Overview – Inherently Safer Design and Investing
Imagine you’re a home builder, and you recently got a client who wants to build a cliffside home facing the ocean.
Of course, a home built in such an area presents unique challenges. For example, assuming the specific area of the cliff being built upon is made of dirt known to get loose in damp conditions, extra precautions and safety features must be taken so that the home doesn’t fall off the cliff when the soil gets excessively wet or when there’s an earthquake.
Because of the unique risks associated with such a location, additional time, effort, and money must be spent to ensure nothing goes wrong.
That being said, all these extra costs could have been avoided (or at least greatly reduced) if the client agreed to have their home built not so close to the cliff’s edge while still maintaining a reasonable view of the ocean, or to have their home built on a different part of the cliff with more bedrock underneath the dirt.
Sometimes, the best way to minimize risks is to take certain actions or make certain decisions that circumvent having to deal with such risks in the first place. Why choose a more treacherous path when you can go on a safer one while still achieving the same, or approximately similar, outcome?
This notion of making a conscious decision to avoid risks in the first place is called Inherently Safer Design, and it is a key design consideration in engineering. If used properly, the principles of Inherently Safer Design can also be applied to investing.
What is Inherently Safer Design?
You may already have some idea based on the name, but Inherently Safer Design (ISD) is an engineering safety philosophy that guides engineering design such that safety is built-in or, put another way, risks are built out.
The Center for Chemical Process Safety (CCPS) defines ISD as follows:
A way of thinking about the design of chemical processes and plants that focuses on the elimination or reduction of hazards, rather than on their management and control.
Inherently Safer Design’s logic is “instead of having to live with a certain risk, why not engineer something so that the risk isn’t a problem in the first place?” This train of thought may seem simple, but if implemented correctly can prove to be quite powerful (as we will discuss later on).
Going back to our earlier discussion, the cliffside home becomes a lot safer if it wasn’t so close to the edge, or if the foundation beneath the house had more rock. Instead of having to deal with the risk of the house going over the edge, that risk can be eliminated entirely just by making some key design decisions.
The Aspects of Inherently Safer Design
Inherently Safer Design can be broken down into four aspects:
- Eliminate/Minimize: Whenever possible, if there is a hazard present and it can be removed, then remove it.
- Substitute: If a hazardous material or piece of equipment can be swapped out for a less hazardous option, then do so.
- Moderate: If a process doesn’t need to run at maximum conditions/quantities to achieve a desired result, then don’t.
- Simplify: If a seemingly complicated process has the potential to be simplified, then do so.
It’s easy to think that these elements can be “ranked” and that there is some sort of hierarchy, but there is none. That’s because not all of these elements will be applicable in all scenarios, and even if they were, all of them serve different roles, so it’s very difficult, if not impossible, to make a fair comparison between them.
Of course, these elements can certainly be used in unison, and the more elements used together, the better.
The Power of Inherently Safer Design
Now that we know what ISD is and what its aspects are, this naturally leads to the big question of “what exactly makes ISD so powerful?” The answer can be demonstrated by way of example, of which there are many.
Imagine you’re operating a chemical plant that features some dangerous elements, such as reactions that take place at high pressures and temperatures, as well as the presence of highly toxic chemicals. Because of these risks, an abundance of safety measures are in place: computerized monitoring overseen by highly-trained technical staff, numerous redundancies in safety-related equipment, and countless standard operating procedures pertaining to the start-up, shutdown, and maintenance of these high-risk elements.
While these safety measures are necessary, what if you learned that you could achieve similar production yields, albeit taking longer, simply by lowering the operating pressures and temperatures? If that isn’t an option, then perhaps the chemicals being used can be substituted with less toxic alternatives. These relatively simple design choices have the power to bring the risk of disastrous failure and serious injury down significantly.
Many communities impose reduced speed limits near high-risk areas, namely schools and playgrounds, as a way to promote safety. While this may be a nuisance for some drivers, this is, in fact, a form of inherently safer design, most specifically an application of “moderate”.
Because of how kinetic energy is calculated, an increase or decrease in speed results in an exponential change in energy. Assuming they have roughly the same mass, a car traveling at 40 km/h will have almost double the amount of kinetic energy of one traveling at 30 km/h. That 10km/h gap can mean the difference between a pedestrian surviving a collision or not. Additionally, this also gives drivers a chance to brake sooner in the event someone unexpectedly darts onto the street.
This simple reduction in speed has the potential to keep hundreds, if not thousands, of people safe.
From these two examples alone, we can clearly see the power of inherently safer design: its ability to reduce the need for active risk management measures.
Having a robust risk management framework is important, yes, but it is something born solely out of necessity. The problem with such frameworks is that they involve time, effort, and oftentimes, money. Depending on how many risks need to be monitored, the expenditure needed to effectively keep an eye on and contain them can vary significantly.
Although a properly structured risk management framework can be very effective, they are imperfect, and being overly dependent on it could prove to be a major mistake when a risk slips through the cracks and ends up materializing (known as the “Swiss cheese” model).
ISD aims to reduce that dependency and instead takes a proactive approach of making sure certain risks aren’t an issue to begin with. In doing so, risk management becomes a lot simpler, saving time, effort, and oftentimes, money, in the process.
How ISD Can Be Adopted to Investing
There are many factors that play a role in an investor’s success (or failure), and one of them is the decisions they make. It’s no exaggeration to say that an investor can live or die based on what they decide to do.
At its core, Inherently Safer Design is all about making smart decisions such that certain risks can be avoided entirely or at least significantly reduced – the ultimate goal is to minimize the dependency on active risk management. Based on this broad definition, and the fact that investing relies so heavily on judicious decision-making, ISD is most certainly applicable for investing purposes.
If a large portion of your equity investments are tied up in a highly volatile industry, then perhaps you can reduce the amount of capital you have tied up in it, or switch over to another industry that won’t collapse at the drop of a dime. In doing so, you eliminate the need to constantly monitor developments in that volatile industry like a hawk.
Say you have a portfolio comprised of investments from all around the world, yet the lion’s share of your holdings are tied up in one country. Political theatre, questionable policy decisions, or one of countless other national developments have the potential to adversely impact your portfolio, and will be amplified the larger your stake in this country is.
By minimizing your stake in this country and instead spreading your capital around a bit more, you no longer have to worry about every economic or political happening that takes place on a regular basis.
There are many ways to implement ISD in investing, and the only limiting factor is arguably an investor’s creativity and personal circumstances.
No matter how many examples we go over, the same lesson is made clear: Inherently Safer Design doesn’t need to be overly complicated for it to be effective. Many times, the simplest solutions are ones that lead to the most inherently safe portfolios.
Implementing ISD Means Accepting Certain Trade-Offs
When properly implemented, Inherently Safer Design is a very powerful tool – the examples we’ve looked at are a testament to that. However, it would be disingenuous to say that there are no drawbacks to it.
As was mentioned previously, ISD is all about making smart decisions. However, every decision will always come down to what you’re willing to give up in order to gain something you feel will be more beneficial. ISD isn’t spared from this reality.
Perhaps you’re familiar with the popular investing mantra of “high risk, high reward”. While this isn’t exactly true (i.e., high returns don’t require investors to take on exorbitant amounts of risk), there is some element of truth to this. Although ISD eliminates the dependency on active risk management measures, there are still some things that may be lost by giving up risk.
Going back to our example earlier of running a chemical plant, running certain reactions at lower temperatures/pressures and using less toxic chemicals could make it inherently safer, but in doing so may lower reaction yields, increase the quantity of required feed material, or prolong reaction times, all of which could ultimately lead to higher operational costs.
Keeping a large portion of your investments tied up in a single country may be an issue down the road, but you may be reducing your stake in some very solid investments by withdrawing from that country, and there’s no guarantee of finding suitable replacements in other countries you look at.
When deciding to pursue one course of action, this usually means giving up certain alternatives as well. Such is the reality of decision-making, and is something investors will need to keep in mind if they wish to make their portfolios more inherently safe.
“Inherently Safe” Does Not Mean “Risk-Free”
Up to this point, we know that the power of Inherently Safer Design is its ability to reduce dependency on active risk management measures. In doing so, there’s the potential to save time, money, energy, and future headaches in the process.
However, despite the power of ISD, risk cannot be removed entirely. By extension, because some residual risk will always be present, ISD does not eliminate the need for active risk management entirely – it only reduces dependency on them.
You could have the most inherently safe portfolio, but there will always be the risk of losing your money, whether this risk is within your control or not.
Therefore, risk management will always have a place in investing, but the less dependent you can make your portfolio on active risk management, the better.
Wrapping Up
Risk management plays an integral role in ensuring certain risk factors don’t materialize into something serious. However, this doesn’t mean steps shouldn’t be taken to try and minimize the need to have risk management procedures in place. Inherently Safer Design aims to reduce that dependency.
If implemented correctly, Inherently Safer Design can eliminate, or at least greatly reduce, certain risks, which subsequently means time and resources no longer have to be spent on active risk management.
When applied to investing, this can prove to be a very powerful tool – the fewer risks an investor needs to keep tabs on, the better. This means investors can allocate their time and energy towards more productive endeavours instead of worrying about certain risks all the time.
Despite its power, Inherently Safer Design does not eliminate the need for a risk management system entirely. Even the most inherently safe portfolio will still have some residual risk that needs to be monitored. Additionally, making a portfolio more inherently safe means certain trade-offs will need to be made. Whether those trade-offs are worth it is dependent on what an investor is trying to achieve.
