Lessons learned on how to manage major systemic risks

William Burkhart

Melissa Eng

It’s time for a new way of thinking about investing – one that can address today’s complex challenges. Previously, investors could find ways to insulate their portfolios from specific global events, but today even seemingly “local” events can have immediate and negative impacts on portfolios. The largest and most influential investors are recognizing this trend and are pondering the correlation between systems under stress and negative portfolio impacts.

These investors follow a discipline known as “systems-level investing.” System-level investors believe that profitable long-term investments depend on healthy financial, social, and environmental systems. They recognize that their portfolios are exposed to systemic risk and seek to use their investments to create value for the system, rather than profit from it.

Systems-level investors deploy traditional portfolio management tools and advanced investment techniques to achieve the goal of supporting more stable and resilient systems, which can include activities such as incorporating industry-wide social and environmental behavioral standards or, more advanced approaches, pursuing investments that provide capital to underserved communities and address unmet environmental or social needs.

As systemic issues like climate change, income inequality, and racial disparities compound, investors must do more to address these issues and build stable investment markets that generate long-term benefits for all. Investment Integration Investment Project (TIIP), a consulting services and data provider focused on helping investors manage systemic risks and opportunities, has completed in-depth case studies of five system-level investors. The case studies provide direction for the field and offer paths for other investors to learn from their peers and join the vanguard of this evolution. The five investors are:

• California Teachers Retirement System – The largest teacher retirement system in the United States and the second-largest public pension fund in the country with $315 billion in assets under management.
• Domani Impact Investments is a women-led investment advisor specializing in impact investing with a focus on forestry and land use.
• The St. Paul and Minnesota Foundation is Minnesota’s largest community foundation with $2 billion in assets under management.
• The Universities Pension Fund, the pension fund serving Ontario’s university sector, has $10.8 billion in AYM.
• Wespath Benefits & Investments is a not-for-profit pension fund and general agent for The United Methodist Church with over $24 billion in assets under management.

Looking at the work of these institutional investors, six lessons emerge for others working on systems-level investing.

Investment belief statements set the direction

An investment belief statement sets the external and internal tone of an investor’s practices and values. A SIB is often the starting point where an investor communicates their understanding of financial markets, their place in them, and their hopes of contributing to them. While public statements of investment beliefs are common among all kinds of investors, system-level investors often emphasize in their statements the importance of the environment, society, and financial systems, how those systems impact investors (and vice versa), and how they aim to enhance them. The SIBs of the five investors surveyed had two notable commonalities:

• They highlight the fundamental connections between environmental, social and financial systems and long-term investment, and show that investors must work to ensure the health of such systems.
• They direct investment policies and practices, including security selection and portfolio construction, engagement and proxy voting, manager selection and due diligence.

Systemic risk management is consistent with fiduciary duty

The profiled investors argue that in SIBs in general, systemic factors are a relevant element of fiduciary duty as they have a material impact on investment returns, especially in the long term. In other words, systemic level risks such as climate change, biodiversity collapse and social unrest pose financially significant risks to investors’ portfolios. For example:

• Domini has published a set of “Forest Beliefs” that convey its fiduciary responsibility to protect and enhance the values ​​that forests provide.
• In describing its ESG approach, UPP links ESG factors that can add or extract value from the system, which are considered at every stage of the investment process, fulfilling its fiduciary responsibility to deliver value to its members.
• In explaining its investment philosophy, SPMF states that it cannot fulfill its fiduciary duties unless it aligns its investment portfolio with its mission.

Climate change is a top priority

Climate change is the top systems issue for these systems-level investors. Four in five investors not only distinguish between climate change and the risks to their investments in their investment policies, but also develop roadmaps for climate change-related actions. These action plans include activities that focus on the threats that climate change poses to global well-being, the risks to long-term asset values, and concerns about the transition to a low-carbon economy.

UPP has developed a strong Climate Action Plan (see below) to guide its securities selection activities, and we hope that this plan will send a signal to all companies that decarbonization is important and to focus capital on companies that take it seriously.

The SPMF is a multi-disciplinary organisation whose main systemic focus is “There is a very intentional focus on and deep engagement with diversity, equity and inclusion (DEI) and racial and gender equity, rather than climate change. A central objective of this strategy is to align SPMF’s investments with the Foundation’s values ​​and mission and to ensure that SPMF’s investment portfolio does not directly or indirectly propagate racial inequities. Nevertheless, ESG considerations are a core part of the Manager’s due diligence and engagement.”

‘Field-building’ strategy brings scale and momentum

While engagement with individual companies is a relatively common investment avenue, all five investors use a technique called “field building” to collectively engage and influence broader change in the financial community.

For example, all five investors are signatories to the Principles for Responsible Investment (PRI) and participate in collaborative engagement groups such as the Net Zero Asset Owners’ Alliance (NZAOA), Institutional Allocators for Diversity, Equity, & Inclusion (IADEI), and Nature Action 100. By joining forces with like-minded organizations, including competitors, these investors are using the strength of their numbers and assets under management to push for change more quickly.

Measurement is a sense check of progress

While all investors surveyed struggle with measuring and reporting on their systemic impact, they nonetheless recognize its importance in assessing progress toward system-level goals.

As a result, system-level investors are focused on measuring progress against their stated commitments and criteria while continuing to explore how to most effectively measure the systemic value of their investments. For example, all five investors have put significant effort into designing and implementing criteria that guide their investment decision-making process and ensure that activities are aligned with their overall goals.

The champions are eyeing the prize

Every organization has at least one systems-level “champion” within their organization — someone who openly, passionately, and persuasively supports or speaks for systems-level investing. These individuals have driven the adoption of systems-level approaches internally and externally; they have served on the boards of collective engagement organizations; and they have helped create systems-level tools for the broader investment community.

While sustainable investing techniques have existed for some time, systems-level strategies are relatively new. Because they are new, their adoption and effectiveness can be difficult to properly evaluate, but these early adopters have demonstrated some potential paths forward. All of these efforts require continued effort and attention, reflecting the urgency of the challenge at hand. Leveraging these lessons, other investors can follow their lead and change how they think about systems issues and ultimately how systemic risks impact investors, portfolios, end stakeholders, and the environment.

William Burkhart is CEO of TIIP, co-founder of Colorful Capital, adjunct professor of international public policy at Columbia University’s School of International and Public Policy (SIPA), and Brandmeyer Fellow in Impact and Sustainable Investing.

Melissa Eng is an IMM specialist at TIIP and co-author of the report, “(Re)balancing Feedback Loops: Guidance for Asset Owners and Institutional Investors Assessing the Impact of System-Level Investments.”

This feature is for general informational purposes only and does not constitute legal or tax advice, and should not be used as or substituted for legal or tax advice. The opinions of the author do not necessarily reflect the position of ISS STOXX or its affiliates.

Tags: Aquity, asset allocation, California Teachers Retirement System and California Public Employees Retirement System, CalSTRS, Domani Impact Investments, institutional investors for governance, inclusion and diversity, investment performance, Nature Action 100, Coalition of Net Zero Asset Owners, Principles for Responsible Investment, St. Paul and Minnesota Foundation, systems-level investing, Investment Integration Investment Project, Ontario University Pension Plan, Wespath Benefits and Investments