#5: Report from the front lines - addressing frequently asked questions about SCI
As a new paradigm approach to responsible investing and system change overall, SCI not surprisingly generates many comments and questions. In today’s post, we discuss a few we came across in recent weeks.
They include:
I like the idea, but don’t really understand how SCI works 🤔
How does SCI fit into the emerging field of systemic investing? 🧭
SCI seems to be moral, not financial 😇
How SCI works (in a nutshell)
SCI enhances existing ESG approaches by adding system change metrics to ESG rating models. ESG has been criticized for failing to resolve climate change and other challenges.
This occurs because current responsible investing approaches seek to change companies, instead of the systems that control them. They also focus on symptoms, such as climate change, instead of root causes.
Flawed systems compel companies to harm the environment and society. They are the root causes of major challenges. Improving these systems (i.e. system change) is the most important sustainability issue. SCI expands the focus to include system change and root causes.
The corporate and financial sectors, in collaboration with others, have the power and resources needed to drive system change. Rating companies on system change performance and shifting investments to system change leaders powerfully incentivizes companies to implement system change strategies – in the same way that ESG compelled them to implement sustainability strategies over the past 20 years.
In a nutshell, with SCI, asset managers use enhanced-ESG ratings in the same way they use current ESG to develop the same types of funds.
How does SCI fit into the emerging field of systemic investing?
It’s true, in addition to SCI a growing number of investment strategies seek to drive system change. They usually focus on particular segments of the capital markets (e.g. private equity, green tech) or issues (e.g. climate change, mobility). The process often involves assessing portfolio-wide exposure to climate change and other risks, and then shifting investments from brown to green companies. This way investors can be protected in the short-term.
Other initiatives also take a systems perspective, mostly related to a specific part of the system, and aim to achieve higher impact through portfolio structures (vs. project) and bringing together different investor groups/stakeholders thereby increasing capital availability. These approaches add a lot of value:
they work on real-world solutions and stop looking at things in a fragmented way, and
they build and cultivate the knowledge (e.g. about regenerative business models/practices, new organizational models, business ecosystems, etc.) and essential skills (e.g. collaboration) needed for a sustainable economic system.
From a meta-perspective, however, they do not address root causes and the most important type of investment risk (structural systemic risk – flawed economic and political systems that compel harmful corporate behavior).
SCI fills this risk mitigation gap. It is the first true full risk mitigation investment strategy. SCI addresses all levels of investment risk (i.e. company, portfolio, sector, environmental/social issue, overarching system). The approach involves rating companies on system change performance and shifting investments to system change leaders.
SCI is unique in that it takes a meta-perspective and aims to mobilize the financial system in ways that drive the evolution of human society into sustainable form. It looks at the current system configuration and acknowledges its inability to achieve truly sustainable outcomes.
Far-reaching approaches like SCI are urgently needed now – approaches that focus on the structural problems of current systems, that constructively question the status quo, and thus provide stimulus for the far-reaching changes we need.
SCI seems to be moral, not financial
We were a little surprised by the comment as we usually focus on the superior risk mitigation and financial performance of SCI when talking about it.
SCI can substantially reduce investment risk and increase returns. It assesses financially relevant systemic risks and opportunities that are not addressed by conventional financial and ESG analysis. And it provides strong indicators of management quality, the primary determinant of stock market performance. On a purely financial basis, SCI adds substantial value.
To illustrate, the capital markets mainly focus on company-level decisions, selecting investments based on strategy and other company-specific factors. They sometimes consider broader issues, such as geographic (e.g. country-level risk), economic (e.g. unemployment, interest rates, economic growth), political (e.g. parties in power, upcoming elections, regulatory reform), and environmental (e.g. climate risk, drought).
However, the markets mostly take the structure of overarching systems (e.g. economic, political, financial, monetary) for granted. This places investors at huge financial risk because the structure of these systems (i.e. structural systemic risk) is by far the largest source of systemic investment risk. These systems largely determine and control corporate behavior. They establish the rules that enable effective markets to exist. (The free market is a fantasy. It does not exist. Without rules that limit harmful behavior, there could be no beneficial, effective markets.)
Still, moral and financial goals are obviously not mutually exclusive. Many profitable business activities are moral, such as running a responsible company that greatly benefits society.
And yes, from a moral perspective, the focus on system change and root causes makes SCI the first investment strategy with the potential to achieve sustainability and the SDGs. Powerfully enabling humanity to survive and prosper certainly is moral. But that does not mean that SCI is not also providing superior financial benefits and performance as described above.
We believe that we live in times where combining the two becomes more important than ever.
Next week we will continue with more questions and comments from the front lines covering:
Can there be a sustainable company in an unsustainable system? 😬
We’re already doing SCI! 🏆
Do companies that block systemic changes intended to achieve sustainability get low SCI scores? 👍