Chris Condon explores two disciplines that can prepare investors for the future.
“Scenarios analysis” is an idea that many investment practitioners say they use in the process of developing their investment strategies. But it can mean different things to different people. In this article I explore two different notions of scenarios analysis that I have been exposed to in recent times. No doubt there are other interesting ideas in this space and by writing this note I am inviting others to share their thinking. scenarios analysis The first concept is one that was introduced to me a number of years ago by Susan Gosling, a former colleague at MLC who wrote “A Scenarios Approach to Asset Allocation” in The Journal of Portfolio Management. The concept, as developed by Susan, together with others in the MLC investment team, is principally designed to improve asset allocation. It does this by deeply imagining a set of possible futures rather than shoehorning past returns into the convenient, but often inappropriate, stricture of the normal distribution, as implied by mean/variance analysis.
The second concept, pioneered by Shell last century, has been promoted by Peter Schwartz, who was a member of Shell’s strategic planning group. It involves organisations building narratives for different futures, rehearsing their responses if those futures were to eventuate, and thus becoming agile in the face of a changing environment. I thank Paul Scully, a trustee of NSW State Super and a long-standing friend in the investment industry, for introducing me to this thinking. The two concepts are different; they live in different domains. In this article I will briefly describe some of the features of each, and conclude with some observations common to both approaches that may help funds improve the way they think about asset allocation.
Art of the Long View I start with the Schwartz concept, as it is intuitive and paints on a broad canvass. Organisations and individuals can use it to prepare for an uncertain world. By designing blueprints for responding to different potential futures, organisations are better able to respond quickly when the world changes. This improves their chances of survival and can give them the jump on their competitors. They can make their organisation deliberately adaptive. Sometimes these blueprints will indicate immediate actions that are inexpensive if the risky future is not realised, but pay off handsomely if it is. This approach seems like common sense. And in a way it is. But in my experience, most organisations only do this implicitly, if at all. Schwartz suggests that this is inefficient and insufficient. The Art of the Long View: Planning for the Future in an Uncertain World is the title of Peter Schwartz’s 1991 book. In it he discusses the technique of planning for different scenarios. He brings this discussion alive by using examples of the day. As an aside, it is interesting to look back at how a futurist in 1991 considered how the world might change in the years to 2011. Some of the trends he postulated are bang on.