Investment stewardship, as currently practiced by asset managers and pension funds, must change dramatically if we are to address two pressing issues of the 21st century: social inequality and climate change.
That’s the conclusion of William “Bill” Burckart, president and COO of the Investment Integration Project (TIIP) and co-author of 21st Century Investing: Redirecting Financial Strategies to Drive Systems Change.
In a recent review of the book, co-authored with ESG veteran Steve Lydenberg, Robert G. Eccles of the University of Oxford’s Saïd Business School notes that it’s no longer sufficient to build efficient investment portfolios. Managers, he says, must now “look beyond individual portfolios and focus on entire economies.”
And as Jeffrey Gordon of Columbia University’s Richard Paul Richman Center for Business, Law, and Public Policy notes in a recent paper, “Systematic Stewardship,” “‘Systematic stewardship’ provides an approach to ESG matters that serves both investor welfare and social welfare, and fits the business model of large diversified funds, especially index funds.”
A portfolio approach like this, he notes, follows already-established behaviors, with asset managers pursuing corporate governance measures that “increase returns across a portfolio even if not maximizing for particular firms.”
In this conversation with Climate & Capital’s co-founder David Garrison, Burckart explores this further. He says the stewardship mandate of institutional investment managers must go beyond the traditional safe-guarding of a portfolio’s financial worth to incorporate techniques that directly address systemic social issues such as social inequality and climate change.
Key points:
- What it involves. “System-level investing, more broadly speaking, includes the adoption of new techniques that are explicitly designed to help investors influence social and financial systems and limit broadly occurring undesirable outcomes from the outset.”
- Why it’s important. “[It’s] important [because climate] trickles down and trickles up to everything: poverty, food supplies, financial systems …”
- There are implications for investors. “Thinking about the performance of an entire economy is a type of risk that’s not reflected in reporting methodologies and that investors need to be aware of.”
- There are hurdles. “That idea alone — that we can impact the ability of other investors to participate in positive ways — is new territory.”
- Who’s paying attention. Burckart and Lyndenberg’s book builds on a TIIP report on investment stewardship that was funded by the Generation Foundation, the non-profit arm of impact investment firm Generation Investment Management, which was founded and is led by former U.S. Vice President Al Gore and investment banker David Blood.
What’s the burning opportunity in climate change?
There’s opportunity in what we call system-level investing, or the adoption of new techniques that are explicitly designed to help investors influence social and financial systems and limit broadly occurring undesirable outcomes from the outset.
Take the circular economy. These are products, manufacturing processes and value chains that are regenerative by design — it’s fruitful terrain at a company level for the impact investment and sustainability community.
It’s also promising at a system level. As opposed to framing circular as a single investable opportunity, industry bodies and foundations are now driving the development of ecosystems — emphasizing the impact and performance of corporates that are integrating circular concepts.
So, why should we care about system-level investing?
The basic premise is that you’re moving your lens from a portfolio or individual security to the context in which that portfolio or security exists.
In the book, we talk about how to justify focusing on a system: These issues — like climate — are interconnected, they’re complex, and they’re constantly changing; so they require multi-dimensional considerations.
There may be, for example, knock-on effects for labor and workers: If enough workers are out of work, that leads to social unrest, and that leads to other effects with disproportionate impact and drags down the long-term performance of economies and portfolios.
This is why taking a system lens is important in climate. It’s something that trickles down and trickles up to everything: poverty, food supplies, financial systems …
That’s a big shift. What’s different now that makes it compelling as an investable thesis?
The big shift is that we now have more longitudinal analysis of the performance of indexes, asset classes and trend data that shows these investments are meeting (and in some cases outperforming) benchmarks.
And we can now demonstrate the material quality of these factors as they relate to climate change across industries. SASB, for example, was able to identify climate change as a material quality that affects 68 of the 77 industries that comprise the U.S. economy. The idea that that’s systemic, that it cuts across industries, that it’s material and that there’s more data available — those counter earlier perception problems the industry’s had.
We can now demonstrate the material quality of these factors as they relate to climate change across industries.
In the book, we make it clear that, in both system-level investing and sustainable investing, you don’t throw away risk-management techniques and you don’t throw away expectations of financial performance. Rather, you enhance the process to consider additional factors.
How do we get people to embrace system-level thinking in their approach to investment?
Making the case has, until recently, been a problem for asset owners. But there are interesting evolutions now — like stewardship codes in the U.K. that require considering systemic risks like climate change or the CFA Institute suggesting that the future of sustainability and investment management involves system-level thinking. These things incentivize investors, and once you let this kind of genie out of the bottle, it’s very tough to get it back in.
It comes down to demand: They’ll move because a big-enough client demands it or because they didn’t get an RFP.
What we’ve found with investors integrating system-level considerations is that it comes down to demand: They’ll move because a big-enough client demands it or because they didn’t get a request for proposal (RFP).
Long-term, institutional investors intuitively understand how these issues affect performance (they’re used to thinking about beneficiaries they have to pay out 75 years from now), but they haven’t had access to all of the data, collaborative opportunities to share best practices or the regulatory environment that would take away the heebie-jeebies. That’s beginning to change.
That brings us to the quality of the data that underlies investors’ decisions. There’s huge variation there. Is that an issue?
You’re touching the third rail. Whether we’re talking about conventional, sustainable or systems-level investment, data is the bedrock it’s all built on. And the data infrastructure we’d like doesn’t exist yet.
That can be frustrating: There’s a lack of standardization; there are missing dimensions in our data infrastructure that we’d like to be able to measure progress on. And yet, compared to where the industry was thirty years ago, it’s night and day.
The data infrastructure we’d like doesn’t exist yet … And yet, compared to where the industry was 30 years ago, it’s night and day.
Back then, if you wanted the ESG characteristics of a company, for example, you literally clipped articles from a newspaper. Or you sent physical letters to companies to get physical annual reports.
Just remember that we’re progressing fast. And the flies that still exist in the ointment? People are actively addressing them. The merger of SASB and IIRC to create the Value Reporting Foundation, for example, was a big jump in terms of figuring out measurement challenges and data flow.
All that said, investors have to understand that, for as much progress as we’ve made, what is material today may not be material tomorrow because of the interconnection and complexity of issues.
Speaking of materiality, are there ways of thinking about risk that become more important in system-level investing?
Big institutional investors like GPIF have a long time horizon and are now investing in the performance of an economy. That’s new territory for most people, who are used to investing in the performance of their portfolio.
That personal lens is understandable. But work like Jon Lukomnik and Jim Hawley’s (in Moving Beyond Modern Portfolio Theory) focuses on the idea that more than 90% of the variation in the return an investor receives is explained by the universe of securities they’re invested in and not just a manager’s stock selection. Something like that is a type of risk that’s not reflected in reporting methodologies and that investors need to be aware of.
What structural changes are you starting to see that reflect the shifts you’re talking about — in pension funds, for example?
Whether or not the embrace of these strategies will change the legal form of entities like pension plans is the territory of lawyers. But take a sovereign wealth fund, like New Zealand’s superannuation fund. They started out signaling a belief that climate change was a risk it needed to integrate into its risk assessment across all asset classes.
That’s where sustainable investors often start and stop. What New Zealand did beyond that is participate in collaborative engagement with companies on climate change and support climate-related data-gathering initiatives.
There are two particularly compelling points in this example. First, they were a founding member of the One Planet Sovereign Wealth Funds initiative, which begins to address climate change and the transition to a low-carbon economy.
And second, their CEO got on the New Zealand Finance Forum, which is about changing the financial system to preserve and enhance systems for future generations.
This is not the typical role of this type of institution. But it’s pivotal because it sends a strong message to the community and drives broader collaborative action.
All that requires dedication. And whether they’re reimagining what a pension fund or sovereign wealth fund should be or they’re just adding to what they’re already doing, well, that’s up for debate. The point is that there are roles to play beyond what they’re used to.
So, where does system-level thinking start?
A digestible and actionable place to start is management diligence and manager selection. Just asking system-level questions there is a good way to generate different kinds of insight for managers.
One criticism of sustainable investment, for example, is that firms often have multiple funds and multiple products. Why is it that some integrate ESG and others don’t? How core to the institution is that focus then?
So, one question to ask is how enshrined it is in the institution. Is it clear? Is it actionable?
I also ask whether an organization has justified focusing on a specific system. Allocating assets and resources towards issue X is great, but you’ve got to justify it.
Then try to get at the levers they’re pulling for disproportionate impact. You want to understand what strategies managers are actually engaging in if they’re focused on something specific, like fixed income or real estate.
The point is to ask questions that require managers to rethink their work and the ways they claim to advance their goals. That’s why we work it into the due diligence process.
The point is to ask questions that require managers to rethink their work and the ways they claim to advance their goals. That’s why we work it into the due diligence process.
How do we actually do system-level investing?
Investors need to use advanced techniques to influence outcomes. In the book, we talk about three big buckets of field-building techniques that help investors act collectively. The first bucket is investment-enhancement techniques that influence the characteristics of a system.
Second is opportunity-generation techniques that strengthen the system itself. In many cases, these relate to allocation decisions, but these also influence infrastructure and the overarching financial community.
The third is field-building techniques and self-organization. That involves collaborating — creating organizations that build the capacity of investors to address particular systems issues and increasing the flow of information and communication.
There are also other ideas to be aware of — like polity, for example, where you’re drawing attention to public policy debates through government rules or regulations, enabling an environment that’s going to ultimately influence these issues.
Each of these techniques goes well beyond traditional security selection and portfolio construction. They get to shared interest and shared infrastructure.
The degree of rigor in these discussions at companies varies significantly. How do skill sets and leadership approaches need to change as we adopt systems thinking?
A systems orientation has implications for how you deploy resources. But you’re right: It also has implications for the expertise and skillsets that institutions need to transform.
Does system-level thinking mean that every board now needs a systems dynamic expert on it? Not necessarily. But it does mean that how the financial community is trained and educated needs to change.
How the financial community is trained and educated needs to change.
In the short term, this transformation does require either some depth in climate change or its interplay with other issues. Having substantive expertise — at a minimum on staff — is necessary to understand nuances and say, if we do this investment, it’s going to have unintended consequences.
It also requires us to see this as part of our jobs; that we elevate the voices of directors of stewardship activities or impact or sustainable investment officers. That’s important because, in many institutions, they’re still novelties.
Now, that’s starting to change as more institutions build out teams, but these voices still need to be elevated to have weight.
What question would you like to hear other leaders answer?
Why didn’t we do this yesterday?
With a lot of investors, once you expose them to these ideas, this process and the potential implications — both existentially and at a practical level — it starts to change things within institutions and their willingness to pursue system-level strategies.
That’s also true for other leaders in the field. I want trustees of these institutions to ask their staff, “Why haven’t we been doing this? What’s preventing us?”
Asking that alone opens the door to questions about how to do it, how to do it faster, and how to do it effectively. That, in turn, opens the door to conversations about talent, more advanced techniques and ultimately, effectiveness.
If we can answer these questions internally, it creates a groundswell. Right now, there are early adopters and a lot of smart people who are intellectually interested but aren’t putting the weight of their institutions behind this.
Climate & Capital’s Leadership Interviews is an ongoing series of in-depth discussions with a wide range of leaders in the climate economy. It explores the nuance and tension in leading bold transformations — of individuals, organizations and markets — at the intersection of climate and capital. We hope these conversations give you food for thought and spark conversations as you lead in the climate age. We’re looking forward to hearing from you.
Twitter: @davidcgarrison
