From Disconnected to Reconnected – The Nature of Investing: Resilient Investment Strategies through Biomimicry

Transformation 4

From Disconnected to Reconnected

Over the past twenty years, I’ve had the joy of traveling to more than twenty countries with Habitat for Humanity, offering manual labor to assist local homeowners as they constructed their houses. On one of my early trips to Africa, the leader of the local Habitat group showed us the storeroom, which was just a small shed with tools and a few bags of cement. I was confused—where were all the other building materials? Having been an analyst covering the home-building industry in the United States, I was used to seeing big stockpiles of materials near any building site.

Soon enough, I realized where the materials were: they were all around us. In the coming days, we took an oxcart down to the riverbank to shovel sand, which we then sifted by hand before mixing into mortar. We walked to the pump down the road to gather water in big, ten-gallon containers, many times each day. We dug clay from the very spot where the house was going to be located, shaping it into bricks for the walls. We went out to the woods to cut lumber for the roof framing. Aside from those bags of cement, a handful of nails, and galvanized metal sheets for the roof, the materials were all hyperlocal.

Even more importantly, the entire community was involved in the building process. Extended family, friends, and neighbors all helped on the jobsite. Some provided food and shelter for visitors. Others provided moral support, stopping by to cheer on the work and to comment on progress. The new house was not just situated within the community; its very construction was a community activity—completely locally attuned. A community investment.

Nature’s Principle: Be Locally Attuned and Responsive

Sometimes I think the challenges of our current financial systems can be traced to the early days of space exploration, or perhaps the original Star Trek series. These modern-day versions of “the final frontier” reinvigorated our zest for stretching and exploring, a concept that has captivated humans for centuries. They exemplified a noble form of exploration, worthy of serious dedication, resources, and sacrifice. They reminded an entire society of the joy of discovery, of stretching physical boundaries in addition to intellectual boundaries and technological boundaries.

In many ways, however, our notion of exploration is curiously limited. We often tend to take a tourist’s view, focusing on what we can bring back from our travels, whether that be greater insights, beautiful photos, goofy T-shirts, new language skills, or moon rocks. In a business and investment context, there is a similar limitation: we often focus on what can be transacted across great distances, rather than on what can be connected. With the click of a button I can buy stocks in Hong Kong, order clothes from London, or book a plane ticket to India, though none of those activities mean that I’ve got any real relationships in those places. Our essential notion of going afar seems inextricably linked to exchange and to our own return, rather than creating ongoing connection.

After a prolonged, intense period of globalization, the idea of being “locally attuned” might sound quaint—something you do on the weekends at the farmers’ market, before stocking up at Target, or jetting off to Monday’s business meeting three thousand miles away. However, the natural principles of being locally attuned are not quaint, and they are not focused on a simple notion of physical proximity; they encompass a more complete concept of life in context.

The subprinciples of “be locally attuned and responsive” are:

  • Use readily available materials and energy.
  • Cultivate cooperative relationships.
  • Leverage cyclic processes.
  • Use feedback loops.

Much like the Habitat houses I’ve seen around the world, bird nests are great examples of the first subprinciple of life in context: use readily available materials and energy. Every backyard explorer has found bird nests made of shredded newspaper, bits of string, and other handy materials, in addition to grasses and twigs. Another illustration is the sea urchin, which can regenerate its spines by precipitating calcite that is already present in the ocean.1 As part of living in context, natural organisms constantly build with abundant, accessible materials and energy, making use of what’s available in the local context. Sometimes this subprinciple is interpreted as the “free stuff” principle—using whatever is there—but that’s not quite accurate. We see nature using freely available materials, but they aren’t literally free. When a bird is collecting twigs or fluff for her nest, there is a big expense of energy involved, as well as some level of risk. Those are costly elements in bird land, anything but free.

Being locally attuned is not limited to materials; it also applies to local relationships. Nature offers plenty of examples to illustrate the second subprinciple, cultivate cooperative relationships. Think of the combination of clownfish and certain sorts of sea anemones. The anemone has stinging tentacles, and this keeps most other organisms away. But the clownfish has a protective mucus coating, so it can live with the anemone, sheltered by those same tentacles. In turn, the clownfish cleans food debris around the anemone and scares away the anemone’s main predator, the butterfly fish. New research also shows that the quick motions of the clownfish bring extra oxygen to the anemone at nighttime, when oxygen levels are otherwise low.2 It’s easy to humanize or romanticize these kinds of relationships, as many an animated movie has shown us. However, these cooperative connections work not because of sentiment, but because the exchange provides real value for both parties.

Living in context also involves being in sync with local cycles, and capitalizing on those cycles to support life. This third subprinciple, leverage cyclic processes, can be observed in the amazing Namib beetle, which thrives in the desert. The beetle takes advantage of the fog that sweeps over the sand dunes at dawn (a cyclic process). When the fog comes, the beetle raises its shell up so that the water condenses on the upturned surface. The shell has bumps that attract water at the tips and channels that then guide the droplets right into the beetle’s mouth.3

Finally, it’s important to note that living in context is inherently a dynamic process. To continue to thrive over time, it’s vital to use feedback loops and information flows. For example, you might have seen those cute meerkats on television in recent years. Well, in addition to being fascinating reality stars, the meerkats are tremendous users of feedback loops. These animals eat a lot of scorpions, and as you might imagine, that’s a tricky proposition. Adult meerkats have some immunity to scorpion venom, but if you’re a young meerkat, it’s still important that you learn how to eat a scorpion without being stung. The adults are great teachers here: first they bring the little meerkats dead scorpions for dinner with the tails bitten off, then they bring live scorpions without tails, then eventually the full live scorpions, stingers and all.4 The little meerkats learn through this iterative instruction, with all of the feedback loops the lessons provide.

There are three crucial components to effective feedback loops. First you need the signal—the information flow. Second, you need a receptor—the information needs to be received in an accurate and useable form. And finally, you need an appropriate response—not just any reaction, but an appropriate one. All three of these components need to align, as they do for the young meerkats.

When we translate the natural principles of being locally attuned to a social context, there are a few vital themes to consider. First is the importance of context. These principles talk about fitting in to our local environments, but more than that, they require connecting and integrating with those local systems. To thrive in any context we need local inputs, local relationships, and local feedback loops. Anyone who’s worked or lived in a group setting can easily see these layers: think of the high school cafeteria. It’s not too hard to fit in on a basic level, to find a spot in the lunchroom where you are nourished and don’t disrupt the rest of the system. But to find your favorite items in the cafeteria line, to have a table of friends to join, to change plans for tomorrow based on conversations and new offerings from the lunch ladies—that is real integration, life in context.

The second major theme is one of cooperation and connection. To be locally attuned means to be locally connected, and those relationships all require some level of cooperation. Sometimes it is tempting for humans to emphasize competition, and there are times when those dynamics are relevant. But because cooperation is already so embedded in our lives, we tend to underestimate its importance. Even as I type this, I am surrounded by cooperation in both human and systemic forms. The power cord to my computer is providing energy in electron form. The tomato bush on my patio is providing energy in the form of nourishment. Perhaps most importantly, the vast network of family and friends and colleagues surrounding me is providing all sorts of different support. And in turn, I am supporting all of these elements: I pay my electric bill, I water the tomato plant and sing happy songs to it, I support family and friends and colleagues in both tangible and intangible ways.

Sure, I have ongoing debates, disagreements, and certain kinds of competition every single day in my investment work. And I may on occasion swoop in to secure a prime Beacon Hill parking spot ahead of other seekers. But these moments of competition are all embedded in—and enabled by—a huge support system that is intensely cooperative. The cooperative system dwarfs the competitive one; it’s just quieter, so we don’t always focus on it.

Finally, we need to consider that being locally attuned is a dynamic, responsive process. As noted above, functioning feedback loops require accurate signals, effective sensors, and appropriate response. In some ways, it seems our human feedback loops are surely becoming more efficient: we are constantly presented with more data, quicker news flow, and easier response mechanisms. But we don’t need to rely on technology. The same sort of dynamic process is embedded in procedures like New England town meetings, where open discussion provides a naturally flexible and evolving set of inputs for governance. Anyone who’s gone to such a meeting can attest that they are not always speedy, but they are certainly locally attuned.

Figure 4–1 Locally Attuned: The Waggle Dance

Honeybee dances are part of a complex, ongoing communications stream, constantly updating and changing as new information is received and conditions shift within the hive and in the exterior environment.

http://www.amazon.com/Honeybee-Democracy-Thomas-D-Seeley/dp/0691147213; http://www.nbb.cornell.edu/seeley.shtml

Translation to Investing

Investing constantly presents chances to create attuned and responsive processes, though we don’t always succeed. Take the simple investment example of quarterly earnings releases. In theory, this could be an example of a process that is well aligned with the principles of being locally attuned and responsive. Compiling the results mainly consists of using facts and figures already at hand—readily available materials. And the intention is for investors to better understand what’s happening at the company—cultivating cooperative relationships. The activity happens every quarter, so it’s clearly a cyclic process. The resulting conversations and changes in security prices could provide useful feedback loops.

Examining one particular company helps to bridge from this theoretically aligned process to the reality of lived experience. When I started covering General Electric in the early 1990s, the press release each quarter consisted of a half page of numbers—revenues, net income, earnings per share, and share count—and a brief comment on performance from then-CEO Jack Welch. After some time a third section was added, including operating summaries for each big division of the company. On days when earnings reports were due, GE analysts all over the world would hover by their fax machines, hoping to be among the first to interpret the results.

These days the quarterly earnings releases from GE (and all other public companies) have ballooned: the latest basic GE earnings report is eleven pages of small print, and the supplemental data packet is thirty-six pages long. These documents are available instantly to anyone with an Internet connection, and are accompanied by detailed slide presentations and a long, recorded conference call.5 Every possible fact and figure is compiled, under the widely held (and legally enforced) notion that more is better, and that the volume of disclosure is somehow related to the quality of a business. What started as a quick, simple feedback loop has taken on weight and complication that may not serve its intended purpose. A thorough analyst has to spend hours and hours to understand just one set of reports like this from one large company, diverting all of that time and energy from other research that might be longer term or more creative in nature.

At the same time that input volume has skyrocketed, the response mechanisms in investment feedback loops have become much quicker and more automated. Instead of walking over to the trading desk or calling a broker to place an order, you can buy or sell stocks with the click of a button. Even quicker, you can set up trading programs with simple flags so that if phrases like “lowered guidance” or “weak margins” appear in a press release, a stock is automatically sold, without any human intervention.

So, our inputs are greater, processing is faster, and responses are easier. This sounds like great progress in all three areas of investment feedback loops. Quite the contrary. Volume, speed, and ease are not what make for effective feedback loops. In all of our endeavors, including investing, we need relevant information, effective processing, and appropriate response. Instead of “more, faster, easier” we need “relevant, effective, appropriate.”

Natural Scorecard: Global Commodities Markets

When we think about “life in context” for our ever more global financial markets, it’s clearly important to define that context. What does “local” mean if your business crosses international borders every day? Commodities markets are a curious hybrid, simultaneously local and global: the physical assets are often produced in very concentrated regions (think of aluminum smelters or orange groves), but their distribution covers a much wider area, and their corresponding financial instruments and markets are among the most global of all securities.

Commodities markets have served some of the same purposes of paper currency over the longer term; both have allowed exchange across much greater distances than would be possible if we were hauling actual tons of aluminum to and fro. This is a huge benefit, especially if, say, you run a large baking company and you don’t want your business to be subject to the whims of short-term changes in one area’s wheat pricing.

This is what I would call the “local” version of commodities markets—people and companies who use the actual products being traded in the course of their own endeavors. Simply speaking, these participants are known as commercial traders. In this context, commercial is the equivalent of local: even though the activity might span great geographic distances, it is a directly connected system, where users and producers of the commodity are the ones engaged in the market. In biological terms this might be analogous to a migratory bird, like the alpine swift. These tiny birds breed in Europe but they winter thousands of miles away in west Africa, where the swifts stay aloft for six months at a time.6 The “native habitat” of this bird crisscrosses thousands of miles, but when put together, all of those miles form one coherent, connected system.

Commercial commodity participants made up the bulk of commodities trading well into the 1990s. In 1998, physical hedgers (people and organizations that dealt with the actual, tangible commodities) comprised 77 percent of market activity.7 How do these commercially centered commodities markets stack up against the principles of being locally attuned and responsive?

Does it use readily available materials and energy? A healthy commodities market requires far less energy than a purely physical market. Instead of moving wheat across the country, your western bushels can be matched up with bushels that are closer to an eastern buyer.

Does it cultivate cooperative relationships? All markets are essentially cooperative relationships—every buyer needs a seller. We often frame trading activities as hypercompetitive, but while the search for a single great trading “win” might feel competitive, the market itself is inherently a cooperative endeavor.

Does it leverage cyclic processes? Effective commodities markets are designed to do just this, distributing more complete information that should even out the dramatic swings in price that otherwise occur from region to region, from planting to harvest, from year to year.

Use feedback loops—info flows. This is one of the main goals of commercial commodity markets, to provide more complete information and more accurate, effective feedback loops. If you were a farmer in Illinois in the 1800s and your county had a great corn crop, the price you received was probably down, even if three counties over there was a drought and record-high prices. With effective commodities markets, a more accurate view of outputs and availability should help both buyers and sellers.

In its essential, user-oriented form, a healthy commodities market matches the natural principles of attunement pretty well. Probably a B-plus, or even an A-minus.

As with all markets, though, expansion in commodities has brought challenges. For entities that actually use aluminum or corn in their business, we can see how commodities markets provide helpful tools. But what about entities that do not use any aluminum in their business, yet participate in the same financial markets as those that do?

Here we hit a slippery slope, the slope between business management, investing, and speculation. In the context of food commodities, speculation is especially important, due to the different functions and flexibilities of food versus, say, metals. If copper prices are very high, construction projects get delayed, inventories are depleted, new sources of supply and substitute materials are sought. Usually, eventually, those adjustments recalibrate prices, and anything that was delayed can be resumed. But if corn prices are very high, people go hungry—and it’s no comfort that prices might come down in a few weeks or a few months. The hunger is real, and it’s now. This intersection between natural systems, financial systems, and social systems is complex and vital, in ways that do not seem well reflected in our regulatory, operating, or analytical processes.

Here is a simplified summary of changes in commodities trading in recent years:

  • Derivatives activity in commodities markets rose steadily through the 1990s and became a source of concern for the Commodity Futures Trading Commission (CTFC).8
  • However, rather than increasing restrictions, in 2000, the Commodity Futures Modernization Act was passed, which exempted certain markets (such as energy futures) from CFTC oversight.
  • The Gramm, Leach, Bliley Act was passed around the same time, which allowed all sorts of new financial players to participate in commodity markets.
  • The Chicago Board of Trade (CBOT), the primary agricultural exchange in the United States, raised speculative limits on grain and oilseed contracts too.
  • Encouragement for the idea of “commodities as an asset class” rose in both academic and financial circles, which contributed to a rise in commodity index funds from $13 billion in 2003 to $317 billion in 2008.9 By 2008 it is estimated that these funds accounted for 41 percent of open long interest in commodities markets.10
  • Perhaps as important as the data above, the perceptions of many participants in food commodities markets seem to have shifted as well. Whereas many individuals involved in these markets historically had some sort of personal tie to agriculture, or at least direct knowledge of how their markets linked to the world, a senior exchange official was quoted in 2010 as saying, “I view what we’re working with as widgets.”11 In my experience, this disconnected point of view is very common.

To be sure, most of the time, most of what’s happening with commodity prices can still be explained by underlying supply–demand dynamics. But what about when speculation is a factor, what happens then? Examining food commodities in particular provides a fascinating and troubling set of answers.

For food commodities, we generally have a long-term backdrop of rising demand due to population growth and global wealth increases, plus some natural limits on arable land and production levels. This combination of rising demand and somewhat limited supply would tend to make long-term prices rise. Supply and demand are just as relevant for food commodities as they are for any other market, and before 2000, supply/demand-based economic models provided strong, fairly complete explanations of food prices.

However, in recent years the proportion of the change in food prices that can be explained solely by supply and demand has been shrinking, indicating that there must be other factors at play. Specifically, as shown by researchers at the New England Complex Systems Institute (NECSI), since 2000, two additional elements have risen in importance when it comes to explaining food commodity prices: ethanol, and deregulation.12 Ethanol policy has increased demand for corn, which creates upward price pressure for both corn and related crops. And as noted above, deregulation had two types of influences: first, it has made it possible for more and more investors to participate in commodities markets, and second, it has made speculation easier.

Still, why should we care if speculation is causing price spikes? It’s not like we go to the store to buy bushels of corn. Oh, wait, we do. As Michael Pollan has highlighted, more than one-quarter of items in our supermarkets contain corn, often in the form of corn syrup, corn-fed chicken and beef, and corn oil.13 There is a tangible and direct link from this speculative activity to our consumer experience.

Even more interesting than higher prices at the supermarket checkout line—and far more concerning—is mounting evidence that commodity price swings contribute to social unrest. A recent study from the same team at NECSI explains the link between food commodities and public violence. As you’d expect, there are many underlying factors that contribute to social unrest, such as poverty and social injustice. But this study found that high food prices, and especially high and volatile food prices, made violent outbreaks more likely.14

This research highlights several important contributing layers to analyze. First, we have created enabling conditions for dysfunction in the structure of our underlying food system: many countries are more reliant on the global markets now, whereas historically local supply and subsistence farming provided buffers to global volatility. Second, we have medium-term, structural price pressures on corn due to government policy, particularly ethanol requirements. And finally, we have introduced significant speculative activity, which has extended price spikes beyond what a nonspeculative, supply and demand–driven market would produce.

This combination of factors, and especially the spike in speculation, is clearly tied to social unrest. In other words, the actions of corn speculators in Chicago are directly linked to food riots in Egypt, Libya, and Syria. These riots caused deaths of thousands of people in 2011.15 One could argue, as noted earlier, that speculation in something like penny stocks is “just a game,” where the impacts, though direct, are fairly limited in scope. But speculation in food commodities markets casts a long shadow. It causes hunger, suffering, and violence. As John Fullerton, founder of the Capital Institute notes, “Commodity market manipulation is fundamentally different and far more dangerous than the garden-variety manipulation of financial markets such as in single stock pump and dump schemes, or even the brazen manipulation of LIBOR. Nobody eats LIBOR.”16

An examination of current food commodity markets, influenced by legislation, regulation, and speculation, reveals a system much less in alignment with the “life in context” principles:

Does it use readily available materials and energy? There is a sort of “false energy” being pulled into commodity markets due to the expansion of external factors like ethanol legislation and financial speculation. These influences are less and less connected with the core function of commodities and the original function of their markets.

Does it cultivate cooperative relationships? The fundamental cooperative nature of markets has been distorted here by a three-in-one combined commodities market function: we have the core commercial market, the legislatively induced market, and the speculative market. Each set of participants has different needs and motivations, which are disconnected and out of sync with one another. This is fundamentally a fragile and volatile system.

Does it leverage cyclic processes? Relationship of commodity markets to the natural cycles of crop growing is more and more distant, due to the expanded market participants and purposes.

Does it use effective feedback loops? Feedback loops are distorted by these same market extensions, rendering correction mechanisms less effective as well.

Not only does speculation amplify price swings, and not only do those price swings increase the fragility of our social systems, but that fragility is causing tangible human harm and suffering. We see in the food commodity markets a combination of market disruption and moral disruption. This is a dangerous combination, one that demands understanding and correction.

Evolution

It would be easy to overlook one of the most vital elements of the analysis we’ve referenced in this chapter: the idea that local food systems used to be more robust, and that many parts of the world used to be less reliant on global food commodities than they are today. The effects of the legislation, deregulation, and speculation discussed above would not be so awful if they did not directly impact so many dispersed local systems. So, yes, we likely need to make some major adjustments to commodities markets. But we also need to strengthen the local systems that can buffer impact. It’s like building up coastal ecosystems so that there is more shelter from ocean storms.

Luckily, there is a lot of vibrant local investing activity, and much of it is particularly focused on nurturing and strengthening local food systems. For example, the Slow Money movement focuses on “bringing money back to earth” and “investing as if food, farms, and fertility mattered.”17 Numerous local chapters have emerged to provide on-the-ground focus in their own regions through investing, education, and support for local entrepreneurs. I belong to a lending group in Boston that is affiliated with our local Slow Money organization and it has proven to be a great way to better understand and invest in our local food system, to meet real live farmers and entrepreneurs who help to nourish that system, and perhaps most importantly, to work with other local friends toward shared benefit for our community.

The Business Alliance for Local Living Economies (BALLE) focuses on creating prosperity through vibrant local economies and communities, with eighty local business networks and a broad offering of opportunities for education, connection, and investment.18 I admire that the BALLE localism movement focuses on the entire system, recognizing that energy, food, business, and community are all inextricably linked, and that to focus on a single element in isolation will not enable full-system prosperity.

Finally, community development financial institutions (CDFIs), over one thousand-strong in the United States, continue to provide crucial small business funding in many communities. As a group, CDFIs grew lending and credit union assets faster than traditional counterparts straight through the late-2000s’ financial downturn.19

These three are just a few examples of a broader wave of local engagement that can be witnessed in political, social, and economic contexts across the globe. And many of these endeavors are supported by the simpler, more direct mechanisms that form the basis of transformation from synthetic to simplified. We can start to see how these transformations intertwine and reinforce each other, forming the basis of a healthier investing ecosystem.

Pathway to Practice

How can we move toward investing that is more connected, more in context? Nature’s principles of local attunement offer a path.

In natural terms, local often means nearby. But even more than that, it means connected. First think of the literal meaning of local. Is some of your investing centered in your own community? Are there ways to connect your resources more with your local life? Then think of the more metaphorical “local,” that is, connected. When you look at your account statements, do you know what’s in those funds? Do you know the products that the companies produce? Can you explain the details of each security? You don’t need to know every detail of every investment (though that is a noble goal), but if you don’t even recognize most of the listings on your own account statements, it might be time to sift through to see which are really serving valuable purposes and which are more speculative, or just “fillers.”

When I think of the house building work I’ve done with Habitat for Humanity, I am struck by the many layers of connection that are present: connection to place, connection to community, connection to mission, and connection of people across all sorts of possible divisions—religious, political, and national. Unfortunately, I still don’t see this kind of connection present in all of my own investing, but I am more and more focused on identifying it and pursuing it. If I can’t describe how my investment is visible in the world, that’s one strike. If I can’t explain its direct and indirect effects (hopefully benefits) in some detail, that’s two strikes. If I can’t even explain how it works, that’s three strikes—out. By filtering my investing through these questions, I am trying to move my investing bit by bit from transactional to relational.

Sowing Seeds of Locally Attuned Investing

Here are some ways to move from transactional to relational investing, to focus on investing that thrives in context:

Define context. Decide what constitutes the context of your investing. Maybe you want to focus on a certain set of themes or a type of organization, a geographic region, or a type of security. Define what is “local” to you.

Cultivate cooperation. Try to back off the alpha tendencies for just a moment, and recognize that we are surrounded and supported by cooperative systems. Competition can be helpful, but it floats in a massive sea of cooperation, and it need not be a zero sum game. Are there ways to achieve your purpose that do not involve crushing someone else? There probably are. Better yet, could you achieve your purpose by supporting someone else? I bet you could.

Create dynamic/responsive—healthy feedback loops. What information are you monitoring for your investments? Feedback loops need to include relevant information, effective processing, and appropriate response. What kinds of feedback will let you know what’s really happening, and if adjustments are needed? Daily price reports and constant investment turnover are not likely to be the most useful inputs.

As we attune to our own contexts, our local environments, our investing naturally becomes more connected.

We can eliminate harmful, needless speculation, and focus on investments that are valued and valuable to both parties.

We can recognize the ubiquitous cooperative systems that enable our small moments of competition.

We can move from disconnected to reconnected.