Urgent hedging strategies for today's impact investors: Think in bets and invest in systems
Our current global risks are likely to persist for generations.
By Eduardo Esparza, founder and CEO of the Blue Dot Project
Has the world ever faced more uncertainty on such a global scale?
I don’t think so.
Even as great civilizations of the past collapsed, many humans in other parts of the world were unaffected. But today, with the world so interconnected, any of a dozen crises on our doorstep could darken the future of most of humanity for hundreds of years.
This is part 2 in a multipart series of posts on the topic of risk hedging for impact investors. The series is for investors who want to fund projects that meet two criteria:
Their investments can deliver acceptable risk-adjusted returns.
Their investments can deliver long-term, measurable results that improve humanity’s ability to thrive on Earth.
Why it matters
We face great uncertainty from a convergence of several crises I talked about in part 1 of this series.
Investors can’t stash their money under a mattress until our current storms blow over. These storms won’t blow over. So investors have to put their money somewhere, or they risk losing it to inflation.
Where and how can they invest amid our current uncertainty?
We should think in bets
When we need to take action in uncertain situations, our best option is to “think in bets.”
Dr. Annie Duke, Ph.D., specializes in the science of making effective decisions when information is incomplete and outcomes are uncertain. She is a former poker champion who holds a doctorate in cognitive psychology. Dr. Duke recommends thinking in bets as an effective decision-making process. 1
Smart investors try to overcome their cognitive biases.
Behavioral psychologists have identified about 120 cognitive biases that are likely to cloud human judgment.
To skirt this minefield of potential biases, effective decision makers gather many data points and diverse perspectives. Then they estimate probabilities for risks and outcomes.
This is how we must think as we try to invest our way out of our current crises.
Our challenge is that natural systems are highly complex, and current science doesn’t fully understand them. It’s hard to assign probabilities to behavior of complex systems whose workings are so interrelated.
The future is never foreseeable
Despite a common phrase in English that suggests the future is foreseeable, it’s never entirely so. Forecasting models are imperfect, and the future is more uncertain the further out we try to predict it.
I’ve spent the past few years exploring ways for investors to hedge their risks in our uncertain and dangerous environment.
Hedging strategies balance investments to ensure that gains in one area will offset losses in another. You invest in assets whose performance is uncorrelated, meaning that the performance of one asset doesn’t directly affect the performance of others.
Beyond finance, hedging strategies are valuable for managing broad systemic risks. We can apply them to environmental, technical, and socio-economic domains.
Our investments in regenerative systems can hedge against the diverse risks of systemwide collapse. They enable a strategic diversification of our “portfolio of civilizations.”
Hedging is essential to enhance our resilience and ensure our sustainability, given the risk of abrupt and widespread disruptions in our global systems.
Why we must think differently as investors
The many world crises we face today are products of the world’s dominant cultures. They result from the economic, political, and social systems we humans have chosen. It’s clear that some—maybe many—of those systems no longer serve our best interests as a species.
Until recently, the world’s top business schools have taught linear thinking.
Linear thinking leads us to believe most causes have direct effects and most problems have direct solutions. This is how most business leaders and many civic leaders think today.
Such thinking can be an effective way to analyze and solve narrow problems.
But it oversimplifies complex systems. It doesn’t help manage environments of high risk and uncertainty. And it leads to myriad unintended consequences.
Linear thinking cannot solve the problems we face today
With linear thinking, we’re less likely to see problems as the output of broken systems whose dynamics we’ve misunderstood or mismanaged. We often apply patches to issues as they arise, without addressing root causes.
When we allow root causes to persist, problems are likely to reappear—sometimes as new symptoms.
Investors who use linear thinking may fund what they see as effective solutions to narrowly defined problems.
We can’t ignore unintended consequences
A focus on narrowly defined problems can yield quick financial returns, but it often ignores broader effects on society and the environment.
Accountants call such negative effects “externalities” because they occur outside a business’s accounting. In investment decisions, we may ignore costs that don’t appear on our profit-and-loss statements or balance sheets.
Although we may acknowledge externalities as problems, we may not see the externalities as our problems to fix. This is how businesses have set up and played the rules of the game. Investors keep their gains private, but they leave many of the costs they create for the public and future generations to pay.
In financing regenerative communities, we must embrace complexity and invest in the long-term health of whole systems.
Invest in systems, not components of systems
Investing in systems—or systemic investing—seeks to improve the performance of complex systems as a whole.
The TransCap Initiative2 defines systemic investing as “a holistic investment logic guiding the deployment of capital for the purpose of catalyzing sustainability transitions in the places, value chains, and other real economy systems that matter most for human prosperity.”
To put this more simply, you derive insights from systems thinking. Then you use those insights to identify strategic leverage points and opportunities.
By investing to improve the performance of entire regenerative systems—including regenerative communities—you can build a diversified portfolio that reduces your risks and increases your returns. You also regenerate nature and reduce harmful externalities.
In the next article in this series, I’ll talk about specific hedging strategies to invest in ways that enable regenerative living.
Annie Duke. Thinking in Bets. Portfolio/Penguin: New York. 2018.
The TransCap Initiative is dedicated to bringing systems thinking to the world of sustainable finance and impact investing.