How to Make Rational Net Zero Decisions

How have portfolio optimisation approaches changed in 70 years?

There have been three generations of portfolio optimisation approaches. The first two assumed market professionals to be rational by default. But we now know better - that none of us is made for the market complexity we have created. The third generation is now taking that into account by respecting behavioural considerations in decision making. Academia has explored around 200 different heuristics and biases that investors are potentially exposed to, and our socialisation has formed a subset that can trigger every single one of us.

Why do we need to be rational to reach net zero? 

The price of reaching net zero carbon emissions (the investment reallocation necessary in order to get there) sums up to $150 trillion USD. This is an unprecedented measure in terms of capital redeployed. This means we need to integrate the profit motive and impact motive in each investment decision, something which our industry is far from capable of doing.

This means:

• All financial decisions will need to take climate change into account in order to integrate profit and impact motive
• Capital redeployment towards net zero requires the most evidence-based investment decisions
• Investors need to establish an adaptive mindset that supports them in making the most evidence-based investment decisions repeatedly

Why is making rational decisions difficult?

Every one of us has a resistance to change – and that comes into play here in a financial context. We find it much easier to stick to our understanding of how things work than to embrace a different way of thinking and acting.

In terms of making rational investment decisions, we find it far simpler to follow our own personal knowledge of how the market looks and works than to adapt to how the market has changed.

The investment decision quality in our industry remains undeniably low, with investors unable to distinguish between skill and luck in their decision outcomes. When it comes to reaching net zero for the sake of the planet’s health, it’s plain to see that it is a rational course of action. However, it remains hard for us to behave rationally when it comes to all the smaller decisions needed to get there. 

What are the seven hacks for rational decision-making?

1. Use causality assessment techniques

Using our flow state well means to select the right assessment tools for our market analysis. Different complexity levels require different tools. Your toolbox should prefer uncertainty over risk assessment techniques to causally comprehend pieces of evidence.

2. Use storytelling

Building symbolic descriptions of relations and events is something that not only feels satisfying to us, but which also comes naturally. We can make use of that by stringing the evidence sourced together into a story with causal plausibility. This makes it easier for you and your team to comprehend whether or not your market assessment makes sense.

3. Avoid multitasking

Our brain is limited in consciously processing our observations, which allows us to either read or listen. If you try to do both, it will cost you 10 to 15 IQ points. You should aim to create a work environment that allows you to consciously process tasks in a serial and not parallel way.

4. Create a set of decision rules

At universities, we learn how to learn. Extending that, as professionals we need to learn how to decide. Build a routine for how to go about sourcing evidence, weighing up its relevance and culminating these insights at the decision point. 

5. Craft your upskilling routine

The half-life of your financial knowledge is between 5 and 10 years. Embrace the upskilling journey to keep the tools in your inventory sharp and relevant.

6. Incentivise rational behaviour

It holds true that incentive trumps ethics every time. Help yourself by incentivising rational investment decisions through the practice of gratitude, by allowing yourself to rest and/or by ensuring skin-in-the-game attached to your performance targets.

7. Surround yourself with high performers who think differently

None of us are intellectually capable of fully comprehending market complexity by ourselves. Still, working in investment teams can often be dysfunctional as it can be more about who is the loudest, the most dominant, the most extroverted when it comes to who wins the argument. Here’s what can be done instead:

• Select a cognitively diverse group of high performers
• Incentivise them to act as constructive challenger stones. The ideal person likes you, but does not care about your feelings