The Transformational Power of Root Cause Investing

The Transformational Power of Root Cause Investing

Frank Dixon
July 28, 2020

Root Cause Investing (RCI) is another name for System Change Investing (SCI), a sustainable investing approach that I developed in 2003. Focusing on root causes is the most important action needed to achieve the UN Sustainable Development Goals. Nearly all work in the Sustainable/Responsible Investing (SRI), corporate sustainability and general sustainability areas is focused on addressing specific environmental, social and economic problems, instead of the root causes of these problems.

The root cause of the major challenges facing humanity is our reductionistic thinking and inevitably flawed economic, political and other systems that result from it.

Economic and political systems unintentionally put business in conflict with society and humanity in conflict with nature. They make it impossible for companies to stop harming the environment and society and remain in business. Trying to resolve sustainability problems without addressing root causes is like trying to put out a fire with one hand while throwing gasoline on it with the other. It will not work.

It is increasingly clear that system change is a critically important, and largely unaddressed, sustainability issue. The World Economic Forum and other mainstream organizations are discussing the importance of capitalism reform and other types of systemic change. Improving our flawed higher-level systems is one of the most complex challenges facing humanity. Actions are required in all major areas of society.

When citizens are divided into debating factions, such as conservatives and liberals, the corporate and financial sectors often are the most powerful segments of society. They strongly influence government, media and the general public. As a result, they have strong power to drive system change. These sectors largely are controlled by investing. RCI and SCI use this strongest lever to engage the most powerful sectors in the most important sustainability issue. RCI/SCI is one of the most powerful, if not the most powerful, short-term system change strategy available to humanity.

The approach is made more powerful by ease of application. Changing economic and political systems is immensely complex. RCI/SCI does not do this directly. Instead, it strongly incentivizes investors and companies to drive system change. It is a form of indirect system change.

For over 20 years, SRI compelled nearly all large companies to implement sustainability strategies. RCI/SCI uses the same approach to engage them in system change. The process involves rating companies on system change performance and developing SCI or RCI funds. Nearly all large financial institutions offer some type of SRI product. RCI/SCI produces a new type of ESG rating. Asset managers use them in the same way they use current ESG ratings to produce the same types of funds. The approach can be quickly implemented by financial institutions, especially those with existing SRI funds.

The power of RCI/SCI is further enhanced by its core business focus. System change often involves collaboration, government interaction and other non-core business activities. The ability to work outside core business areas usually is limited. RCI/SCI uses investing (a primary financial sector core business) to drive system change. This enables financial institutions to enhance investment returns, reputation and assets under management, and thereby greatly enhance their core businesses.

Rating companies on system change performance is more complex than traditional ESG rating. System change must be understood overall before the optimal corporate role in driving it can be identified. Aspects of this role become metrics in RCI/SCI rating models.

Three Broad Metrics

I developed the first SCI model (Total Corporate Responsibility) in 2003. The model is segregated into three broad metric categories – traditional ESG, mid-level system change (sector, stakeholder, environmental/social issue-level) and high-level system change (economic, political, social system-level). Examples of SCI metrics include system change strategy, public awareness and media campaigns, system change collaboration, government influence activities, addressing specific system flaws, and supporting NGOs, academia and other groups that promote system change.

RCI/SCI ratings enhance investment returns by assessing systemic risks and opportunities that are not addressed by traditional financial and ESG analysis. They also increase returns by providing strong indicators of management quality and stock market potential. System change is a highly complex management challenge. Companies that do well in this area presumably have the sophistication to perform well in other business areas, and thereby earn superior investment returns.

System change is the most important sustainability issue. As a result, RCI and SCI funds have the potential to provide greater sustainability benefits than other types of SRI funds. This enables financial institutions to attract new investment and position themselves as world leaders in the large and rapidly growing SRI market.

Current SRI funds mainly are focused on changing companies, instead of the systems that largely control them. They also are focused on addressing problems instead of root causes. SCI switches the focus to system change and root causes. It is one of the most significant SRI advancements since positive screening was introduced in 1990s.

Flawed systems create growing problems for businesses, investors and society. They compel all companies to negatively impact the environment and society. As the human economy expands in the finite Earth system, these impacts return more quickly to harm companies, often in the form of market rejection, lawsuits and reputation damage. System change is the most important action needed to reduce negative impacts, and thereby protect investors and companies.

The metrics in SCI models provide corporate system change roadmaps. As investors adjust their portfolios based on system change performance, companies will be incentivized to implement system change strategies. This work often will involve integrating system change into sustainability strategies, publicly discussing the importance of system change, joining system change collaborations, and lobbying government for regulatory changes that make sustainability the profit-maximizing strategy. SCI will increase demand for corporate system change advisers and consultants.

Covid-19 shows the fragility and vulnerability to nature of the human economy and society. Growing division, disruption and problems show that human systems are in the process of changing. Throughout human history, all flawed systems changed, usually by collapsing. System change is inevitable. If we do not voluntarily improve our unintentionally destructive systems, nature and reality will change them, probably in a highly traumatic manner. The corporate and financial sectors are far better off voluntarily working for system change, rather than being greatly disrupted and possibly destroyed by involuntary system collapse.

Past system change efforts have not produced the scale of change needed, usually because they focused on only one issue, such as economic reform. In reality, all aspects of society are connected. Whole system approaches that address all relevant factors are needed. This is the only way to achieve the pace and scale of systemic change required to avoid system collapse.

For those interested in learning more, I have written a series of books called Global System Change: A Whole System Approach to Achieving Sustainability and Real Prosperity. These provide a system change roadmap for business and society and a foundation for SCI rating and fund development.

Frank Dixon advises financial institutions on improving short and long-term financial performance, most effectively addressing the SDGs, attracting new investment and enhancing reputation by developing RCI and SCI funds. He established Global System Change in 2005 when he recognized that system change would become the dominant sustainability issue of the 21st Century. His experience as the Managing Director of Research for the largest ESG research company (Innovest) and sustainability advisor to Walmart and other organizations showed that flawed economic and political systems compel all companies to degrade the environment and society. He conducted several years of multidisciplinary research to produce a true whole system approach to sustainability (described in the Global System Change books). The approach provides practical system change strategies for all major areas of society. In the corporate and financial sectors, System Change Investing represents the most advanced and effective sustainability strategy. Frank Dixon advises businesses, investors and governments on sustainability and system change. He has presented at many corporate and financial sector conferences around the world, as well as leading universities, including Harvard, Yale, Stanford, MIT and Cambridge.

Frank Dixon has an MBA from the Harvard Business School. He is a Fellow of the World Academy of Art and Science.

Copyright © 2020  Frank Dixon