System change investing is the next evolution of ESG
May 2, 2023
Over the past 20 years, ESG has grown faster than traditional investing, rising to about $40 trillion. However, despite this progress, environmental and social problems are growing rapidly.
The climate crisis and other challenges addressed by the UN Sustainable Development Goals (SDGs) won’t be resolved by current ESG methodologies. That’s because ESG efforts are largely focused on changing companies instead of the systems that control them, and they are almost completely focused on addressing climate change and other symptoms rather than root causes.
A new kind of ESG investment strategy is emerging that addresses social and environmental challenges by shifting the focus to system change. System change investing (SCI) has the potential to resolve major problems, protect business and society and achieve superior investment returns.
As head of research for the largest ESG research firm (Innovest/MSCI), I saw that companies only could profitably mitigate about 20 percent of total negative impacts. Reductionistic economic and political systems unintentionally compel businesses to degrade the environment and society. These systems are the root causes of major challenges. Improving them (system change) is at least 80 percent of the SDG and sustainability solution.
Current ESG strategy is based on a flawed premise. Companies are encouraged to voluntarily stop harming the environment and society under systems that will put them out of business if they do so fully. Beyond a certain point, voluntary corporate responsibility equals voluntary corporate suicide. This is why current ESG has not and cannot achieve the SDGs and sustainability.
Shifting the focus to system change is essential. SCI provides a practical and profitable way to engage the corporate and financial sectors in system change. Here’s how SCI could lead the next evolution of ESG.
How system change investing works
SCI could drive system change in the same way ESG drove corporate sustainability over the past 20 years. Like ESG, SCI involves rating companies on system change performance and using this research to guide investment decisions. As investors shift investments to system change leaders, companies will be incentivized to implement system change strategies.
I developed the SCI approach in 2003. The first SCI model, Total Corporate Responsibility, was introduced in an Ethical Corporation magazine article. Since then, I have developed several other SCI models, ranging from introductory to full whole system approaches.
Rating companies on system change performance requires a frame of reference. The optimal corporate system change strategy cannot be identified until system change overall is understood. I wrote the “Global System Change” books to provide this frame of reference. They use whole system thinking and the laws of nature to clarify sustainable society, the systemic changes needed to achieve it and the optimal corporate and financial sector roles in system change.
Under current systems, companies often maximize profits by degrading the environment and society. A primary system flaw is the failure to hold companies fully responsible for negative impacts. This is the general mechanism that makes it impossible in competitive markets to stop harm and remain in business. Sustainable systems hold companies fully responsible. Under these systems, companies maximize profits by not harming society.
The whole system SCI model is segregated into three metric categories — traditional ESG, mid-level system change (sector, stakeholder, environmental/social issue-level change) and high-level system change (economic, political, social system change). Sample SCI metrics include system change strategy, business consciousness (whole system thinking), system change collaboration, government influence activities, media campaigns, supporting system change organizations and system change results and benefits.
Implementing SCI involves adding system change metrics to ESG models. These enhanced ESG ratings are used to develop the same types of funds marketed through the same channels. SCI can be used as an overlay on nearly all types of investment funds — value, growth, index, equity, debt, public, private. All companies can be rated on system change performance. This enables nearly all of the capital markets to be used to drive system change.
The benefits of systems change investing
SCI can increase short-term and long-term investment returns and provide many other benefits. For asset managers, SCI can enhance reputation, assets under management and investment returns. Shifting the focus to system change and root causes allows SCI funds to provide greater sustainability benefits than current ESG funds. This enables asset managers to attract new investment and position themselves as global ESG leaders.
SCI increases returns by assessing systemic risks and opportunities that are not addressed by conventional financial and ESG analysis. More importantly, it provides a strong indicator of management quality and stock market potential. System change is a complex management challenge. Companies that do well in this area presumably will outperform in other areas and earn superior investment returns. Like ESG, SCI mainly increases short-term returns by shifting investments to better-managed companies that outperform in many areas, including financial.
In the corporate area, many companies value their leading sustainability reputations. System change is the most important, and therefore most financially relevant, sustainability issue. Going forward, corporate sustainability leadership increasingly will require a strong system change strategy.
Over the longer term, SCI protects investment returns by incentivizing the corporate and financial sectors to engage in practical, collaborative, non-disruptive systemic change. For at least the past 100 years, companies could profit by degrading the environment and society. This is not sustainable. Economic and political systems that compel harm inevitably will change through voluntary or involuntary means.
Throughout history, all flawed human systems changed, usually by collapsing quickly. Rapidly growing environmental, social, economic and political problems show that humanity almost certainly has entered another phase of rapid system change. Involuntary change (collapse) will greatly disrupt business and society. Voluntary system change is the vastly superior option.
Vested interests sometimes argue that system change will lower returns, for example, by holding companies more responsible for the harm they impose on society. This assumes that current systems could remain the same. But companies cannot continue to profit by destroying that which enables business existence. Keeping systems the same is not an option for much longer.
The “do nothing” system change strategy (involuntary system change) will eliminate extensive profits and investments. Practically evolving systems into sustainable forms protects business and society and enables investors and companies to prosper over the very long-term.
The shift to system change and root causes is the most significant ESG transformation since the introduction of positive screening. By profitably engaging the corporate and financial sectors in system change, SCI potentially is the most powerful strategy for achieving the SDGs. Superior sustainability and financial benefits enable SCI to become a dominant ESG strategy of the 21st century.
Frank Dixon is a sustainability and system change pioneer and leader. He saw 20 years ago that system change was the most important sustainability issue. As a result, he established Global System Change and developed the System Change Investing (SCI) approach. It provided the first model for rating companies on system change performance and integrating system change into corporate sustainability strategies. He also developed a true whole system approach to sustainability, described in the Global System Change books. It provides systemic solutions for all major areas of society. In the financial and corporate sectors, SCI offers the most advanced and effective sustainability strategies. Before writing the GSC books, Frank Dixon was the Managing Director of Research for the largest corporate sustainability research firm in the world (Innovest/MSCI). He developed ESG rating models and research processes that consistently provided superior investment returns. He advises companies, investors and governments, including Walmart and the US Environmental Protection Agency, on sustainability and system change. He has presented at many corporate and financial sector conferences around the world, and spoken at leading universities, including Harvard, Yale, Stanford, MIT and Cambridge.
Frank Dixon has an MBA from the Harvard Business School and is a Fellow of the World Academy of Art and Science.