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

Authors

  • Siqi Jia

DOI:

https://doi.org/10.54097/2dksd066

Keywords:

Markowitz Model, Portfolio Optimization, ESG, TMT, Constraints.

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.

Downloads

Download data is not yet available.

References

H.M. Markowitz. (1952) Portfolio selection, The Journal of Finance, 7, 77-91.

H.M. Markowitz. (1990) Mean-Variance Analysis in Portfolio Choice and Capital Markets, Basil Blackwell.

M. Ivanova, L. Dospatliev. (2017) Application of Markowitz Portfolio Optimization on Bulgarian Stock Market from 2013 to 2016. International Journal of Pure and Applied Mathematics, 117(2), 291-307.

G. A. Pogue. (1970) An Extension to the Markowitz Portfolio Selection Model to Include Variable Transaction Costs, Short Sales, Leverage Policies, and Taxes. Journal of Finance.

M. Özyeşil. (2020) Markowitz Portfolio Optimization Model: An Application on Listed Firm on Borsa İstanbul -30 National Stock Index (Bist-30). III. International Istanbul Scientific Research Congress.

W. F. Sharpe. (1966) Mutual Fund Performance. Journal of Business, 39(1), 119-138.

G. Chacko, L. M. Viceira. (2005) Dynamic Consumption and Portfolio Choice with Stochastic Volatility in Incomplete Markets. Review of Financial Studies, 18(4), 1369-1402.

M. Kaurissaari. (2021) Markowitz Revisited: Is there trade-off between return and responsibility?

A. B. Schmidt. (2020) Optimal ESG Portfolios: An Example for the Dow Jones Index. Journal of Sustainable Finance & Investment, 12(2), 529-535.

A. Riedl, P. Smeets. (2017) Why Do Investors Hold Socially Responsible Mutual Funds? The Journal of Finance, 72(6), 2505-2550.

A. Kempf, P. Osthoff. (2007) The Effect of Socially Responsible Investing on Portfolio Performance. Centre for Financial Research.

L. H. Pedersen, S. Fitzgibbons, L. Pomorski. (2021) Responsible Investing: The ESG-Efficient Frontier. Journal of Financial Economics, 142(2), 572-597

G. Friede, T. Busch, A. Bassen. (2015) ESG and Financial Performance: Aggregated Evidence from More than 2000 Empirical Studies. Journal of Sustainable Finance & Investment, 5(4), 210-233.

L. Chen, L. Zhang, J. Huang, H. Xiao, Z. Zhou. (2021) Social responsibility portfolio optimization incorporating ESG criteria. Journal of Management Science and Engineering, 6(1), 75-85

N. Lapanan. (2018) the investment behavior of socially responsible individual investors. The Quarterly Review of Economics and Finance, 70, 214-226

L. Renneboog, J. Ter Horst, C. Zhang. (2008) Socially Responsible Investments: Institutional Aspects, Performance, and Investor Behavior. Journal of Banking & Finance, 32(9), 1723-1742.

Downloads

Published

01-09-2024

How to Cite

Jia, S. (2024). Impact of ESG Risk on Portfolio Optimization and Returns: An Analysis Using the Markowitz Model. Highlights in Business, Economics and Management, 40, 1184-1192. https://doi.org/10.54097/2dksd066