Impact of ESG Risk on Portfolio Optimization and Returns: An Analysis Using the Markowitz Model

Abstract

This paper explores the integration of Environmental, Social, and Governance (ESG) factors into portfolio optimization using the Markowitz Model, focusing on two groups of ten stocks each from the Technology, Media, and Telecom (TMT) sectors. These stocks are categorized into low and high ESG risk groups according to established ESG rating agencies. Employing historical data, the study computes key financial metrics such as annualized returns, standard deviation, and Sharpe ratios to conduct various portfolio optimizations including the minimal risk frontier, efficient frontier, and inefficient frontier, while also applying five specific operational constraints reflective of real-world investment limits. The analysis distinctly highlights the superior performance of the low ESG risk group, which demonstrated higher returns and better risk-adjusted return profiles, as evidenced by elevated Sharpe ratios. These findings suggest that ESG integration not only aligns with broader societal goals but also enhances financial performance, especially under diverse regulatory and strategic constraints. This research enriches the discourse on sustainable investing by providing empirical evidence on how ESG factors influence traditional portfolio management strategies, potentially guiding future investor decisions and promoting a shift towards more sustainable investment practices.