Social Finance and the Postmodern Portfolio: Theory and Practice

Abstract

The field of social finance, which includes a range of investment practices that consider both the social and financial characteristics of investments, has grown tremendously over the past decade. As the Millennial generation acquires increasing amounts of wealth, the trend is likely to continue, and wealth managers will need to adapt. In this article, the authors propose a “post-modern” portfolio theory that incorporates metrics of social return into the portfolio construction process. The article first develops an investor utility function that accommodates each investor’s unique preferences for different types of social impact. Using the heterogeneous expectations version of the capital asset pricing model, the authors then expand the utility function into a model of general equilibrium. Estimation and forecasting problems are discussed, as are the implications of this model for both investors who care only about traditional financial utility, as well as those who value other forms of well-being in the context of their portfolio goals. Finally, the article offers wealth advisors a simple approach to implementation that is amenable to clients with varying degrees of interest in social return.

TOPICS: Wealth management, portfolio theory, portfolio construction, ESG investing