Building Momentum through Portfolios

Aristotle is credited with first observing that in certain situations “the whole is greater than the sum of its parts.” This used and abused phrase rings true, particularly when making investment decisions, where we often seek to leverage value to get the best possible outcome. This is reflected in a portfolio-based approach to investing where we offset risks and seek to gain scale through diverse yet targeted decisions.

The wisdom of this maxim can easily be overlooked, particularly when dealing with situations where goals are more complex than optimising financial risk and return. A consequence of the ever-increasing drive to rationalise complex decision making through better designed and more structured frameworks is that many decisions are increasingly made based upon single project-oriented metrics. In finance, this is reflected in stand-alone net present value or internal rate of return calculations. In other fields, decisions may focus on measures, such as a stand-alone social return on investment metrics.

All of these tools aim to inform decision makers of certain characteristics of a proposed investment or series of investment options. They aim to summarise key metrics in a manner that makes the decision-making process as objective as possible. This is seen as important in providing rigor and transparency in both public and private decisions (all of which are good things).

There are, however, large and significant consequences for firms, organisations and governments that choose to follow a project-oriented style of decision making over a portfolio - or program-based approach. 

Systems modellers talk about the importance of feedback loops in understanding systems performance. Broadly they consider these loops as either reinforcing or balancing. Reinforcing loops create momentum towards an outcome by building on existing stocks of resources - in essence a snowball effect. Conversely, balancing loops reinforce an existing state by resisting change. They stabilise systems, representing an inertia against which change must push. 

One of the opportunities of a portfolio-based approach to decision making that is lost when projects are considered on a stand-alone basis is the ability to develop reinforcing feedback loops that build momentum towards a desired outcome. These loops can create their own momentum, exceeding expectations and potentially even achieving self-organising properties. Likewise, single project-based decision frameworks can easily turn into balancing loops that reinforce the status quo through overly technocratic and rigid structures that lack flexibility to deal with uncertainties and risks. Public sector investment in economic development is an area that has the potential to take advantage of a portfolio-based approach. A recent project that I worked on (in my previous role as principal consultant with Pracsys) considered the merit of combined investment in the following:

  • A waste-water recycling initiative that sought to capture, treat and store waste water that was polluting a major waterway;
  • An intensive agricultural zone that took advantage of the new water source to produce next-generation food production initiatives (including horticulture and prime beef herds); and
  • An integrated industrial area/food hub that would act to add value to locally and regionally grown produce through production, manufacturing and logistics processes.

The evidence suggested that whilst this project still required significant technical planning, the potential value generated to the regional economy of the combined projects far exceeded that which would have occurred from any of the projects individually.     

Unfortunately, project concepts such as this are rare, and even more rarely funded, with project-oriented decision-making processes encouraging the development of individual stand-alone business cases that rarely relate to other opportunities surrounding them. This approach also potentially restricts the ability of decision makers to offset higher-risk projects with safer projects - as many venture capital and commercial investment funds do. 

The opportunity cost of this project-based approach to investors, the economy and the community as a whole is potentially significant and often unrecognised.

Big Hairy Prediction: In the most, entrenched systems will continue to implement fragmented project-specific decision-making structures. When portfolio-based decision-making does occur in public sector investment, it will be through individuals driving a strong, consistent vision for change over an extended period of time. At least one Region in Western Australia will develop a portfolio-based approach as a result of their current strategic planning, with the results being recognised as impactful and lasting.  This may occur as early as during the next State election.  

For more information on our big hairy predictions follow the link.