As we all usher in 2022 with renewed optimism, there is one investing skill that we at Panarchy Partners aim to continue to sharpen and deploy. It was this same skill and mindset that helped design Panarchy Partners as an institutional fund manager, with a mission to redefine wealth and how it is created. Today, I will share with you this under-utilized skill in investing, which we see as being crucial for asset owners and managers as they evolve their investment processes for all stakeholders.
Let’s start by answering the question in the diagram below…
THE QUESTION - How to make an existing investment process better?
The above challenge exemplifies a skill/mindset that must be deployed in all investment processes for them to evolve.
Currently, individual investors, asset managers and asset owners are all reviewing their respective investment processes. The question being asked is how to evolve it so that it can help them with Returns and Impact. Investment processes with decades of track record cannot be changed wholesale as it has implications for client’s financial return expectations, firms’ assets under management and selfishly the portfolio manager bonuses. However, these same processes do need to evolve and at least show some respect for other forms of capital (Human, Social and Environmental), if not outright Impact. This is an exciting challenge for most investment teams.
At Panarchy Partners, our Panvesting process is our answer to the above question.
Our Panvesting process has revealed companies that are driven by a purpose to innovate and change their industries, it has cleared the portfolio of any unwanted distractions and risks, it has also allowed our portfolio to carve out areas of focus and profitable impact. Most of all it has allowed us to be very closely connected with our portfolio companies as partners. All of the above because we deployed one particular skill when designing our Panvesting process.
THE ANSWER - Subtract… improve your investment process by removing parts of it.
In the opening challenge, did you move the four blue squares in the left corner to each of the four quadrants to make them symmetrical? Or did you remove all 4 squares from the page altogether, as the pattern was already symmetrical without them. If the latter, then you have a rare talent of seeing the value of subtracting.
German American social psychologist, Kurt Lewin’s Force-Field theory argues that to create change you can either 1) add forces that are in the direction that you want to go in or 2) remove barriers to the change that you want… which is counter intuitive as we don’t think we can.
As an example, Lewin’s theory can be seen deployed in real life through our traditional bike with training wheels versus a Strider bike, a relatively new invention. The former (which I learnt on) applied Lewin’s first approach for change, i.e., adding training wheels to an existing bike for new riders. But as we all know these training wheels restricted our movement, put limits on our skills, and probably delayed our ability to balance. The strider bike on the other hand looked at the cycling process differently. What was holding kids back? The chains, pedals and training wheels. By removing them all, balancing as a skill became more interactive, intuitive, faster and easier to learn for the rider. Balancing (the outcome) is now achieved through a process with less not more.
For me the strider bike example and affirmation of the power of subtraction came through Leidy Klotz and his book Subtract - The untapped science of less (Thanks Steven for the recommendation) – Klotz an engineer by training, came to behavioral science through sustainability. He was trying to address what engineers and architects can do to help climate friendly designs, in built environments. His observation on how environmental challenges are being dealt with through subtraction driven process change can be helpful to us with our investment processes. Environment is trying to teach us something we have under-appreciated … which is the power of subtraction.
Subtraction is the unlikely mother of invention as seen in the strider bike example. Just because something is already there, we leave it because we have biological, cultural, and more recently economic compulsions to do so. Whatever is there must either be necessary or too much trouble to reinvent seems to be the logic. If anything, we just add more believing it will make it better. This is the easiest and lazy approach to get to good enough. Subtraction as an active option for us is often overlooked and discouraged.
SUBTRACTION IN INVESTMENT PROCESSES
Let me start with an admission. As we have developed our own Panvesting process to capture the four forms of capital that we see as crucial for all companies to grow for profitable and impactful returns, our process parameters by default have also expanded. However, a basic design decision when we want to change something from what it is to what we would like it to be, requires both additions and subtractions.
Using the example of the traditional bike above, investors have also been adding bells, whistles, and training wheels to their investment processes to accommodate needs of clients. Since the advent of collective investments schemes with regulated mandates our investment processes have accepted certain training wheels as permanent fixtures thus limiting our investing abilities and possible potential. Indices as benchmarks to beat being one such training wheel, which have not only stifled active management, encouraged short termism, but have also led to the growth of cheap impact-less ETFs. In short, our investing processes have become hostage to these training wheels.
To make things worse we are now asking these same investment processes to also incorporate (integrate) impact for other stakeholders. So now we are adding ESG frameworks, sustainability ranking and ratings to the existing training wheels. Good Luck with your impactful investing!
At Panarchy Partners the first and biggest subtraction we made to our process even before we added parameters to cover human, social and environmental capital, was to remove a love affair with an index as a benchmark. Investing should not be a race or a game with all of us jostling to beat each other and Mr Market (as Benjamin Graham nicely termed). Indices do not prove one’s worth let alone impact in creating that worth, which we at Panarchy Partners are very much focused on. Institutional managers have widely accepted index benchmarks as part of their process requirement, not many realizing them to be a siren which lures them into passive management through benchmark hugging. If financial capital benchmarks killed active financial management, why would we use ESG benchmarks to do the same for Panvesting? Subtract I say.
As our Panvesting process analyses human, social and environmental capital it does so through a process of elimination (subtraction). The second important subtraction in our process is to exclude all companies from our investable universe which have not done a Stakeholder Engagement and identified material issues, both risks and opportunities associated with these stakeholders. Risk is a function of probability and consequences, and without a genuine stakeholder engagement exercise a company’s board and management are blind to both. This subtraction of stakeholder agnostic companies from our investible universe is done painlessly because we don’t have a benchmark to beat. Subtraction allows for further subtraction.
Our process of elimination continues as we remove all companies that don’t have S.M.A.R.T (Specific, Measurable, Attainable, Relevant and Timed) targets on the material issues they have identified through their stakeholder engagement, including financial targets. We further remove companies that are not delivering on these SMART targets. This subtraction allows us to identify companies that we believe to be sustainable, impactful and profitable over the coming years.
By now you should see a pattern to our process, with subtraction first and additions second. By removing the shackles of a benchmark, we are not forced to waste time on the top 10 index names unless they come through our process. By removing companies that don’t deliver on stakeholder engagement, our process is not exposing our portfolio to unwanted social and environmental capital risks, while identifying companies that act on social and environmental opportunities. By subtracting companies without SMART targets our process is not second-guessing company management targets, rather keeping those with targets on our radar. By subtracting companies that don’t deliver on their sustainability targets we are ensuring we have a portfolio that is also impactful and not just profitable.
Institutional investing is going through a seismic shift with risks and returns concerning stakeholders also being managed in investing processes and portfolios. Our natural tendencies are to just add factors, parameters, ratings, scores and analysis to our existing process without questioning the underlying design of our process. This is a great opportunity for institutional investors to consider subtraction as a tool when evolving their process. History and nature have shown us the power of subtraction and its benefits, it is for us to now deploy it wisely and profitably.