What does it take to change a system?
We live in a highly interconnected world and currently face multiple interdependent crises affecting both human society and our host planet.
Over half of the 1,500 global experts surveyed through the World Economic Forum, “anticipate a significant degree of instability and a moderate risk of global catastrophes” in the next two years. Such systemic risks impact long-term investment returns across all asset classes in ways traditional risk management is not accustomed to addressing.
Systemic risk (like climate risk, for example) will affect all industries and all asset classes. This means that a fund cannot diversify away from climate risk – there is no place to hide. Funds must therefore take all feasible steps to minimize the long-term risk of climate change itself, rather than simply manage risks for their individual portfolios. Source: Burckart, W., & Lydenberg, S. (2021)
While sustainable investors incorporate some forward-looking investment strategies, they often do not fully address complex system-level risks. They may assess their portfolio based on carbon emissions and gender diversity to reflect their values, however, this approach lacks consideration of the interconnections within the system, and subsequently misses the opportunity to create a more sustainable and equitable future.
Investing in systems shifts resources from one approach to another. The way capital gathers and moves within a system significantly prompts the people's behavior in that system.
When we say systems, we are talking about those large social, financial, and environmental foundations of society necessary for any successful investment. At the broadest levels, social systems include healthcare, food and water security, fair employment, freedom of expression, consumer safety, economic and environmental justice, and education and training. Financial systems include fair and honest markets, access to basic services, and transparency of data. Global environmental systems include climate stability, natural resources, oceans and freshwater, forests, and arable land. These large systems are in turn made up of subsystems. All are interconnected and ultimately impact one another. Source: Burckart, W., & Lydenberg, S. (2021)
Recognizing that investors are looking for a better way to create impact from their portfolios, I facilitated a conversation on systemic risk and systems change with John Hoeppner, Bruno Bertocci, and Steve Lydenberg at the US SIF Forum 2024.
Here’s what I learned the investment community can do to spur shifts in the system:
Make the desired outcome clear – Clarify that you are prioritizing medium- and long-term risk-adjusted returns and committing to a quantifiable change in the system. Make sure your Investment Committee and Stewardship team are aligned on the outcome. This will act as the compass for all decisions.
Find the right tools to address systemic risk – Portfolio-level risk is different from systemic risk, therefore so are the tools you will need. Systemic risks arise on the macro level and create an impact on your portfolio across all asset classes. Your approach may include engaging in public policy – something you may not do when tackling portfolio-level risks.
Don’t go at it alone – Foster partnerships and be collaborative but focus your actions on areas where you can exert the most influence. This approach will help prioritize your activities.
The panelists identified these simple steps to start:
Pick an issue: You can’t do it all – prioritize the system you want to influence and map out the pain points and the linkages with other systems.
Benchmark your portfolio. For example, when addressing climate change, benchmark with a climate risk index and identify the biggest emitters in your portfolio. You can then create a strategy for managing those biggest emitters – divest or engage them.
Expand the list of metrics and apply a long-term horizon. System changes take time and require consideration of other subsystems. When considering weather systems, for example, water and deforestation are also essential to map out.
Set a minimum threshold for the issues you are trying to influence in your portfolio and utilize these minimum thresholds to engage with lagging entities. For example, set a minimum number of women on boards when considering diversity.
Seek out others addressing the same system and collaborate with them. Organizations like FAIRR Initiative address the global food sector. At the same time, the Predistribution Initiative (PDI) supports investors in co-creating investment structures and practices that share more wealth and influence with workers and communities.
Dive deeper, and check out these panelists' referenced resources:
CFA Institute’s Net Zero in the Balance: A Guide to Transformative Industry Thinking.
LGIM’s Climate Impact Pledge commits to an annual engagement program to raise market standards and encourage companies to play their part in achieving the goals of the Paris Agreement.
TIIP’s Systems Aware Investing Launchpad (SAIL), a “one-stop shop” for answers to fundamental questions, practical tools, and support for implementing system-level investing.
ImpactARC highly recommends this book: 21st Century Investing: Redirecting Financial Strategies to Drive Systems Change, by William Burckart and Steve Lydenberg.
At ImpactARC, we collaborate with others to design systems-level solutions. Reach out to verify if your portfolio creates systems-level impact: monika@impact-arc.com.