Sustainability for Portfolio Optimization

Sammanfattning: The 2007-2008 financial crash and the looming climate change and global warming have heightened interest in sustainable investment. But whether the shift is as a result of the financial crash or a desire to preserve the environment, a sustainable investment might be desirable. However, to maintain this interest and to motivate investors in indulging in sustainability, there is the need to show the possibility of yielding positive returns. The main objective of the thesis is to investigate whether the sustainable investment can lead to higher returns. The thesis focuses primarily on incorporating sustainability into Markowitz portfolio optimization. It looks into the essence of sustainability and its impact on companies by comparing different concepts. The analysis is based on the 30 constituent stocks from the Dow Jones industrial average or simply the Dow. The constituents stocks of the Dow, from 2007-12-31 to 2018-12-31 are investigated. The thesis compares the cumulative return of the Dow with the sustainable stocks in the Dow based on their environmental, social and governance (ESG) rating. The results are then compared with the Dow Jones Industrial Average denoted by the symbol (^DJI) which is considered as the benchmark for my analysis. The constituent stocks are then optimized based on the Markowitz mean-variance framework and a conclusion is drawn from the constituent stocks, ESG, environmental, governance and social asset results. It was realized that the portfolio returns for stocks selected based on their environmental and governance ratings were the highest performers. This could be due to the fact that most investors base their investment selection on the environmental and governance performance of companies and the demand for stocks in that category could have gone up over the period, contributing significantly to their performance.