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Cleaning a Passive Index: How to Use Portfolio Optimization to Satisfy CSR Constraints

30 Pages Posted: 17 Dec 2004  

Moshe A. Milevsky

York University - Schulich School of Business

Andrew R. Aziz

Algorithmics Inc.

Allen Goss

Ryerson University - Ted Rogers School of Management

Jane Thomson

Institute for Research and Innovation in Sustainability

David Wheeler

York University - Schulich School of Business

Date Written: December 2004

Abstract

The emotionally charged debate regarding the broader role of corporations within society has landed squarely in the lap of pension fund and endowment trustees, many of whom are being pressured by their stakeholders to divest themselves of companies that lack so-called social responsibility. Some researchers claim that these companies are destined to mediocre financial performance given their irresponsible behavior and should rightfully be divested. A more traditional group argues that any attempt to second-guess the market by constraining the investible universe is itself destined to mediocrity.

In this paper we take neither side of the debate. Rather, we illustrate how portfolio optimization can be used to locate statistical portfolio substitutes for investments and companies that fail a corporate social responsibility (CSR) screen. And, while the mathematics behind constrained portfolio optimization was developed more than 50 years ago, we find that the economic penalty for eliminating a small group of undesirable stocks - whether justified or not - is economically insignificant when the remaining investments are properly realigned. We illustrate the feasibility of this procedure with a cleansing process for the Canadian S&P/TSX 60 index, based on an employee practice CSR screen developed by Thompson and Wheeler (2004).

Keywords: Investments, Pension Funds, Efficient Frontier, Socially Responsible Investing

JEL Classification: A13, D60, G11

Suggested Citation

Milevsky, Moshe A. and Aziz, Andrew R. and Goss, Allen and Thomson, Jane and Wheeler, David, Cleaning a Passive Index: How to Use Portfolio Optimization to Satisfy CSR Constraints (December 2004). Available at SSRN: https://ssrn.com/abstract=630622 or http://dx.doi.org/10.2139/ssrn.630622

Moshe Arye Milevsky (Contact Author)

York University - Schulich School of Business ( email )

4700 Keele Street
Toronto, Ontario M3J 1P3
Canada

Andrew R. Aziz

Algorithmics Inc. ( email )

185 Spadina Avenue
Toronto M5T 2C6, Ontario
Canada
1-416-217-4113 (Phone)

Al Goss

Ryerson University - Ted Rogers School of Management ( email )

575 Bay Street
Toronto, Ontario
Canada

Jane Thomson

Institute for Research and Innovation in Sustainability ( email )

4700 Keele Street
Toronto, Ontario M3J 1P3
Canada

David Wheeler

York University - Schulich School of Business ( email )

4700 Keele Street
Toronto, Ontario M3J 1P3
Canada

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