What is system-level investing?

Defining system-level investing

System-level investing explicitly focuses on how relationships within and between systems – financial, economic, environmental, social and political – impact investment risks and returns. By adopting this approach, investors centre the belief that portfolios are more strongly influenced by systemic and systematic factors and externalities versus risk and return to each individual investee – an idea raised by Jon Lukomnik and James P Hawley in their seminal 2021 publication, Moving Beyond Modern Portfolio Theory: Investing That Matters.

The key terms used in system-level investing are:

• System-level risks are non-diversifiable risks. They include:
  1. Systematic risk: transmitted through financial markets and economies and that cannot be mitigated through diversification. Also referred to as ‘market risk’ (e.g., inflation, recession).
  2. Systemic risk: leads to a cascading set of consequences resulting in the destabilisation and eventual collapse of a system (e.g., the collapse of the financial system due to destabilised asset prices, or the collapse of planetary living systems due to a rise in GHG emissions).
• System-level influence or systemic impacts can affect entire systems or individual entities, interconnected relationships, structures and mechanisms.
• Causal relationships or feedback loops refer to cyclical processes where outputs from one system or one part of a system feed into and influence the behaviour of the overall system. Feedback loops can be positive (reinforcing the phenomena) or negative (weakening or diluting the strength of the phenomena).¹

System-level investing: an evolution of ESG and Modern Portfolio Theory

System-level investing can be seen as an evolution of traditional ESG integration.

Conventionally, ESG integration has often focused on managing risk and opportunities at the level of individual assets and investees to optimise risk-adjusted returns. However, in the roughly two decades since its inception, proponents of ESG integration have been challenged to better explain how investee or portfolio-level ESG performance amounts to improvements in the economy or system upon which returns rely.

System-level investing tools and models seek to respond to this challenge by considering those causal relationships or feedback loops through which negative externalities are mitigated and positive externalities are reinforced.

This approach also addresses the insufficiency of Modern Portfolio Theory by explaining the relationship between investment decision-making and system-level risks and considering the time horizons across which the effects of such risks are realised. System-level investors recognise investee or portfolio-level risks (traditionally ‘alpha’ factors) as intricately linked to systemic risks or ‘market risks’, (traditionally ‘beta’ factors), and seek to tailor their investment and stewardship strategies alongside appropriate time horizons.

Approaches to system-level investing

There are a variety of ways that investors choose to integrate system-level thinking. Two of the most common ways are:

• System-level investment practices: Whereby investors develop and apply investment models and strategies that merge traditional analysis of investee or portfolio-level risk with analysis of impacts of systemic and systematic risks. For example:
  1. The Investment Integration Project’s System Aware Investing Launchpad provides investors with tools to implement a system-level approach in areas such as asset allocation and manager selection.
  2. The Predistribution Initiative (PDI) and The Responsible Asset Allocator Initiative (RAAI) conduct programming for asset owners and allocators to adjust their financial benchmarking practices for system-level investing.
  3. The Institute of Energy Economics and Financial Analysis  developed a test case for a ‘systemically adjusted’ investment model that aims to empirically value assets in the context of systemic risks with Norway’s sovereign wealth fund.

• System stewardship: Focuses on interconnections in the investment ecosystem and prioritises activities that can achieve system-level impacts, including engagement and voting practices.

  For example, the Investor Action on Anti-Microbial Resistance initiative, which aims to combat the spread of drug-resistant superbugs, mobilised investors including Amundi, Legal & General Investment Management, Australian Super and HESTA to file shareholder resolutions on the issue of antibiotic use in the supply chain of multinational companies.

Key organisations and initiatives

There are a diverse and growing set of system-level investing and related initiatives, models, and training platforms that some PRI signatories are independently or collaboratively involved in. Aside from those mentioned above, we also note the pertinent work of The Shareholder Commons, The Thinking Ahead Institute, Transformation Capital and The School of System Change in Finance, run jointly by Aviva Investors, Forum for the Future and School for System Change.

Groups such as Impact Management Platform, Impact Frontiers, the Global Impact Investing Network, and the Sustainable Investing Research Initiative (Columbia University) also support investors to develop tools and practices to address the challenges of systems-level risks.

System-level investing at the PRI

We advance the development of system-level investing approaches through several programmes as noted in the table below. 

In 2025 we will continue to support knowledge-building and develop our work programmes in relation to system-level investing.

We encourage signatories to explore how the insights produced by the above groups can support your own journey in responsible investment.

To share your views on this area of work, please contact Nithya Iyer in the Sustainable Financial System team by emailing [email protected]