LEGO® Serious Play® Rapid Prototyping of Sustainable Investment Funds
What do LEGO and finance have in common? The UM-Ross School of Business and ETLA use the communication, visualization and imaginative power of the colored blocks and connectors to design a new investment vehicle.
As I am about to partake in a UN SDG workshop on financing sustainable development post-Paris, I thought it was worthwhile sharing a one-of-a-kind design experience in sustainability finance.
I recently completed a three year program at the Research Institute of the Finnish Economy (ETLA) as Finnish Distinguished Professor. Under an ambitious $2M. program funded by the Finnish Funding Agency for Innovation (Tekes), my colleague Dr. Antti Tahvanainen and I set out to develop a financing roadmap for green industrial renewal. The project involved partners from industry centers of excellence, economic development groups and equity investors, with an advisory board that included the European Investment Fund (EIF), banking and representatives from the Finnish national government.
The objective was to design, build and test a new multi-asset financing model to engage institutional investors such as pension funds, family offices, sovereign wealth funds and endowments in green growth. Rather than targeting individual companies or projects, the investment target was capital placements in thematic industry ecosystems. The ecosystem is the collective of buyers and suppliers in the value systems that make up emerging green industries, including smart grids, green chemistry and smart mobility. For more detail, please see our 2016 book: Financial Technology for Industrial Renewal.
Visualizing investment concepts using LEGO®
Fund structures or investment vehicles are abstract concepts. They have no physical meaning, but are imbued with characteristics of size, time, risk, return, and management. Given that the complexity of different corporate capital structures (startups, SMEs, corporates) in industry ecosystems needed to be layered on the fund characteristics, we decided on a rapid prototyping exercise.
LEGO® SERIOUS PLAY® is a facilitation methodology created by the LEGO Group, available under an Open Source community based model. Its goal is to foster creative thinking through team building metaphors of organizational identities, experiences, and abstract concepts using LEGO bricks. The value of engaging a student facilitator was driven by the need to break down pre-conceived notions of professionals on the topic, and the requirement to impart a creative visualization component in the exercise that does not necessarily come naturally to those of us who have been done playing with LEGO decades ago.
For example, an 'equity-invested company' should not be represented by a visual of a factory, but by a physical metaphor of a high risk - high return - fast growing enterprise. How do you visualize failure (e.g. recycling bin), growth (e.g. trees and shrubs), investment rounds (e.g. wheels), acquisition (e.g. a ladder), patents (e.g. a pipeline of individual blocks leading to an organized structure), etc... Similar exercises focus on risk and returns, management, and other fund components. The approach allows you to break out of your comfort zone of business and finance speak, and engages others not as versed on the topic.
The rapid prototyping design team was comprised of eight public and private equity analysts, investors, economists, management scientists, supply chain management practitioners, and academics in entrepreneurship. They were led through a series of increasingly complex exercises, starting with individual learning how to express abstract concepts into visually representations of Fund components and structure.
Integrating investment concepts into fund designs
After the team members learned how to respond to individual challenges, the second session was based on team builds. The overall challenge of this exercise was to integrate and manage the risk/returns of companies and bonds that become part of the multi-asset fund.
How would such a portfolio be structured and managed? What is the pipeline of deal flow? How will due diligence be conducted? What is the allocation strategy that aligns with risk and return profiles of the targeted investor? What is the management and cost structure of this type of fund? How should it be classified from a regulatory perspective? What is the role of public financing to de-risk private investments through first-loss guarantees or other risk underwriting?
The chart shows that, as opposed to the individual builds, the fund is represented with a lot more connectors between the asset class segments, the management, and the risk assessment/due diligence activity. The connectors represent financial data flow, information flow, and allocation or buy/sell decision feedback loops.
The spirited discussions around the design exposed the tension between economists, management scientists and investors, and centered on the (types of) data used for decision-making, and the fundamental portfolio (theoretical or case-based) underpinnings that guide the investor and company management team.
Building & testing the fund: Generating 'alpha' from asset diversification and ESG value
An early blog on the outcome of the fund design attracted attention from Deutsche's product development team in London, with whom we organized a 'tear down' session. The objective was to understand 'real world' constraints' placed on asset allocation, buy/sell decisions, and investor engagement strategies. Follow up meetings with pension funds' alternative asset managers further informed the design and asset allocation.
Actual allocations of companies from the Finnish mobility ecosystem in the private credit and private equity asset classes, combined with global assets selected for the thematic ETFs and bond segments indicated that the funds exhibited risk similar to high yield US/EU bonds with returns tracking listed private equity. Minimum volatility portfolios using companies and bonds in the new mobility space yielded 7.7%, while maximum Sharpe ratio portfolios returned 10.5%
A $500M. new mobility multi-asset renewal fund (MARF) comprises investments in nearly 80 growth companies, SMEs and corporate indices. The lack of correlation between the asset class segments (high diversification) was found to exhibit significant alpha, mainly in the risk (VaR, volatility) profile of the fund. Though not explicitly calculated, environmental benefits from the shared access economy in mobility have the potential to confer additional alpha.
Additional funds focused on smart grids and green chemistry in Finland, as well as sustainable water use in the US (The Great Lakes & St. Lawrence Blue Growth Fund) are under development.
Learnings from LEGO Serious Play® facilitation for green finance use cases
The application of LEGO® Serious Play® facilitation to design, build, and test new investment funds was shown to be effective in a number of respects.
First, it engaged teams with broad expertise to contribute to the development of fund intentionality and conceptualization. Second, it allowed individuals without financial expertise (undergraduate interns, management and academic consultants) to partake. Third, the use of metaphors and connectors resulted in the democratization of talking points about the fund. Four, the rapid prototyping results in cost reduction of financial product development, as 'white spaces' in the fund's tactics and operations can be rapidly teased out and addressed.
Derivative effects are considerable, from educating students and non-specialists in the field of finance, to the development of financial innovations that will help scale and accelerate green growth. Indeed, the MARF concept has been included in green public financing strategies, and has been presented at UN SDG (sustainable development goals) finance meetings. More recently, LEGO facilitation has been integrated in a course on Sustainability Finance at The University of Michigan to engage engineers, scientists and policy students in finance.
Facilitation participants: Sven Adriaens (facilitator), Antti Tahvanainen (ETLA, Finland; Corymbus), Tim Faley (UVI, US), Timo Seppala (Aalto University, Finland), Weidi Sun (Yinling Capital, China), Peter Adriaens (Ross School of Business; Corymbus); Alex Mercier (Wavestone, UK); Nelli Valmari (ETLA, Finland).
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