ESG integration in portfolio selection: A robust preference-based multicriteria approach

Abstract

We present a framework for multi-objective optimization where the classical mean–variance portfolio model is extended to integrate the environmental, social and governance (ESG) criteria on the same playing field as risk and return and, at the same time, to reflect the investors’ preferences in the optimal portfolio allocation. To obtain the three–dimensional Pareto front, we apply an efficient multi-objective genetic algorithm, which is based on the concept of ɛ-dominance. We next address the issue of how to incorporate investors’ preferences to express the relative importance of each objective through a robust weighting scheme in a multicriteria ranking framework. The new proposal has been applied to real data to find optimal portfolios of socially responsible investment funds, and the main conclusion from the empirical tests is that it is possible to provide the investors with a robust solution in the mean–variance–ESG surface according to their preferences.

Keywords

• Multi-objective optimization
• Portfolio selection
• Evolutionary algorithms
• Preferences
• SMAA–TOPSIS
• ESG integration