#45: Is There a Conflict Between Superior Investment Returns and System Change Leadership?

Concerns about reduced profits and investment returns are a main barrier to system change. Over time, implementing sustainable systems could reduce returns. For example, holding companies responsible for harming the environment and society and prohibiting wealth concentration through inappropriate government influence and other unjust means could restrict profits. Nevertheless, corporate system change leadership can enhance short-term and long-term investment returns. This post discusses how.

The Inevitability of System Change

Reductionist economic, political, financial and other systems fail to hold companies fully responsible for harming the environment and society. This often makes it impossible to voluntarily stop harm in competitive markets. If companies try, their costs frequently increase, and they ultimately go out of business.

Flawed systems that unintentionally degrade the environment and society inevitably will change through voluntary or involuntary means. For more than 100 years, companies could profit by harming the environment and society. But at some point, this becomes impossible. As shown throughout history, rising negative impacts collapse harmful systems if they are not voluntarily changed first.

Rapidly growing environmental, social, economic and political problems show that we have entered another phase of system change. System collapse will wipe out many companies and investments. Investors and companies are far better off working to drive collaborative system change. But how can this proactivity enhance short-term and long-term returns?

Short-term Outperformance

SCI is an enhanced measure of corporate sustainability. It expands ESG by adding system change metrics. Current ESG and corporate sustainability approaches have not resolved major challenges because they are focused on about 20 percent of the sustainability solution. They mainly seek to change companies and address symptoms, such as climate change.

System change is at least 80 percent of the sustainability and Sustainable Development Goal (SDG) solutions. Companies largely do what systems demand. Improving flawed systems is the most important action needed to achieve the SDGs.

SCI enhances short-term performance in essentially the same way as ESG. Over the past 25 years, extensive research showed that ESG leaders frequently outperformed. Two main reasons for this are assessing financially relevant risks and opportunities and the proxy value for management quality.

ESG addresses relevant risks and opportunities that are ignored by conventional financial analysis. This can reduce risk and increase returns. More importantly, ESG performance is a strong indicator of management quality, the primary driver of investment returns. Sustainability is a complex management challenge. Companies that do well in this area implicitly have the sophistication to excel in other areas, and thereby achieve superior financial performance.

The same logic applies to system change. SCI assesses financially relevant systemic risks and opportunities that are not adequately addressed by conventional financial and ESG analysis. In addition, system change is a more complex challenge than sustainability, and therefore a stronger indicator of management quality and stock market potential.

Sophisticated companies understand that continuing to profit by harming the environment and society will not be a viable strategy for much longer. They also realize that they cannot unilaterally end environmental and social harm and remain in business. Improving flawed systems before they collapse is essential for protecting business, investors and society.

These sophisticated companies work with others to evolve systems in a minimally disruptive manner. They also often do many other things well and thereby earn superior returns.

Taking corporate system change performance into account when investing can reduce risk and increase returns immediately. As a result, there is no conflict or tradeoff between short-term returns and system change leadership. As with ESG, there frequently will be a high correlation.

Long-term Outperformance

Systems that unfairly concentrate wealth and degrade the environment and society inevitably will change, probably soon. These systems violate the laws of nature. They are the root causes of climate change and nearly all other major challenges.

Flawed, unintentionally destructive systems will not continue in current forms much longer. Either they will collapse and cause major disruption, or we will figure out how to evolve them into forms that abide by the laws of nature, and thereby can endure over the very long term.

Under sustainable systems, overall returns might be lower as companies are prohibited from harming the environment and society and public wealth is fairly distributed. But well managed companies will continue to earn relatively higher returns. System change leaders will outperform over the longer-term because they are more sophisticated and better managed.

For more information about SCI, visit our website SystemChangeInvesting.com or listen to this recent SCI podcast