New Normal Investing
Investments aren’t analysed and considered for portfolio selection by the required rate of return only, or the sharpe ratio only — not any more. And history doesn’t tell you much about the future, not at the moment. There are these mega trends you probably heard of: globalisation, climate change, demographics & migration, pandemic & health care crisis, leading to a supply chain crisis and last not least leading to not one but several financial crises. And then there is digitalisation and cyber risk & security which are in interaction with all the above. All in all this is bearing considerable seeds to uncertainty for the near and for the far future. Having said this, I’d like to amend that all this is not a situation of depression. There is hope and there is movement and there are some solutions and there might be more to come. Although for some, in particular for our children — the Fridays for future generation, it’s too little, too slow and it needs much more. Looking back at the last 50 years a lot of changes took place but that doesn’t count much looking forward to the next 50 years. And to be honest, some things didn’t change at all …
Responsible investing is widely understood as the integration of environmental, social and governance (ESG) factors into investment processes and decision-making. ESG factors cover a wide spectrum of issues that traditionally are not part of financial analysis, yet may have financial relevance. — Georg Kell (Forbes July 2018)
Hence there is one or more dimensions to be added to the portfolio selection and optimisation process, and there is a life-cycle to be considered. That seems to be a suggestion. But really? Is that the way to handle the situation?
The Transformation and Adjustments
Regulation is a new driving force because the political mainstream eventually adopted the responsibility and sustainability requirements and now enforces transition processes and induces adjustments, e.g. regarding energy sources, production and conservation. The more general target is the greenhouse gases (CO2, CH4, N2O, NF3 and several more industrial gases) and in particular the carbon footprint that is generated by using fossil resources as fuel and input for industrial production. Measuring carbon footprint is just one of several metrics but a popular one, since it can be applied to several entities and levels and under a bunch of assumptions it can be broken down up to the individual level at the life cycle.
The UN World Commission on Environment and Development (WCED) is also known as the Brundtland-Commission. It operated from 1984 to 1987 and published its results in the Brundtland report 1987. Thereafter, sustainable development became an important concept in the vocabulary of politicians, practitioners, and planners.
‘Sustainability’ according to the Brundtland Report:
… sustainable development is not a fixed state of harmony, but rather a process of change in which the exploitation of resources, the direction of investments, the orientation of technological development, and institutional change are made consistent with future as well as present needs. We do not pretend that the process is easy or straightforward. Painful choices have to be made. Thus, in the final analysis, sustainable development must rest on political will. — UNWCED: United Nations World Commission on Environment and Development (1987).
The footprinting-idea was born in the early years of the last decade of 20th century. The original stance of this concept was The Urban Ecological Footprint: Appropriated Carrying Capacity (Rees, Environment and Urbanization, 4(2), 121-130. 1992; Wackernagel, Ecological footprint and appropriated carrying capacity : a tool for planning toward sustainability. PhD thesis. University of British Columbia, 1994).
The ecological footprint accounting is a procedure with a metric to track biocapacity, the unit is ‘hectares’ (land). The focus is on renewable resources (Wikipedia contributors, 2021). Ecologists define ‘carrying capacity’ as the population of a given species that can be supported indefinitely in a given habitat without permanently damaging the ecosystem upon which it depends. For human beings, carrying capacity can be interpreted as the maximum rate of resource consumption and waste discharge that can be sustained indefinitely in a given region without progressively impairing the functional integrity and productivity of relevant ecosystems.
The inverse of carrying capacity provides an estimate of natural capital requirements in terms of productive landscape (land). Rather than asking what population a particular region can support sustainably, the question becomes: ‘How much land in various categories is required to support the region’s population indefinitely at a given material standard?’ All innovations and technology that make production more efficient reduce the footprint if properly accounted for, ceteris paribus, and in particular at a given living standard.
Of course there is a trade off between living standard and footprint, e. g. more mobility needs more cars meaning more resources for production and more pollution for using them, hence a bigger footprint. Once the required resources measured in terms of footprint overshoots the maximum capacity (the projected state of renewable resources) the system is kind of ‘hanging in there’ like a runner switching from aerobic to anaerobic metabolism due to energy demands that exceed the aerobic system’s capacity for bringing in oxygen and get rid of the ‘waste’ (di Prampero & Ferretti, 1999). We all know that this is usually painful, can’t be endured for long and needs compensation in some other form. On the other hand complementing aerobic exercise with anaerobic exercise, e. g. strength training and short-distance running (fast), offer the best of health benefits. Having said this, however, doesn’t mean that management of ecology and economy should run like that. There must be other means to establish fitness or resilience for the system under investigation.
Almost any company on this planet must review its business model against the context of the new requirements from climate change and the other mega trends. Sustainability is going to be added to the strategy because it is required by the stakeholder and the customers and all means for resilience needs to be in place for not going to be wiped out when the wind blows but to stay competitive. Regulation will try to incorporate the negative external effects of business activities into the decision making at micro level, or taxes will do the corrections according to pricing of inputs and products or services on the markets. The risk management at the micro level must analyse the threats, identify the weaknesses and try to avoid, secure or hedge the risk. If the capital cushion is stressed more than the company can bear it will exit the market for good. This time is different: The shareholder can’t do that risk management or hedging because they don’t see the real risks coming and the transformation is moving fast and faster within the time frame that is set by multilateral agreements. Adjustments need to be made in time and on target — the investors as well as other stakeholders effectively don‘t have no need for extra transitions risks in excess (no reward for that).
At the macro level we’ve seen crises and we’ll see more crises, hence, the development can be represented in cycles. That are business cycles if you look at the time series of GDP or similar indicators. Every administration will — within its bounds and feasibility — certainly target sustainability and resilience for the greater good of their peoples living standard and security.
Does that set-up the stage for search of more dimensions and factors in the investments process? Stay tuned …
One more thing and a reminiscence — going back 50 years
The situation doesn’t really start with the Club of Rome Report The Limits to Growth — on the Predicament of Mankind (Meadows, et al., 1972). But the end of the nineteen-sixties is certainly a milestone and it is mutually considered as the end of the long post-WWII period of rapid growth and prosperity in terms of living standards. The nations and the societies were characterised not only by the fierce horse race between the US and USSR who will be first landing on the moon but inevitably by:
- the arms race (the cold war)
- an environmental deterioration
- a presumed explosion of population
- the forefront of an enduring economic stagnation
- an ending of post war-settlements: rising counter cultures
- the break down of the Gold Standard — looming to be definitive
- and the period of high inflation was yet to come (we knew it before).
The US had Flower Power and race riots. Wars were going on in Vietnam and in the Middle East. Europe was still politically kind of fragmented but the Warsaw Pact was established by USSR-domination as a balance of power to NATO. China was living through their Great Proletarian Cultural Revolution (and dying). Most consumer goods were made in Hong Kong (not China) and electronics came from Japan. Some more contemporary cultural context: In the movies there was The Graduate and Easy Rider, and young people were listening to Space Oddity and Sympathy for the Devil or Hair. Books that defined the late sixties are In Cold Blood (Capote, 1965) and To kill a mockingbird (Lee, 1960).
And please remember, there was barely a telephone or a TV-set in every household, no personal computer, no internet nor smartphones or social media. On the other hand there was the delta-wing Concorde, which made its first flight on March 2, 1969. The Concorde planes had a maximum supersonic cruising speed of 2,179 km/h, or Mach 2.04, allowing the aircraft to reduce the flight time between London and New York to about three hours, well, until its retirement in April 2003. However, the impact analysis has been updated recently by NASA: Global Environmental Impact of Supersonic Cruise Aircraft in the Stratosphere (Speth, et al., 2021).
The Limits to Growth-Report outlines a very understandable thesis: If we consume (and therefore destroy) finite resources, i. e. raw material reserves, the process of growth of industrial output cannot be infinite. Further, if we
- hesitate to control population growth and pollution
- miss to achieve to expand productivity beyond the limits in particular in the agricultural sector for food production
- being ignorant about the much needed innovation and technology against resource depletion
… we are doomed to be confronted with a break down and collapse in all scenarios but the best case scenario by sometime around — well, actually — at the time of writing of this text, or in the next few years, as seen from 1970 (some 50 years ago) looking to simulations through time up to 2100. See the figures below.
Although the modelling and numerical effort was immense for this report and it received huge publicity — in academics it is more considered as a heads up call regarding the obvious rather than rigorous scientific research nor a reliable forecast in any sense. The background is the rather obscure field of General Systems Theory (Hammond, 2003) and System Dynamics (Sterman, 2000) that has been staged later into SystemsThinking and DesignThinking as a spin off out of this world view, and as consulting approaches.
The tendency for overshoot and collapse is one of the postulated feedback dynamics at the center of the World3 model which is the original Limit-to-Growth-Model. The Model is available at openmodelica.org and has been refactored by Brian Hayes at americanscientist.org. But the mechanics was not empirically identified, estimated nor validated in the ‘Limit to Growth’ context.
More recently, the concepts of footprint, sustainability, resilience and tipping points are more at the core of the discussion. The meaning is not too far off but the empirical content is much better, i. e. the understanding and scientific facts are based on much broader and deeper data basis and the analysis is more sophisticated. However, any post hoc fallacy needs to be avoided.
Look out
Scientists keep reminding us of ‘tipping points’ in relation both to vital ecosystems like rainforests, soils or lakes and the climate system. Once such tipping points are crossed and the original ecosystem has flipped or the climate system is severely destabilised, the damage made may be irretrievable. Examples include hydrocarbon leakage from the melting tundra in Siberia, the bleaching of coral reefs and parts of the Amazonian rainforest tipping over and becoming a savannah (von Weizsäcker & Wijkman, 2018). That risk is real and might be inevitable, and it is closing in quite fast.
Epilog
»The future cannot be predicted, but futures can be invented. It was man’s ability to invent which has made human society what it is« (quoted from “Inventing the Future”. Book by Dennis Gabor, p. 161, 1963).
Later in 1970 Dennis Gabor, a Nobel Laureate, founding member of the Club of Rome and the Father of Holography, said: »The most important and urgent problems of the technology of today are no longer the satisfactions of the primary needs or of archetypal wishes, but the reparation of the evils and damages by technology of yesterday.«
That might not be entirely true today, but we still have to conquer climate change and the like.
