industry means we’ve experienced some similar market challenges in the past. We’re approaching the current environment by being very disciplined about the points at which we buy or eliminate positions. We’re doubling down on our conviction in management teams that we think can navigate this tricky environment. 

Note: This interview was edited for length and clarity.

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• The people power that runs Vanguard’s index-investing engine (portfolio manager Q&A, issued December 2022)