Markowitz Revisited: Social Portfolio Engineering

In recent years socially responsible investing has become an increasingly more popular subject with both private and institutional investors. At the same time, a number of scientific papers have been published on socially responsible investments (SRIs), covering a broad range of topics, from what actually defines SRIs to the financial performance of SRI funds in contrast to non-SRI funds. In this paper, we revisit Markowitz’ Portfolio Selection Theory and propose a modification allowing to incorporate not only asset-specific return and risk expectations but also a social responsibility measure into the investment decision making process. Together with a risk-free asset, this results in a three-dimensional capital allocation plane that allows investors to custom-tailor their asset-allocations and incorporate all personal preferences regarding risk, return and social responsibility. We apply the model on a set of over 9000 international stocks and find that investors opting to maximize the social impact of their investments do indeed face a statistically significant decrease in expected returns. However, the social responsibility/risk-optimal portfolio yields a statistically significant higher social responsibility rating than the return/risk-optimal portfolio.