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.