Systems Frame – The Interconnected System
In the opening chapter of her book, Thinking in Systems, Donella Meadows relates the ancient Sufi story of a village full of blind men who were visited by a King with an elephant. A number of blind men rush out to grasp the elephant, eager to understand it. Each grabbed something and thought he knew the nature of the beast;
The man who felt an ear said “it is large, rough, wide and broad.”
The man who felt the trunk said “it is like a straight and hollow pipe. Awful and destructive.”
The man who felt the legs said “it is mighty and firm, like a pillar.”
This parable neatly demonstrates the difference between understanding the mechanistic parts that make up a system and understanding the holistic nature of the system. In their book, “The Systems View of Life” Fritjof Capra and Pier Luigi Luisa note that this “tension between mechanism and holism has been a recurring theme throughout the history of Western science”.
For example, Biology has been characterised by a debate between the Reductionists who sought to explain everything via the principles of physics and chemistry and Organismic biologists who believed these factors alone were insufficient to explain the phenomenon of life. The discovery of the genetic code was a triumph of reductionist Biology, however, “it seems evident that the primacy of the gene as the core explanatory concept of biological structure and function is more a feature of the twentieth century than it will be of the twenty-first”.¹
Traditional equity analysis has also been developed using a mechanical, reductionist approach, based on bottom up company analysis. Start with the elements – balance sheet, cash flow, business model and from there aim to develop an understanding of the valuation, which should ultimately be reflected in the market price. Indeed, approaches that adopt a more holistic view of markets to include behavioural aspects such as changes to expectations, investment flows, risk preferences, are often dismissed as being purely momentum driven.
The premise of this website is that both views are important. In order to understand, and hopefully exploit, the behaviour of the system, it is necessary to understand not just the individual elements of the system, but also the inter-relationships between these elements. As Donella Meadows notes:
“I don’t think the systems way of thinking is better than the reductionist way of thinking. I think it’s complementary, and therefore revealing. You can see some things through the lens of the human eye, other things through the lens of a microscope, others through the lens of a telescope, and still others through the lens of system theory. Everything seen through each kind of lens is actually there.”
The essence of the Systems Frame is therefore about understanding how to link the behaviour and understanding of individual parts and how to interpret the system as a whole. We will examine this frame through the following topics:
- The Nature of Systems – The Basic Tools of Systems Thinking and Behaviour
- Implications of Systems – Applying these tools to Equity Analysis and Investing.
- Context in Systems – Putting analysis in context