The first step in adopting a Systems Solution to equity analysis is understanding the basics of systems. These basics are applicable to all types of problems, not just equity analysis, and represent a fundamental mindshift from mechanical to holistic thinking.
1. The Distinction between Mechanistic and Holistic (Systems) Thinking
In their book, “The Systems View of Life” from which much of this material is drawn, authors Fritjof Capra and Pier Luigi Luisi note that systems thinking is the opposite of analytical thinking:
“Analysis means taking something apart in order to understand it; systems thinking means putting it into the context of a larger whole.”
Thinking in systems involves a complete rework of the analytical approach away from certainty and prediction towards approximate understanding. Such an approach often conflicts with underlying behavioural and institutional biases that favour certainty and confidence. This is the challenge and opportunity for investors in systems thinking.
We have discussed the distinction between systems and analytical thinking in more detail here.
2. Systems Basics
Capra and Luisi describe a system as:
“an integrated whole whose essential properties arise from the relationships between its parts”.
For example, the human body is a system, within which are separate sub-systems (circulatory, nervous, muscular, respiratory etc) organised in various system hierarchies (DNA, Cell, Organ). The individual human in turn inter-relates with other systems (humans, animals, plants etc).
In the social domain, a company is a system, comprised of various sub-systems (accounting, management, operations, marketing etc) in turn part of a heirachy – business/company/industry/economy. This industrial system inter relates with other systems – political, natural, financial.
All systems have the following major components:
These are the building blocks within our system and the focus of traditional analytical approaches. Elements come in two types, stocks and flows, where stocks represent the historic accumulation or depletion of the flows. Stocks act as stabilisers in a system and as they are depleted the potential for volatility increases.
In a company system the stocks are Cash, PPE, Inventory, Receivables, Intangibles etc.. , whilst the flows are Sales, Expenses, Cashflow, Capex etc. In an accounting sense, stocks are recorded on the balance sheet and flows in the P&L or cash flow. The balance sheet in this model is both an historical record of performance and an indicator of the future stability of the company.
Whilst the elements of a system seem to be its defining characteristic, they are not. Changing the elements often has minimal impact on system behaviour. The cells in the body, players in a football team and equipment in a company are all in a constant state of change, yet the system in which they operate largely retains its character. It is not the elements, but the relationships between them, that are critical for understanding the system.
The interconnections between the various elements and the process by which change in one element feeds into changes in another, are the defining features of a system. As Donella Meadows notes:
“One of the central insights of systems theory, as central as the observation that systems largely cause their own behaviour, is that systems with similar feedback structures produce similar dynamic behaviours, even if the outward appearance of these systems is completely dissimilar”
Feedback is ubiquitous in systems and can be either stabilising (acting to dampen the system towards some form of equilibrium) or reinforcing (acting to accelerate change). Business, finance and financial analysis are full of examples of both types of feedback. For example:
- Economies of scale are a reinforcing feedback loop, acting to lower cost, enabling increased market share and hence lower costs further.
- Competition is a stabilising feedback loop, whereby higher returns attract more capital leading to lower returns.
Almost every important element of Financial, Operational, Market or Investment analysis involves consideration of feedback loops.
Read more here..
Goals or purpose
Most systems have a goal or a purpose. For organic systems the goal is to stay alive and propogate genes. For companies, the goal is (generally) to maximise returns to shareholders. Understanding this goal is critical to understanding the behaviour of the system and how it will adapt to change. A company is a dynamic entity that will adapt to changing circumstances by product innovation, mergers, cost cutting etc.
Focussing on the goal of the system helps explain many behaviours that at first glance appear “irrational”. Political systems seek re-election, not necessarily economic productivity. Management systems often seek remuneration and power, not shareholder returns. Advisory systems seek advisory fees, not necessarily good advice.
A boundary or environment.
Even in systems thinking we need to define a boundary for our analysis. Although everything in the world is interconnected, it is impractical to consider every possible interaction. We therefore usually confine our thinking to an element of the overall system – a leaf, a tree, a forest, an ecosystem.
There are obvious risks in our choice of system boundry. Define it too narrowly and we risk missing important connections that drive behaviour. Define it too broadly and we risk getting bogged down in irrelevance. We define our boundaries using the terms endogenous (within our system) and exogenous (outside it). This in turns leads to a belief that exogenous factors are both outside of our control and incapable of understanding (Black Swans).
A classic example of this was during the GFC when CEO’s repeatedly claimed the GFC was an unpredictable Black Swan event – outside the system. In contrast, those who “predicted” the GFC understood that leverage and liquidity were endogenous to the system as described by Minsky.
The behaviour of CEO’s during the GFC was typical of bounded rationalists – those who make a decision that is correct within the narrow constraints of their knowledge. CEO’s (and analysts) who look only at the company system, will fail to grasp the broader systemic implications (e.g. competitive response) of their decisions (e.g. cut costs).
3. Systems Behaviour
The interaction of these elements results in certain common behaviours and properties of systems:
Systems have a tendency to organise themselves into different hierachies. For example:
- Human Body – Molecules/Macro Molecules/Organelle/Cell/Tissue/Organ/Organ System/Organism
- Industry – Machine/Production Line/Factory/Business Unit/Company
A common property of systems is that each level of this hierachy may have different levels of complexity, such that some properties of the system emerge only at one level of complexity, but cannot be predicted from the behaviour of the lower level. For example, the human mind cannot be predicted from studying individual cells – it is an emergent property of the organism. Similarly, an Industry will have different emergent properties that cannot necessarily be predicted by studying the individual factors of production.
Equilibrium and Chaos
The nature of feedback within systems results in different types of potential outcomes for that system. Stabilising feedback may result in tendencies towards equilibrium and may give the system inherent resilience. Reinforcing feedback may have the opposite effect, especially if it operates in a non-linear way, leading to chaotic behaviour.
Given that systems can often only be understood in terms of their general behaviour, rather than specific outcomes, understanding whether feedback works to stabilise or amplify the system and whether this occurs in linear or non-linear ways, is perhaps the ultimate goal of systems thinking.
Fractals and Self Similarity
Another property of feedback is the tendency for systems behaviour and outcomes to look similar at various levels of scale. This fractal type behaviour manifests regularly in the natural world in patterns of growth (e.g. tree branches) and erosion (mountain ranges/coastlines). It is also seen in market behaviours. Share prices often appear fractal at different scales – intra day, daily, weekly, etc.
A related outcome is that distributions of outcomes often follow power laws rather than normal distributions. For investors this has major implications for understanding value and risk.
Criticality and Phase Changes
A further derivative of these behaviours is the tendency for systems to self organise themselves into a state of criticality. The standard metaphore being the sand pile where further grains of sand cause “landslides” of various, unpredictable sizes. Markets appear to to organise themselves into similar patterns – what appears a stable market can be a small disruption away from a crash.
Another useful metaphor from systems analysis is the idea of a phase change. In physics the transition of water from solid to liquid to gas represents a classic example. But markets can also be viewed as subject to phase changes – the classic being the switch from positive to negative investor sentiment that defines a bull vs bear market.
Capra and Luisi note that,
“the tension between mechanism and holism has been a recurring theme throughout the history of Western Science.”
The tension is not so overt in investment analysis but is there nonetheless. Portfolio managers tend to focus on the systemic wood whilst stock analysts get lost in the mechanical trees. Strategists adopt top down systemic models to contrast analysts bottom up forecasts. Traders focus on the behaviour of the market systems, analysts focus on mechanical understanding of the company.
As Donella Meadows noted, both parties are seeing something that is there, and successful investors need to be aware of both approaches. Mechanical analysis that works on one scale needs to be incorporated into a systems framework for succesful investing.
Hatua ya kwanza katika kupitisha Suluhisho la Mifumo kwa uchambuzi wa usawa ni kuelewa misingi ya mifumo. Misingi hii inatumika kwa aina zote za matatizo, si tu uchambuzi wa usawa, na inawakilisha mabadiliko ya msingi ya akili kutoka kwa kufikiri kwa utaratibu hadi kufikiri kwa jumla. 1. Uwe na mtazamo wa kweli Katika kitabu chao, The Systems View of Life, ambao sehemu kubwa ya nyenzo hii imetolewa, waandishi Fritjof Capra na Pier Luigi Luizi wanabainisha kwamba kufikiri kwa mifumo ni kinyume cha kufikiri kwa uchambuzi: Uchambuzi unamaanisha kuondoa kitu ili kuifahamu; kufikiri kwa mifumo kunamaanisha kuiweka katika muktadha wa jumla kubwa. Njia kama hiyo mara nyingi hupingana na tabia ya msingi na upendeleo wa taasisi ambao hupendelea uhakika na uaminifu. Hii ni changamoto na fursa kwa wawekezaji katika mifumo ya kufikiri. Tumezungumzia tofauti kati ya mifumo na kufikiri uchambuzi kwa undani zaidi hapa. 2. Uwezekano wa kupata Misingi ya Mifumo Capra na Luisi kuelezea mfumo kama: <unk>a nzima jumuishi ambayo mali muhimu kutokea kutoka mahusiano kati ya sehemu zake<unk>. Kwa mfano, mwili wa binadamu ni mfumo, ndani ya ambayo ni tofauti subsystems (circulatory, neva, misuli, kupumua, nk) kupangwa katika hierarchies mbalimbali mfumo (DNA, seli, chombo). Mtu binafsi kwa upande wake inter-mahusiano na mifumo mingine (wanadamu, wanyama, mimea nk). Katika uwanja wa kijamii, kampuni ni mfumo, ulioundwa na mifumo mbalimbali (uhasibu, usimamizi, shughuli, masoko, nk) kwa upande sehemu ya herarchy <unk> biashara, kampuni, sekta, uchumi. Mfumo huu wa viwanda inter inahusiana na mifumo mingine <unk> kisiasa, asili, kifedha. Mifumo yote ina vipengele vifuatavyo kuu: Hizi ni vitalu vya ujenzi ndani ya mfumo wetu na lengo la mbinu za jadi za uchambuzi. Vitu kuja katika aina mbili, hisa na mtiririko, ambapo hisa kuwakilisha mkusanyiko wa kihistoria au kupungua kwa mtiririko. Hifadhi kutenda kama stabilizers katika mfumo na kama wao ni exhausted uwezekano wa kuongezeka kwa kutofautiana. Katika mfumo wa kampuni hisa ni Cash, PPE, Inventory, Receivables, Intangibles nk.., wakati mtiririko ni Mauzo, Gharama, Cashflow, Capex nk. Katika maana ya uhasibu, hisa ni kumbukumbu juu ya usawa na mtiririko katika P&L au mtiririko wa fedha. Mkataba wa Mkataba wa Mkataba wa Mkataba wa Mkataba wa Mkataba wa Mkataba wa Mkataba wa Mkataba wa Mkataba wa Mkataba wa Mkataba wa Mkataba wa Mkataba wa Mkataba wa Mkataba wa Mkataba wa Mkataba wa Mkataba wa Mkataba wa Mkataba wa Mkataba wa Mkataba wa Mkataba wa Mkataba wa Mkataba wa Mkataba wa Mkataba. Wakati vipengele vya mfumo vinaonekana kuwa sifa yake ya kufafanua, wao si. Kubadilisha vipengele mara nyingi ina athari ndogo juu ya tabia ya mfumo. Chembe za mwili, wachezaji wa timu ya mpira wa miguu, na vifaa vya kampuni, zote ziko katika hali ya mabadiliko ya mara kwa mara, lakini mfumo ambao zinafanya kazi kwa kiasi kikubwa huhifadhi tabia yake. Si vipengele, bali mahusiano kati yao, ambayo ni muhimu kwa kuelewa mfumo. Mawasiliano kati ya vipengele mbalimbali na mchakato ambao mabadiliko katika kipengele moja kulisha katika mabadiliko katika nyingine, ni sifa ya mfumo. "Kama Donella Meadows anasema, ""Mmoja wa ufahamu wa msingi wa nadharia ya mifumo, kama muhimu kama uchunguzi kwamba mifumo kwa kiasi kikubwa husababisha tabia yao wenyewe, ni kwamba mifumo na miundo sawa ya maoni hutoa tabia sawa za nguvu, hata kama muonekano wa nje wa mifumo hii ni tofauti kabisa." Biashara, fedha na uchambuzi wa kifedha ni kamili ya mifano ya aina zote mbili za maoni. Kwa mfano: - Uchumi wa kiwango ni kuimarisha mzunguko wa maoni, kutenda kwa gharama ya chini, kuwezesha kuongezeka kwa sehemu ya soko na hivyo gharama ya chini zaidi. - Ushindani ni kuleta utulivu feedback kitanzi, ambapo mapato ya juu kuvutia mtaji zaidi na kusababisha mapato ya chini. Karibu kila kipengele muhimu cha Uchumi, Operesheni, Soko au Uwekezaji uchambuzi inahusisha kuzingatia loops maoni. Soma zaidi hapa.. Lengo au kusudi Mifumo mingi ina lengo au kusudi. Kwa mifumo ya kikaboni lengo ni kubaki hai na kueneza chembe za urithi. Kwa makampuni, lengo ni (kwa ujumla) kuongeza faida kwa wanahisa. Kuelewa lengo hili ni muhimu kwa kuelewa tabia ya mfumo na jinsi itaweza kukabiliana na mabadiliko. Kampuni ni chombo cha nguvu ambayo itabadilika kwa kubadilisha hali kwa ubunifu wa bidhaa, kuunganishwa, kupunguza gharama nk. Kuzingatia lengo la mfumo husaidia kuelezea tabia nyingi ambazo kwa mtazamo wa kwanza zinaonekana <unk> isiyo ya busara<unk>. Mifumo ya kisiasa hutafuta uchaguzi upya, si lazima uzalishaji wa kiuchumi. Mifumo ya usimamizi mara nyingi hutafuta malipo na nguvu, si mapato ya wanahisa. Mifumo ya ushauri inatafuta ada za ushauri, sio lazima ushauri mzuri. Mpaka au mazingira. Hata katika mifumo ya kufikiri tunahitaji kufafanua mpaka kwa ajili ya uchambuzi wetu. Ingawa kila kitu ulimwenguni kimeunganishwa, haiwezekani kufikiria kila mwingiliano unaowezekana. Kwa hiyo kwa kawaida sisi hupunguza kufikiri kwetu kwa sehemu moja ya mfumo mzima - jani, mti, msitu, mfumo wa ikolojia. Kuna hatari dhahiri katika uchaguzi wetu wa mfumo wa mipaka. Kufafanua sana narrowly na sisi hatari kukosa uhusiano muhimu kwamba kuendesha tabia. Kufafanua kwa upana sana na sisi hatari ya kupata bogged chini katika irrelevance. Sisi kufafanua mipaka yetu kwa kutumia maneno endogenous (ndani ya mfumo wetu) na exogenous (nje yake). Hii kwa upande wake inaongoza kwa imani kwamba mambo ya nje ni wote nje ya udhibiti wetu na haiwezi kuelewa (Black Swans). Mfano wa kawaida wa hii ilikuwa wakati wa GFC wakati Mkurugenzi Mtendaji mara kwa mara alidai GFC ilikuwa tukio la Black Swan lisilotabirika nje ya mfumo. Kwa kulinganisha, wale ambao <unk> alitabiri <unk> GFC kueleweka kwamba leverage na uwiano walikuwa endogenous kwa mfumo kama ilivyoelezwa na Minsky. Utendaji wa Mkurugenzi Mtendaji wakati wa GFC ulikuwa wa kawaida wa rationalists zilizofungwa - wale ambao hufanya uamuzi sahihi ndani ya vizuizi vidogo vya maarifa yao. Mkurugenzi Mtendaji (na wachambuzi) ambao kuangalia tu katika mfumo wa kampuni, kushindwa kuelewa athari pana ya mfumo (kwa mfano Mshindani (mshindani) wa maamuzi yao (kwa mfano kupunguza gharama). 3. Uwe na mtazamo wa kweli Mifumo tabia: mwingiliano wa vipengele hivi matokeo katika baadhi ya tabia ya kawaida na mali ya mifumo: mifumo kuwa na mwelekeo wa kujipanga katika hierarchies tofauti. Mwili wa binadamu, molekuli, makromolekul, organelles, chembe, tishu, mfumo wa viungo, viumbe, viumbe, viumbe, viumbe, viumbe, viumbe, viumbe, viumbe, viumbe, viumbe, viumbe, viumbe, viumbe, viumbe, viumbe, viumbe, viumbe, viumbe, viumbe, viumbe, viumbe, viumbe. Kwa mfano, akili ya binadamu haiwezi kutabiriwa kutokana na kujifunza chembe za mtu binafsi - ni mali ya kiumbe hai. Vivyo hivyo, Viwanda itakuwa na mali tofauti emergent ambayo haiwezi lazima kuwa alitabiri kwa kusoma mambo ya mtu binafsi ya uzalishaji. Usawa na Chaos Asili ya maoni ndani ya mifumo matokeo katika aina tofauti ya matokeo ya uwezekano kwa ajili ya mfumo huo. Kudumisha maoni inaweza kusababisha mwelekeo kuelekea usawa na inaweza kutoa mfumo asili ya uimara. Kuimarisha maoni inaweza kuwa na athari kinyume, hasa kama inafanya kazi kwa njia isiyo ya mstari, na kusababisha tabia ya machafuko. Kwa kuwa mifumo inaweza kueleweka kwa njia ya tabia yao ya jumla, badala ya matokeo maalum, kuelewa kama maoni hufanya kazi ili kuimarisha au kuimarisha mfumo na kama hii hutokea kwa njia ya linear au isiyo ya linear, labda ni lengo la mwisho la kufikiri kwa mifumo. Fractals na Self-Ufanani mwingine mali ya maoni ni mwelekeo kwa ajili ya mifumo tabia na matokeo ya kuangalia sawa katika ngazi mbalimbali za kiwango. Hii fractal aina ya tabia inaonekana mara kwa mara katika ulimwengu wa asili katika mifumo ya ukuaji (kwa mfano matawi ya miti) na mmomonyoko (milima ya milima/pwani). Pia inaonekana katika tabia ya soko. Bei ya hisa mara nyingi kuonekana fractal katika mizani tofauti <unk> ndani ya siku, kila siku, kila wiki, nk. Matokeo yanayohusiana ni kwamba usambazaji wa matokeo mara nyingi hufuata sheria za nguvu badala ya usambazaji wa kawaida. Kwa wawekezaji hii ina athari kubwa kwa kuelewa thamani na hatari. Criticality na awamu mabadiliko ya derivative zaidi ya tabia hizi ni mwelekeo kwa ajili ya mifumo ya kujipanga wenyewe katika hali ya criticality. Mfano wa kawaida ni rundo la mchanga ambapo chembe zaidi za mchanga husababisha "mlipuko wa ardhi" wa ukubwa mbalimbali, usioweza kutabiriwa. Masoko kuonekana kujipanga katika mifumo sawa <unk> nini inaonekana soko imara inaweza kuwa usumbufu mdogo mbali na ajali. Mfano mwingine muhimu kutoka kwa uchambuzi wa mifumo ni wazo la mabadiliko ya awamu. Katika fizikia mabadiliko ya maji kutoka kwa kitu kigumu hadi kioevu hadi gesi inawakilisha mfano wa kawaida. Lakini masoko pia inaweza kuonekana kama chini ya mabadiliko ya awamu - classic kuwa kubadili kutoka chanya kwa hasi mwekezaji hisia kwamba hufafanua ng'ombe-mwitu dhidi ya soko dubu. Capra na Luisi wanasema kwamba, "mvutano kati ya utaratibu na holism imekuwa mandhari ya mara kwa mara katika historia ya Sayansi ya Magharibi". Mvutano si wazi katika uchambuzi wa uwekezaji lakini bado upo. Wasimamizi wa kwingineko huwa na kuzingatia mbao ya mfumo wakati wachambuzi wa hisa hupoteza katika miti ya mitambo. Wasanifu-mkakati huchukua mifano ya mfumo wa juu chini ili kupingana na utabiri wa wachambuzi wa chini juu. Wafanyabiashara kuzingatia tabia ya mifumo ya soko, wachambuzi kuzingatia uelewa mechanical ya kampuni. Kama Donella Meadows alivyosema, pande zote mbili zinaona kitu ambacho kiko huko, na wawekezaji wenye mafanikio wanahitaji kuwa na ufahamu wa mbinu zote mbili. Uchambuzi wa mitambo ambayo inafanya kazi kwenye kiwango kimoja inahitaji kuingizwa katika mfumo wa mifumo kwa uwekezaji wa mafanikio.