Constructing Social Portfolios: A Quantitative versus Screening Approach

Abstract

Environmental, Social and Governance (ESG) investing is a fast-growing field and of rising importance in portfolio management. However, whereas both academic research and practice have given much attention to environmental and governance related issues, the social dimension has not yet received the same popularity when it comes to the integration in investment portfolios. We raise awareness about this issue by focusing our research on the integration of social scores in portfolio composition using two distinct investment strategies. The first portfolio is constructed applying a negative screening approach. Despite often discussed shortcomings such as sectoral tilts and loss of diversification, this strategy is among the most common ones in practice. In contrast, the second approach quantitatively integrates social ratings alongside financial performance as a third factor, therefore looking to optimize a risk-return-social trade-off. The constructed portfolios are based on 591 US listed companies over an investment horizon from 2013 to 2021. Using the MSCI USA index as a market benchmark, our empirical findings suggest that both investment strategies can lead to financial outperformance under asset pricing theory. In the non-financial dimension, only the quantitative model consistently yields higher exposure to companies with strong social ratings. Furthermore, by including controversy scores on a single-pillar level, we additionally aim to take a step beyond the common practice of looking at disclosed information and consider real life actions alongside reported initiatives in investment decisions.