9. Active Management of Socially Responsible Portfolios

We consider the problem of an investor who wishes to allocate her wealth according to some socially responsible (SR) criteria. The reduction in the investment set opportunity produces a cost for the investor which we call “cost of sustainability”. On the other hand, the investor is aware that the financial performances of some actively managed SR portfolios may be better or comparable to those of conventional portfolios. For this reason, the investor decides to entrust her wealth to a portfolio manager able to produce accurate forecasts of SR asset returns. The investor’s task is threefold: (a) hiring a manager who can offset the cost of sustainability; (b) setting a bonus to compensate the manager for the investment restriction; (c) attracting only the best and more motivated managers. We provide a solution to these problems and apply our results to data consisting of S&P500 firms screened by KLD scores.