The Choice-of-Future Problem in Systemic Investing (Part II): Strategies and Decision Tree
This is the second article in a three-part series on the Choice-of-Future Problem in systemic investing. Part I introduces the problem and Part III discusses special topics that arise from it. These three parts are meant to be read sequentially, as each builds on the preceding one.
In the first part of this article series, we introduced the Choice-of-Future Problem. In this part, we describe the strategies that systemic investors have at their disposal and present a framework for working through the problem to identify the best course of action in a specific context.
Before we delve in, please note that what follows is, in many respects, an incomplete, simplistic, and immature proposition. There is much to be improved and much to be discussed about the ways in which the model’s assumptions and implications must be qualified. We will do so in Part III of this article series.
We posit that the strategies available to systemic investors for working through the Choice-of-Future Problem fall into three categories:
- Focused strategies, which require investors to take a stance,
- Unfocused strategies, which allow investors to not concentrate effort, and
- Deferment strategies, which result in the postponement of a commitment.
Let us look at these in turn.
A) Focused Strategies
A1) Preference-Based Positioning
Choosing to foster the one version of the future that investors like the best, the one most in line with their values and preferences
A2) Objective Positioning
Choosing to foster the one future that is objectively most preferable, as assessed through either a scientific or humanistic lens. This strategy can further be divided by the motivation behind the choice:
- A2(p) Precautionary Imperative: When the situation calls for the application of the do-no-harm principle in choosing to foster one plausible future over another
- A2(i) Impact Imperative: When the fundamental purpose of impact investing calls on investors to maximize the amount of good that money can do in the world
A3) Pragmatic Positioning
Choosing to foster the one version of the future that is objectively most probable, as determined through quantitative or qualitative methods
B) Unfocused Strategies
B1) Multi-Future Strategy
Investing in two or more futures (of different TEPs) simultaneously
B2) Future-Neutral Strategy
Focusing on those enabling and/or ancillary elements of a system that will be valuable irrespective of which specific TEP will prevail
X) Deferment Strategies
Conducting (or sponsoring) additional research so that more information about different plausible futures becomes available
X2) Do Nothing
Not to invest at all
Now, we will look at a framework to work through the Choice-of-Future Problem to help make sense of which strategy to choose in a given set of plausible futures.
The following figure depicts a decision tree. Central to this schematic are two things: the decision nodes and the strategies at the end of each branch. We introduce the strategies above, so let us now look at the nodes.
The totality of options is represented by all futures deemed possible. However, this includes futures that are so improbable that it would be irrational to invest in them — say, the invention of the warp drive from Star Trek. We thus posit that systemic investors should only be concerned with those futures deemed plausible.
Primary Test Questions
When evaluating a set of futures from within the cone of plausibility, we posit that there should be three major nodes in the decision tree:
- Improvement Test:
Test 1: Is at least one future in the set of plausible ones an improvement over the status quo?
Test 2: If so, are there more than one futures that are an improvement over the status quo?
- Relative Probability Test: Can the relative likelihood of different futures be estimated to a reasonable degree?
- Relative Preferability Test: Can the relative desirability of different futures be estimated to a reasonable degree?
Secondary Test Questions
A special case arises when neither the probability nor the desirability of competing futures is the same. We posit that, in that case, three more questions should be asked:
- Equivalence Test: Is the most probable future also the most preferable one?
- Stepping-Stone Test: Can the most probable future reasonably be seen as a transition state, an Horizon 2 future enabling a more desirable Horizon 3 end state?
- Marginal Utility Test: Does the investor derive more marginal utility from environmental and social impact or from financial return?
Futures that Fail the Plausibility Test (Yellow Track)
…are best left in the land of dreams and science fiction. Is the invention of the warp drive theoretically possible? Yes, it looks like it is. But if someone pitches you an investment opportunity in this field, you’d better not invest all of your retirement savings, because the science still has a long way to go.
Futures that Fail the Improvement Test (Red Track)
If none in a set of plausible futures represent an improvement over the status quo, the only course of action is to not pursue an investment (X2).
If, however, it is unclear whether there is at least one in a set of plausible futures that is better or worse than the status quo, the do-no-harm doctrine dictates that more research be conducted to understand the situation (X1). This is what happened when the European Court of Justice, in 2018, ruled that gene editing techniques using CRISPR/Cas9 needed to be subjected to the EU’s GMO Directive, decreeing that more research needed to be done before deeming them safe (and thus definitely better than the status quo).
And if there is exactly one future that represents an improvement over the status quo, the only course of action is to promote that future (A2(i)).
→ In the fortunate situation in which there is more than one future that represents an improvement, the journey down the decision tree continues.
Futures with Unknown Relative Probabilities (Blue Track)
If two or more futures have unknown relative probabilities but are equally preferable, the investor is free to choose which one’s effectuation to support (A1).
For example, in the emerging space of Negative Emissions Technology (NET), several strategies are competing for investor attention, including enhanced rock weathering and ocean fertilization. While there is a large “it depends” factor at play (see Part III for more on this), all these concepts aim to remove CO2 from the atmosphere, making them — on some simplified level — equally preferable. And yet none of them exists at scale and whether they ever will remains unknown. So, ceteris paribus, investors can pick the technologies they like the best, whether this is simply a matter of taste or the result of rigorous due diligence.
In the case in which two or more futures have unknown relative probabilities but one future is objectively preferable to the other(s), investors should choose the most preferable one, driven by impact investing’s imperative to maximize the amount of good that money can do in the world (A2(i)).
And if neither the probability nor preferability is known, the right course of action is to either conduct more research (X1) or pursue multi-future (B1) or future-neutral (B2) strategies.
For instance, Japanese car manufacturers are still making an effort to develop hydrogen-based fuel-cell vehicles. It is therefore conceivable that, in certain parts of the world (e.g. Japan), hydrogen-based mobility has a chance of becoming a dominant transportation technology. In such a setting, it might make sense to invest in both battery-electric mobility and hydrogen mobility (B1) or only in those parts of the mobility system that will benefit irrespective of which technology prevails (B2). The latter could entail investing in sustainable car tire materials or mobility-focused service start-ups, as both are agnostic as to whether cars are powered by a hydrogen-based fuel cell or electricity delivered by a battery.
Futures with Equal Relative Probabilities (Green Track)
If two or more futures are equally probable and equally preferable, ceteris paribus, investors are free to choose which one to champion (A1).
For instance, there are two technology platforms for producing renewable methane in Power-to-X processes, one using a thermochemical process (Sabatier) and the other leveraging the ingenuity of biology (Archaea). Both have a similar life-cycle emissions performance, and both are demonstrated at scale but depend on policymakers to create a market for them, so they are arguably equally preferable and probable.
That said, in situations in which there is one clearly preferable option amongst equally probable ones, then the impact imperative of systemic investing (A2(i)) dictates that the preferable future be chosen.
For instance, in the early 2010s, plug-in electric vehicles — which have both an electric motor and an internal combustion engine — were jostling with all-electric vehicles for dominance of the future of the car. At the time, the race was still open (equal probability), but systemic investors should have chosen all-electric vehicles because of their superior lifecycle emissions profile (unequal preferability).
Finally, if the relative preferability is not known, we propose that investors pursue either a multi-future (B1) or future-neutral (B2) approach. Which one to choose depends on the likelihood that multiple existing systems will be able to co-exist with each other.
For instance, in the choice of hydrogen vs. electricity for a single city, strategy B2 appears to be superior, because it is unlikely that a city will make the investment required to develop both supply chains. However, in the case of electric cars vs. electric bikes, it is reasonable to assume that both modes of transportation will be accommodated in a city, so strategy B1 would be a viable choice.
Futures with Unequal Relative Probabilities (Purple Track)
In a scenario in which one or more futures have unequal probabilities but equal preferability, systemic investors should choose the one future with the highest probability (A3), this being the financially pragmatic choice. For instance, a choice to promote electric vehicles over hydrogen fuel-cell vehicles is also, in large parts, a pragmatic one, because the momentum seems to be clearly on EVs.
If, on the other hand, the probabilities are unequal and the preferability unknown, investors should choose a future-neutral strategy (B2).
It gets complicated when both probability and preferability are unequal. In this case, we need to call into service another set of questions:
If the most probable future also happens to be the most preferable one, the choice of future is clear, with both strategies A2(i) and A3 leading to the same outcome.
If, however, the most probable future is not the most preferable one, then the question is whether the most probable future can be reasonably seen as a stepping stone to a more ambitious Horizon 3 future.
For instance, it seems clear that the electrification of personal transport — i.e., simply substituting internal combustion engines in cars with electric motors — will not produce the environmental and social outcomes we need, but can reasonably be seen as a stepping stone to a mobility future that moves beyond the Drive-Your-Own-Car paradigm (cf. Part I).
If the answer is unknown, the precautionary principle dictates that the most preferable future be chosen (A2(p)).
And if the most probable future cannot be seen as a Horizon 2 stepping stone, then the impact imperative dictates that systemic investors promote the most preferable future (A2(i)). For instance, it is highly questionable that carbon capture and storage (CCS) technology is a viable stepping stone to a fully renewable future, as it entrenches the fossil system and prevents countries from making the kind of commitment necessary to lead renewable energy to a tipping point. So systemic investors should not invest in CCS but promote renewable energy instead.
Marginal Utility Test
In case the most probable future is a Horizon 2 stepping stone, then the question is whether systemic investors derive the greatest amount of marginal utility from impact or financial return. If it is impact, investors should choose the most preferable future (A2(i)). If not, investors should pick the most probable one (A3), as this is the pragmatic choice.
What is most relevant?
From a practical perspective, we believe that there are two scenarios that systemic investors are the most likely to encounter in practice.
In the first scenario, the most probable future is not the most desirable one but represents a viable Horizon 2 stepping stone. For instance, today’s alternative protein products like those sold by companies such as Impossible Foods solved a significant problem — eliminating the need for industrial animal farming — but tend to rely on genetically modified crops while scoring poorly on a health scale.
It is conceivable that, in the future, these companies will be able to source sustainably produced ingredients while improving the health score of their products. One could therefore make the case that investing in today’s alternative protein supply chain will build a bridge to a deeply and structurally sustainable future of food.
In the second instance, the most probable future is not the most desirable one, does not represent a Horizon 2 stepping stone, and an investor derives more marginal utility from impact than from financial return. This is the space of impact-first investing, where investors commit to promoting solutions that will have to work hard to reach scale.
Oftentimes, this is where some of the most promising potential for transformative change lies — innovation that is structurally different and thus does not readily plug into the existing economic order but instead paints a vision for a new economic logic. Some of these will take the form of Horizon 3 solutions or systems configurations. An example from the food system would be business models based on agroecological practices.
What patterns emerge from the decision tree?
The decision tree reveals several patterns, three of which are worth calling out:
First, systemic investors will often find themselves pushing for the most impactful strategy (A2), particularly when it is clear what that looks like. Sometimes, this will come at the expense of an inferior financial risk/return prospect.
Second, multi-future (B1) and future-neutral (B2) strategies are desirable strategies when there is uncertainty about the preferability of different plausible futures. In some way, then, these strategies can be used for hedging impact risk. (NB: More on financial risk hedging in Part III).
Finally, preference-based positioning (A1) is not that common. This means that there is often a higher-level consideration steeped in evidence or a principled imperative that shows the right course of action and overrides personal tastes. In practice, this means that investors must do their homework to understand the relative preferabilities and preferabilities of different futures instead of following their gut. This stands in contrast to today’s dominant practices, which all too often are based on what looks or feels right instead of what is objectively the most sensible course of action.
Please keep in mind that the model presented above is stylized. The examples given are mostly illustrative, and the validity of the model itself should not be judged by the quality of the examples we picked.
The model gives rise to a number of important questions:
- How do we deal with the problem that aspects of probabilities and preferabilities are inherently difficult to measure, and that actual preferability often depends on how exactly the future eventuates?
- How do investors ensure that the futures they bet on are democratically legitimized?
- What role should the aspect of additionality play?
- To what extent is the model generalizable for impact investing at large?
- What are topics for further research?
These and other questions are going to be treated in Part III of this article series (forthcoming).