#4: Beyond conventional wisdom: Exploring the benefits of SCI

This last post of our introductory series lays out why and how SCI provides the highest possible sustainability benefits and risk mitigation, while enhancing investment returns.

Let’s dive right in. Currently we see two major and largely ignored elephants in the room that prevent resolution of today’s major challenges:

• Complexity

• Structural systemic risk

SCI addreses them head on.

Let’s start with complexity. We often hear, yes, we see there are problems with our underlying systems, but it’s far too complex to effectively address. It’s true, complexity is a main barrier to system change. To illustrate, changing the US political system can seem extremely difficult, if not impossible. And yet, changing economic and political systems is essential for ensuring the long-term survival and prosperity of business and society.

Companies largely do what economic and political systems demand. These reductionistic systems unintentionally compel all companies to degrade the environment and society. They are the root causes of climate change and other major challenges.

There are many specific economic and political system flaws that compel harm. They all could be rolled up into the meta-flaw of failing to hold companies fully responsible for negative impacts. In competitive markets, this makes it impossible for companies to stop harming the environment and society and remain in business. Consequently, the structure of these systems poses by far the largest risk to investors (i.e. structural systemic risk).

And the problem with that is:

• Mainstream and responsible investing primarily focus on company-level risks, while taking the structure of economic, political and financial systems for granted.

• By failing to adequately address structural systemic risk, current approaches place investors at rapidly growing risk and fail to resolve major challenges.

Awareness is growing in the pension fund community that current scenario analysis and risk mitigation strategies are inadequate. This potentially could be a breach of fiduciary duty and thereby create personal liability for directors. Advocated solutions include using ecological models to better assess climate risks, and then shifting investments from brown to green companies. This can provide short-term benefits.

But it does not address structural systemic risk. To illustrate, climate change is not a structural risk. It is a symptomatic risk. The root causes of climate change are the flawed systems that compel companies to cause it.

Bottom line: Effective investment risk mitigation must address structural systemic risk. SCI does this by focussing on root causes, not symptoms. It is the first true full risk mitigation investment strategy.

Getting back to complexity. SCI effectively addresses this primary system change barrier by greatly narrowing the focus. SCI models are based on necessary systemic changes. But they do not seek to drive them directly. Instead, SCI narrowly focuses on particularly effective acupuncture points – assessing corporate efforts to change systems at the sector and overarching system levels. It is a form of indirect system change. Shifting investments to system change leaders strongly incentivizes companies to directly drive system change.

Let’s recap:

• Yes, system change overall is broad and complex, but it needs to be tackled. By taking a targeted and narrow approach, SCI is able to effectively drive system change indirectly.

• It is also relatively easy to implement. It enhances ESG approaches that nearly all large asset managers already are using by adding system change metrics. Ease of implementation enhances SCI’s power to drive systemic change.

• Broad capital market applicability (every company can be rated on system change performance) and extensive sustainability and financial benefits further enhance it.

• By addressing root causes and system change (i.e. structural systemic risk), SCI provides the highest possible sustainability benefits. This enables asset managers to attract new investment and position themselves as global responsible investing leaders.

The best that current responsible investing can do is slow the rate of environmental and social descent (because it mainly focuses on company change and symptoms). SCI has the potential to reverse environmental social decline and achieve the SDGs because it expands the focus to include system change and root causes.

But of course we don't want to forget about the superior financial benefits of SCI - here they are:

• Increasing financial returns by assessing systemic risks and opportunities that are not addressed by conventional financial and ESG analysis.

• Providing strong indicators of management quality, the primary determinant of stock market returns. System change is the most complex challenge facing business and society. Companies that do well in this area presumably have the ability to excel in other areas, and thereby earn superior investment returns.

• Enhancing returns by providing the most effective risk mitigation strategy. SCI addresses all levels of investment risk (i.e. company, portfolio, sector, environmental/social, structural systemic).

Concluding this post, we would like to leave you with two questions:

• When investors are given a choice between slowing climate change and other SDG problems or solving them, what will they choose, especially when investment returns are equal or better?

• Considering that every company can be rated on system change performance and SCI can be used as a risk-reducing, alpha-generating overlay on nearly every type of investment fund, does it have the potential to convert the capital markets into the most powerful driver of systemic change available?

We think the answers are obvious and believe SCI (and variations of it) will become the dominant form of investing in the 21st Century.

As Einstein said, higher-level thinking is needed to resolve our most complex challenges. SCI brings this higher-level, whole-system thinking to the capital markets.

This was the last post of our introductory series. Next week we’ll provide a report from the front lines, addressing frequently asked questions about SCI.