That more investors care about the impact of their assets is evident from the US$17 trillion that has flowed into a range of sustainable investing strategies globally, reshaping investment management as firms scramble to meet their needs.
But some pioneers of approaches that emphasize environmental and goals are thinking bigger, towards what they are calling system-level investing. That is, investing with an awareness that capital allocations can have big impacts on environmental, social, or financial systems, and that these systems are complex and interconnected.
Sustainability consultant William Burckart began considering the shift to a systems change approach after exploring whether greener, more socially responsible portfolios were actually creating broad, complex change.
“I often came down to this conclusion of, ‘I don’t think we really are,’” says Burckart, president and chief operating officer of the Investment Integration Project (TIIP), a Massachusetts-based thought-leadership and investment consulting firm.
Steve Lydenberg, TIIP’s founder, meanwhile, was questioning the ability of investments in sustainable public funds and companies to produce meaningful, transformational change. Lydenberg, who is also partner, strategic vision of Domini Impact Investments, began researching corporate social and environmental performance in 1975 and was a co-founder of KLD Research & Analytics (bought by MSCI in 2010).
Both Burckart and Lydenberg began to think that “there had to be a better way to do this,” Burckart says. They came to understand that the health of big societal, environmental, and financial systems affects long-term investment performance, and vice versa, “that the decisions of investors, individually and collectively, have an impact on the health of these overarching systems,” Burckart says.
“Until we start to understand the feedback loops between investors in these systems, we really won’t be able to drive that transformational change that we’re looking for, that ultimately results in more resilient, more stable systems,” he says.
In April, Burckart and Lydenberg published 21st Century Investing: Redirecting Financial Strategies to Drive Systems Change, a book offering individual and institutional investors guidance and tools to broaden their approach to sustainable investing to the system level.
Penta recently spoke with Burckart about the evolution of system-level investing, and how to put this approach into practice.
Onramps to the System-Level Highway
Existing sustainable investment strategies, such as the integration of environmental, social, and governance practices, universal ownership (the idea of tying investor assets to the health of the economy by owning a cross-section of securities in all asset classes), and investing to have a direct positive environmental or social impact are “shades of trying to aspire to that broader thing, but they don’t reach it,” Burckart says.
These approaches, which largely impact single portfolios, can serve as onramps, however, he says. Investors can get on the “systems highway” when they shift their approach from being portfolio-centric, to trying to “fundamentally solve a problem,” Burckart says. Or when investors work together to influence other investors or regulatory bodies.
Even the biggest pension fund in the world—Japan’s Government Pension Investment Fund (GPIF)—which has taken a universal ownership approach —can’t solve big societal, environmental issues alone, he says.
“A lot of the techniques that we as the sustainable impact investment crowd have been using—they don’t necessarily work on their own, or aren’t necessarily the right things if you’re trying to address the fundamentals,” Burckart says.
The unseating of three Exxon Mobil directors in favor of those with experience in transitioning to clean energy started with a hedge fund, Engine No. 1, but it was fueled forward by several investors, including members of the Climate Action 100+, an initiative of 575 institutional investors that had flagged the vote to its members.
“That happened because investors got organized, and they started to work collaboratively,” Burckart says.
A Road Map for Change
The book authors outline a six-step process that investors can follow to engage in system-level change and it begins with goal setting. For system-level investors, these goals go beyond one’s own portfolio concerns to influencing the underlying fundamentals to the benefit of all investors, according to the book.
The approach is distinct from simply investing in companies with the best environmental practices, for example. “A lot of folks think, well, ‘I’m a sustainable investor, I’m an impact investor, I’ve been doing parts of this,” Burckart says. But the question is, “Have you been doing it comprehensively and doing [many] of these things? Have you been doing it so that it’s aligned with the actual purpose that you’re trying to solve?’”
A second important step is deciding where to focus. “Not every issue rises to a system level,” Burckart says. Investors need to consider whether the issue—such as fresh water or income inequality—has broad consensus as a global issue, and is relevant because it can affect portfolios across industries and asset classes.
They also should ensure that it’s an issue that investors can influence, according to the book, and whether the issue is generating uncertainty. Climate change is a great example of an issue that creates uncertainty, as no one knows what the full implications of the changing climate will be to the environment and society if it’s not addressed.
The other steps are: allocate assets to create system-wide social and environmental benefits; apply investment tools to create system-wide norms around social and environmental standards; use tools to manage systemic risk and rewards—such as field building; and evaluate results by assessing the consistency of the beliefs and actions of investment managers.
A New Standard Already Underway
21st Century Investing is filled with examples of institutional investors and foundations that have employed elements of system-level investing over the years. An example is the F.B. Heron Foundation, a New Haven, Conn.-based private foundation that began moving 100% of its endowment to investments that met its community economic development goals in 2012, a process that led to creating a U.S. Community Investing Index of publicly traded companies.
Another step in this direction is the U.K. Stewardship Code, which includes a directive to asset managers to consider systemic risks. Other countries are looking into similar directives, Burckart says.
And there are associations, including the CFA Institute, which came out with a report in December 2020 that discussed the need to elevate sustainable investment to consider systems thinking.
A systems focus, Burckart says, is “an acknowledgment of complexity.” It’s understanding that climate change affects not just the environment, but income inequality and health systems.
“All these things are super interconnected,” Burckart says. “They’re complex in the sense that they’re constantly changing. They’re interconnected, so there’s constantly interplay between the issues, and there’s this long-term aspect to it that if you’re going to really drive sustained change, it happens over a longer period.”