Art vs Science, and a 50-year trend to fuel markets: the investment philosophy of Dawn Kanelleas

I recently sat down with Dawn Kanelleas, First Sentier Investors’ head of small and mid caps and chatted about everything from how to make a good cup of coffee in America to the disruptive art of Ai Wei Wei in the hopes of uncovering the secret to investment success.

Dawn has an uncommon background compared to most fund managers in Australia.

She completed her PhD in inorganic chemistry (specifically monodisperse colloids), after which she continued as a post-doctoral research scholar at the University of Oxford in physical chemistry.

You might think this would sway Kanelleas towards a particular sector, or investment class, but rather her greatest takeaway from those years of study was the importance of an innovative mindset, one she shares with those in her team.

Over the past 12 years, Kanelleas has worked with the same core team at First Sentier Investors and during that time the fund has dramatically outperformed the benchmark of the ASX Small Ords.

If you had invested $10,000 into the First Sentier Wholesale Australian Small Companies fund back in 1994 your investment would now be worth more than $250,000.

Benchmark is the ASX Small Ords. Source: Livewire Markets/ First Sentier Investors.

Part of this is due to strategy, and part of it is due to building a winning culture that challenges and innovates.

As legendary management consultant Peter Drucker once said, "Culture eats strategy for breakfast". Culture and the dynamics of her team play are powerfully linked to Kanelleas' overarching investment philosophy.

"We all are very similarly wired," she said.

A 50-year trend to fuel markets

With such a strong performance track record, and as such a widely read individual, Kanelleas is in a great position to see which trends were going to have the biggest impact on markets today.

Here are Kanelleas' top three:

• Low-interest rate environment
• Digital revolution
• Decarbonisation
  

By far, decarbonisation stuck out as the biggest issue of the three.

Kanelleas believes it will be a driving trend for the next 50 years.

"The existential question that we're all asking is the decarbonisation of the world and the exciting opportunities that are going to result from that," she said.

Australia stands to benefit greatly from decarbonisation as we have listed the second-largest rare-earth company on the planet, Lynas (ASX: LYC). The resources industry will fuel the forecast growth of decarbonisation technology, such as magnets, batteries and wind farms. The resources boom has been largely driven by lithium, copper, nickel and other raw materials.

"The demand for these outstrips supply ... hence the fact that you've seen rare earth prices skyrocket is because it's a strategic metal. In terms of Western supply, Australia is in an extremely good position to supply to the rest of the world," she said.

Disrupt, or be disrupted

While Kanelleas didn't mention this as an outright investment trend, she clearly has a strong belief in the power of innovation. Take, Breville (ASX: BRG), for example. 

Breville is the much-favoured holding in the First Sentier small-cap fund. It's the number one holding by weight and has been touted by the fund repeatedly over the past few years. It's a household name, as we both recollect in the video, a favoured brand for cheese-toastie makers. But Breville is so much bigger than cheese-toasties. In fact, their competitive edge brings them to number one in a range of household appliances. 

Breville's CEO Jim Clayton has been in the role since 2015, and Kanelleas believes he has the right mindset and vision to really grow the company.

"He recognised that there was something that this business was able to generate, that people were prepared to pay a premium for as long as it kept innovating and solving problems in the smaller domestic appliance space," she said.

What she admires most is a sound understanding of the consumer, adapting to local markets. It's as simple as solving problems that people are willing to pay for - whether that's how to brew coffee or how to avoid spillage in your waffle-maker. 

Since Clayton took the helm in 2015, Breville's stock price is up nearly 300%. 

Source: Google.

Who is Dawn Kanelleas and how does she outperform markets? 

There's a complexity and simplicity to Dawn's approach. The simplicity lies in the dichotomy of art versus science, while the complexity is in how to navigate two different worlds to the benefit of investors. 

The scientific world is daring, innovative and also critical. While the art world is renowned for being anchored in the aesthetic, the creative and the philosophical. Art is removed, often intentionally, from the world of investing. 

Kanelleas believes both are necessary for a sound investment strategy. 

"Science breeds people who are contrarian by nature, and obviously that feeds in very well to being a successful fund manager over the long term," she said. 

"(It's) about solving problems and understanding risks, understanding business models, and it helps to be able to desegregate businesses ... Science is one of the great encouragers of innovation and of thinking out-of-the-box, and that's really important in identifying structural changes that might be occurring in marketplaces and being able to capture them for your client's interests and also seeing where downside risks might come through."

But Kanelleas also believes there is so much we can learn about investing from art and literature. 

 "Art is usually ahead of the pack with respect to actually bringing up some of those social issues before they become investment issues," she said. 

"A lot of artists do because they're reflecting how society is changing. And therefore we, as investors, have to also be aware of those trends."

She speaks about how far ahead the art world was on the movement towards one of the biggest trends in markets today: decarbonisation. 

Whether conscious or not, you can certainly perceive a common thread of humanity and disruption in the art and literature Kanelleas favours. Activist-artist Ai Wei Wei (above photograph by Jindřich Nosek) is known for his "art as protest" which predominantly criticises the nature of authority, while author Rachel Cusk is known for playing literary games with the concept of the novel and the characters within it. 

More importantly, you also see this same thread in the stocks Kanelleas chooses, although you wouldn't expect it from the names alone, but you can see it in the way they disrupt, innovate and adapt. The way the leaders listen to their customers to solve their problems. 

People used to want to find the Amazon of the world, when really you have a lot more options hunting out the Brevilles in your home. 

On stepping up and solving problems 

Problem-solving is something that repeatedly came up in conversation with respect to some of the greatest ideas and trends Kanelleas is seeing in the world right now. How we recognise and identify, not only those problems but also who is willing to step up and solve them is critical to the success of the fund and of Kanelleas' stock picking. It requires a deep knowledge of these companies and the people who run them. It requires wide reading and awareness of the world outside the investment bubble and an appreciation of what makes people tick. 

So what do you need to be an outstanding investor? 

A dash of science, a bit of art, the ability to see a problem before anyone else and the drive to fix it. 

Invest in Australia’s up-and-coming companies

Outside of the heavily researched S&P/ASX 50 Index lies the fast-paced world of Australian small and medium sized companies. Dawn and her team have worked together for more than a decade and have delivered consistent absolute returns with above market performance over the medium and long term. To learn more, please click here.