The NZS approach goes beyond ESG by considering a broader definition of fiduciary duty that delivers non-zero-sum or win-win outcomes taking into account customers, employees, the planet and society, in addition to shareholders.
NZS use the behaviour of power laws to propose a new framework for capital allocation that avoids narrow predictions and emphasises adaptability, innovation, network effects and duration of growth.
A power law is a mathematical relationship where the frequency of an event varies as an exponent of some characteristic of that event. Earthquakes are an example – if minor earthquakes are common, we know that massive earthquakes exist, yet we just never know exactly when or precisely how big. Apply this to financial markets and everyone should see extreme events not only as common, but ‘the norm’.
Volatility is often thought of as risk, but NZS question this. For NZS, thinking about complex systems, volatility leads to emergent behaviour that improves the system over time. This approach balances Resilience and Optionality to avoid pitfalls from the false belief in a normally distributed world.
“Balancing Resilience and Optionality allows us to remain agnostic about the various paths that the future might take”
NZS embrace volatility and focus on allocating capital to companies that thrive in a complex environment. To do so these require two characteristics described as ‘Resilience’ and ‘Optionality’.
The relentless pursuit of productivity at the expense of resilience has been the dominant business philosophy for decades. In the animal kingdom, ants are the epitome of industriousness and diligence, yet the surprising truth is that most of the time half the colony is just sitting around doing nothing. In fact, ants have adapted to be resilient to extreme events. If a flash flood kills those out harvesting, or an animal damages part of the colony, then there are plenty of ants in reserves to stage a recovery.
Translating that to business, resilient companies are those that are less optimised on maximising short-term returns and more focused on their ability to adapt and evolve to changing conditions, surviving and even capitalising upon extreme events.
Optionality refers to a large potential payoff resulting from a relatively small investment – it’s how the power laws mentioned earlier can work in our favour. Power laws are no secret to venture capitalists, they know that many of their investments will amount to nothing and they only need a small number of winners to make the portfolio successful. For start-ups and disruptive businesses, the uncertainty may be too great to feel confident about outcomes for specific investments, but holding many companies with a high degree of optionality could produce several losers and it could also produce a few outsized winners.
For NZS there are three key factors to consider when searching for businesses that can thrive in a complex system, creating an optimal balance of Resilience and Optionality. These are: quality, growth and context.
Quality: For NZS the essence of a quality business comes down to its management team and structure. Long-term thinking and adaptability are two sides of the same coin, as often a successful company will balance a focus on what will NOT change for their business with a strong ability to anticipate the evolving needs of customers. This is something the best management teams understand intuitively. NZS say these businesses are likely to have certain products or services and can be optimised for Resilience and these recurring revenue, high cash generative business units should be used to fund a series of Optionality investments around the business’s core or adjacent competencies.
Growth and ‘Non-zero sum’: In a complex world with increasing interdependencies, the best outcome for all players is to make decisions that create positive non-zero sum scenarios, win-win situations that leaves both parties better off than if they had not transacted in the first place.
A company that operates a platform focused on creating value for all participants, including itself, is creating large amounts of ‘non-zero sum-ness’. The optimal win-win situation is achieved when the platform creates more value for the ecosystem than it does for the company’s own treasury. Companies disrupting large established markets can do so by offering all constituents higher non-zero sum than the incumbents.
Context and understanding change: NZS select investments that will not make the overall portfolio fragile to a particular view of the future. This is why much of their research is directed toward understanding what is going on within the ecosystems, determining what will change and what will not change.
Meet the team
NZS Capital also consists of investors Jon Bathgate and Joe Furmanski, who each have over 10 years investment experience, and senior adviser Jim Goff who was previously Director of Research at Janus Henderson. NZS Capital’s President and Chief Risk Officer is Adam Schor, who has almost 30 years of industry experience.
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