We usually select investments analyzing two factors: potential profitability and potential risk. There is a relationship between a good investment and its complexity rating. The common way to look at this point is joining the complexity rating to risk. We know that a more resilient business is stronger under unexpected events. As there is a direct relationship between the complexity rating and resilience, we can understand easily that a good resilience (or complexity) rating implies a lower risk investment.
But this is not the only point to consider. Portfolios of low complexity investments are overcoming the general index of most financial markets. This is showing that complexity rating must be related to profitability too.
How can we analyze this? Well, I am going to put you some example: when you want to analyze the value of a business in order to sell or buy it, you know that the value on the accountancy will not define the final price; there is an additional component that we name goodwill.
Goodwill can be broken down into several parts:
- General goodwill that reflexes the general image of the company, the use of trademarks, its notoriety, and so on.
- Commercial goodwill related to clients’ attitude, location of facilities, advantages of products, and so on.
- Industrial goodwill related to adequacy of facilities, technical staff, salary policies, and so on.
- Financial goodwill related to the attitude of providers, banks and investors towards the business.
- Political goodwill related to the experience of the managing staff to create a positive image for public organisms collaborating in political actions.
- Technical goodwill due to the use of a certain advanced technology, production procedures and their relationship with those ones of the competition.
When we want to determine the value of a business we need to evaluate all these factors too, but these factors are contributing to the complexity of the business. For instance, the more positive the clients’ attitude, the lower the complexity to run the business. Then, the complexity of a business is a function of all these factors that we use to define the value of a business. The higher the goodwill, the lower the complexity and the better the resilience rating.
The use of low complexity portfolios is a proper way to have a portfolio of high value assets because there is a clear relationship between the goodwill and the complexity.