Lessons on How to Manage Major Systemic Risks

Investors’ thoughts on how system-level investing, focusing on interconnections between stressed, complex systems, can impact portfolio performance and where it can help.

From left: William Burckart, Melissa Eng.

It’s time for a new way to think about investing, one that can contend with current complex challenges. Previously, investors could find ways to insulate their portfolios from certain global events, while today, even seemingly “local” events can immediately and adversely affect portfolios. The largest, most influential investors are recognizing this trend and contemplating the interconnection between systems under stress and adverse portfolio performance.

These investors follow a discipline of “system-level investing.” System-level investors believe that profitable, long-term investments depend on healthy financial, social, and environmental systems. They acknowledge their portfolio’s exposure to systemic risks and aim to use their investments to generate value for such systems rather than extract from them.

System-level investors deploy a suite of conventional portfolio management tools and advanced investment techniques to achieve their goals of supporting more stable and resilient systems. These include activities like incorporating standards for social and environmental conduct for entire industries. Or more advanced techniques like pursuing investments that provide access to finance to underserved communities and address unmet environmental or social needs.

As systemic issues—such as climate change, income inequality, racial inequality, and more—increase in complexity, investors must do more to respond to these issues and create a stable market for investments that creates long-term benefits for all. The Investment Integration Investment Project (TIIP), a consulting services and data provider focused on helping investors manage systemic risks and opportunities, completed in-depth case studies on five system-level investors. The case studies demonstrate where the field is headed and present a path forward for other investors to learn from their peers and join the vanguard of this evolution. The five investors include:

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California State Teachers’ Retirement System – the largest teachers’ retirement system and second-largest public pension fund in the U.S. with $315 billion in assets under management.
Domani Impact Investments, a women-led investment adviser that focuses exclusively on impact investing, with a focus on forest and land use.
Saint Paul and Minnesota Foundation, the largest community foundation in Minnesota with $2 billion in AUM.
University Pension Plan, a pension fund serving the Ontario university sector that has $10.8 billion in AYM
Wespath Benefits and Investments, a nonprofit pension fund and a general agency of the United Methodist Church that has more than $24 billion in AUM.

Looking across the work of these institutional investors, six lessons emerge for others approaching system-level investing.

Statements of investment beliefs set the tone

Statements of investment beliefs set an external and internal tone for the investor’s practice and values. SIBs are often a starting point for investors to convey their understanding of financial markets, their place within them, and their desired contribution to them. While a public statement of investment beliefs is common among investors of all kinds, system-level investors often highlight in their statements the importance of environmental, social, and financial systems, how systems impact investors (and vice versa), and how they aim to strengthen them. The SIBs for all five investors studied shared two notable core features:

They emphasize the fundamental link between environmental, social, and financial systems and long-term investment and indicate that investors must work to ensure the health of such systems; and
They dictate investment policy and practice, including security selection and portfolio construction, engagement and proxy voting, and manager selection and due diligence.

Systemic risk management is aligned with fiduciary duty

The profiled investors commonly assert—typically in their SIBs—that systemic factors are material to investment returns, particularly over the long term, and are, therefore, relevant components of fiduciary duty. In other words, system-level risks, such as climate change, biodiversity collapse or social instability pose financially material risks to investor portfolios. For example:

Domini published a set of “forest beliefs” that communicate its fiduciary obligation to preserve and enhance the value that forests provide;
In describing its ESG approach, UPP links ESG factors, capable of adding or extracting value from systems, as accounted for in every stage of its investment process in order to meet its fiduciary duty of providing value to its members; and
In describing its investment philosophy, SPMF states that it cannot meet its fiduciary duty without mission-aligning its investment portfolio.

Climate change is a paramount issue

Climate change is the top systemic issue for these system-level investors. Four of the five investors not only isolate climate change and its risks to investment in their statements of investment beliefs but also developed roadmaps for action related to climate change. Such action plans include activities focused on the threats of climate change to global well-being, the risks posed to long-term asset values, and concerns about the transition to a low-carbon economy.

UPP created a robust Climate Action Plan (see below), which it developed as a guide for its security selection activities. It hopes the plan sends a signal to all companies demonstrating the importance of decarbonization and targeting capital to those who take it seriously.

SPMF is the only studied organization the primary systemic focus of which is not climate change. Instead, it has a highly intentional focus and deep engagement on diversity, equity, and inclusion (DEI) and racial and gender equity. The core objective of the strategy is to align SPMF’s investments with the foundation’s values and mission and ensure that SPMF’s investment portfolio does not directly or indirectly propagate racial inequities. Even still, ESG considerations are a core part of manager due diligence and engagement.

“Field building” strategies offer scale and momentum

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

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

Measurement is a sense-check on progress

All studied investors struggle with measuring and reporting on their impacts on systems, but they nevertheless recognize its importance in assessing progress toward system-level goals.

As a result, while system-level investors continue exploring how best to measure the systemic value of their investments, they focus on measuring their progress against their stated commitments and standards. For example, all five investors put considerable effort into designing and implementing criteria that guide their investment decision-making process, ensuring that their activities remain consistent with their overarching goals.

Champions have their eye on the prize

All the organizations have at least one system-level “champion” within the company: an outspoken, enthusiastic, and convincing advocate or spokesperson for system-level investing. These individuals have advocated internally and externally for the adoption of system-level techniques. They serve on the boards of collective engagement bodies and have supported the creation of system-level tools for the wider investment community.

Although sustainable investing techniques have existed for some time, system-level strategies are relatively new. And while their newness can make it difficult to evaluate their implementation and effectiveness properly, these early adopters are demonstrating several potential paths forward. These efforts all require significant ongoing commitment and attention, mirroring the urgency of the challenges at hand. Using these lessons, other investors can follow their lead and help shift their thinking about systemic issues, ultimately transforming how systemic risks impact investors, their portfolios, end stakeholders, and the environment.

William Burckart is the CEO of TIIP, co-founder of Colorful Capital, and Adjunct Professor of International and Public Affairs and The Brandmeyer Fellow for Impact and Sustainable Investing at the School of International and Public Affairs (SIPA), Columbia University.

Melissa Eng is an IMM Specialist at TIIP and the co-author of the report “(Re)Calibrating Feedback Loops: Guidance for Asset Owners and Institutional Investors Assessing the Influence of System-level Investing.”

This feature is to provide general information only, does not constitute legal or tax advice, and cannot be used or substituted for legal or tax advice. Any opinions of the authors do not necessarily reflect the stance of ISS STOXX or its affiliates.

Tags: Aquity, Asset Allocation, California Teachers’ Retirement System, CalSTRS, Domani Impact Investments, Governance, Inclusion, Institutional Allocators for Diversity, investment performance, Nature Action 100, Net Zero Asset Owners’ Alliance, Principles for Responsible Investing, Saint Paul and Minnesota Foundation, system-level investing, The Investment Integration Investment Project, University Pension Plan Ontario, Wespath Benefits and Investments

One of the more well-known players in global investing is Mario Gabelli’s firm, which manages institutional and retail money, even though its $31 billion in assets under management are far down on the list from the likes of Vanguard, No. 1 with $7.2 trillion In a recent webinar, a trio of strategists at GAMCO Investors Inc. (formerly Gabelli Asset Management Co.) sketched out their preference for U.S. stocks.

In general, overseas stocks have long been an investment management imperative, under the theory that other nations, particularly emerging markets, show greater promise than domestic equities do. A “global” strategy, as the name suggests, encompasses both foreign and U.S. markets.

These days, though, the U.S. is the best bet, according to the three strategists: Howard Ward, Gabelli’s CIO of growth equities, John Belton, portfolio manager for a variety of the firm’s growth strategies, and Caesar Bryan, co-portfolio manager of the Gabelli Global Growth AAA fund. Belton and Ward are the two other co-managers of the portfolio. Indeed, the fund has 68% of its investments in U.S companies, per Morningstar.

Gabelli Global Growth’s track record has earned it investor attention. This 30-year-old fund, one of Gabelli’s largest with $186 million in assets, has long beaten its benchmark, the MSCI All World Index—this year, according to Morningstar, the fund is up 25.7%, outpacing the world index by almost 12 percentage points. One big reason is that the fund has that heavy allocation to U.S. stocks, at a time the index has just 63% (which is up significantly from the level 20 years ago, 40%).

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U.S. equities have been way ahead of the rest of the world for many years. The S&P 500 has increased 14.7% in 2024, leading the other major indexes (except for the Nikkei 225’s 17.1%, in a comeback after years of blah performance for Japanese stocks).

“The U.S. has the best secular growth prospects among the developed world, as we lead in both demographics and productivity,” said Belton. The nation has the strongest capital markets, mightiest military, best infrastructure and largest consumer market, he pointed out. America, he added. has “trounced the rest of the world’s markets over the past five, 10, 15 and 20 years.

Mario Gabelli, the founder, CEO and chairman of GAMCO, is a perennial value investor, who disdains hot-stock devotees chasing after popular growth shares. But the three growth “portfolio managers operate independently from Gabelli,” said Doug Jamieson, president and COO at Gabelli Funds, in a statement.

The Gabelli Global Growth fund has maintained its exposure to U.S. tech stocks for many years, having bought them when they were cheaper. It has not only added tech stocks, of course; Chipotle is a large position. As a Morningstar analysis of the fund wrote, the stocks it buys “are likely to have rapid growth in revenues and earnings and potential for above average capital appreciation or are undervalued.”

This blueprint has worked well, as tech stocks have been on a roll this decade: Apple has been a fund holding for 11 years, Alphabet for 12, Amazon for 16 and Microsoft for 15. All have leapt up in value.

Of the fund’s top-10 holdings, which make up almost half its asset value, only two are from abroad, both French: luxury goods maker LVMH Moët Hennessy Louis Vuitton and beauty products company L’Oreal.

The strategy is to look at portfolio stocks in terms of fundamentals, with little attention to a stock’s national origin, Bryan said. “Think of equities as a single asset class and build a portfolio of best ideas and companies without the somewhat artificial constraint of geography,” he declared. Right now, to be sure, that approach has resulted in a major emphasis on U.S. names.

Unlike many managers who invest overseas, the Gabelli folks do not do currency hedges. Ward explained that their expertise is not foreign-exchange forecasting: “We generally avoid investing in the kinds of countries or currencies that are going to have massive percentage changes.”

Emerging markets, which earlier this decade were a hot area, are not high on the three strategists’ list. China’s massive growth was the largest driver for EM companies, which sold commodities to the Asian giant—yet now China’s growth has slowed, Ward observed. In addition, he said, commodity-based economies are just too risky, especially in light of climate change. For one thing, he went on, “the extreme heats are destroying crops” and “rising waters” also threaten them

Given China’s threats to invade Taiwan, the Gabelli managers also are not eager to invest there. Ward said, “Should China choose to [conquer] Taiwan, I don’t think that would be very helpful for investors in China.” Added Belton, “We view the risk in Taiwan Semiconductor as is too much right now.”

The Gabelli managers also are down on one U.S. stock, that of Tesla Inc. The Gabelli funds sold their entire stake in the electric vehicle maker in 2024’s first quarter—65,900 shares. Belton said the decision was not due to the controversial behavior of its founder, Elon Musk. In Belton’s view, “The moral of the story is the fundamentals just deteriorated,” with demand and deliveries slowing for Tesla’s autos and now the company is cutting prices, “which is eating into their profit margins.”