Markowitz revisited: Social portfolio engineering

In recent years socially responsible investing has become a 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 but also a social responsibility measure into the investment decision making process. Applied in an a posteriori fashion, the model results in a three-dimensional capital allocation plane illustrating the complete set of feasible optimal portfolios. It enables investors to custom–tailor their asset allocations and incorporate all personal preferences regarding return, risk and social responsibility. In an empirical analysis with a data set of over 6000 international companies (including the complete universe of social responsibility-rated stocks), we 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.