In the last 40 years, multicriteria methods have emerged as a branch of decision science. At the beginning of this period, the multicriteria tools did not seem convincing to those reviewers educated in the traditional paradigm, but years later the usefulness of multicriteria tools was undeniable. This intruding and welcome perception of their importance has caused some change in the decision-making map as well as in the optimization methods. For centuries, mathematicians have been interested in optimizing a single variable depending on other variables under constraints. This problem, elegantly solved by Lagrange in the eighteenth century, has a unique criterion character. Classic financial theory has insistently assumed this unique criterion of investing: to maximize the investor's wealth, or more precisely, to maximize the expected utility of wealth under uncertainty. Normative portfolio management models based on this assumption have been fertile in the past and are helpful for managers today, although psychologists and sociologists have commented their unrealism. One can argue that fund managers consider multiple criteria such as historical returns, market trends, conjectures about companies in the near future and in the long term, historical volatilities, downside risk, liquidity, expected changes in macromagnitudes, probability or likelihood of these changes, unpredictable events, appropriate size of portfolios and attractive image of portfolios to investors. Reducing all these criteria to a single variable seems quite impossible.
This book attempts to articulate socially responsible investments (SRI) into modern portfolio theory from the multicriteria perspective. Socially responsible Investment is a new deal defended by sectors of institutional investors and banks. These agents, which influence mutual funds and other collective investment schemes, think that financial strategies without ethical constraints can damage sustainable growth and welfare. To avoid this threat, they think that financial criteria such as profitability and risk should be combined with ethical criteria such as ecosystem protection, responsible consumption of energy, health care campaigns, no monopoly, no cartel agreements, and others. An increasing flow of financial resources should be invested in companies with ethical projects and a decreasing flow invested in companies with anti-ethical activities. Freedom but not government interventionismis a widely accepted principle of efficiency in Economics today, and therefore ethical investment is viewed as a private initiative.
As the title of this book suggests, the multiple criteria decision making methods play a visible role in this work. Some aspects should be highlighted. First, the overall approach of the book, except for some chapters at the beginning, is normative rather than descriptive. We emphasize the use of goal programming and compromise programming models to select ethical financial portfolios and evaluate fund performance. Second, applicability is a friendly purpose in the book. In every part of the book illustrative examples and actual cases are numerically developed. We think that theory alone is insufficient, not only to implement the methods, but also to get insight into them in a variety of details. Going from practice to theory is more natural and didactic than going from theory to practice. Third, we would be happy if the book is useful to graduates, researchers and practitioners as well as undergraduate students.
Thanks are given to Ignacio Gonzalez for reviewing the English style and grammar.
Finally, we would like to follow properly the path left by Prof. Ballestero, especially because of his interest in the increment and effective implementation of social responsibility in our society.
Thanks, Prof. Ballestero, for all you have taught us. Alcoy, Spain Enrique Ballestero; Oviedo, Spain Blanca Perez-Gladish; Alcoy, Spain Ana Garcia-Bernabeu July 2014

Part I Critical Issues in Ethical Investment

1 The Ethical Financial Question and the MCDM Framework 3

Enrique Ballestero, Blanca Perez-Gladish, and Ana Garcia-Bernabeu

      1.1 What SRI Means 3

      1.2 Historical Outline 8

      1.3 Why SRI? Sustainability Constraints in the Classical Economic Model 11

      1.4 Multiple Criteria Decision Making (MCDM) Framework 12

      1.4.1 A Brief MCDM History 13

      1.4.2 MCDM and Portfolio Selection 14

      1.4.3 MCDM Applications to SRI 16

      Conclusions 16

      References 17

2 Profiling Ethical Investors 23

Paz Mendez-Rodrfguez, Laura Galguera, Mila Bravo, Karen Benson, Robert Faff, and Blanca Perez-Gladish

      2.1 Introduction 23

      2.1.1 The Australian SRI Market 24

      2.1.2 The Spanish SRI Market 25

      2.2 Literature Review 27

      2.3 Research Design and Results 30

      2.4 Case Studies for the Spanish and the Australian Investors 32

      2.4.1 Spanish Investors 33

      2.4.2 Australian Investors 42

      Conclusions 49

      References 51

3 Social Performance and Financial Performance: A Controversial Relationship 53

Hajer Tebini, Bouchra M'Zali, Pascal Lang, and Paz Mendez-Rodriguez

      3.1 Introduction 54

      3.2 Research Hypothesis 56

      3.3 Research Method 57

      3.3.1 Description of Data and Sample 57

      3.3.2 Methodological Approach 58

      3.3.3 Measures 59

      3.3.4 Model Specification 61

      3.4 Results 62

      3.4.1 The Impact of SP on FP Depends on the Period of Study 63

      3.4.2 The Impact of SP on FP Depends on the Extent of SP 65

      3.4.3 The Impact of SP on FP Depends on the Extent of FP 65

      3.4.4 The Impact of SP on FP Depends on the Selected Sample 66

      3.4.5 The Impact of SP on FP Depends on the Model Used 67

      Conclusions 69

      References 70

4 Measurement of Assets' Social Responsibility Degree 75

Mila Bravo, Ana B. Ruiz, David Pla-Santamaria, and Paz Mendez-Rodriguez

      4.1 Introduction 75

      4.2 The Role and Practice of Social Rating Agencies 76

      4.2.1 KLD 80

      4.2.2 VIGEO 81

      4.2.3 EIRIS 86

      4.3 Academic Literature Review on the Measurement of Mutual Funds' Social Responsibility Degree 87

      4.4 A First Proposal for the Measurement of Assets' Social Responsibility Degree 97

      4.4.1 Aggregated Social Responsibility Indicator 97

      4.4.2 Applying SRD Indicator to a Real World Case Study 99

      Conclusions 106

      References 107

Part II Goal Programming and SRI Funds

5 Portfolio Selection by Goal Programming Techniques 111

Enrique Ballestero, Ana Garcia-Bernabeu, and Adolfo Hilario

      5.1 Deterministic Weighted Goal Programming 111

      5.2 An Example of SRI Decisions 115

      5.3 Risk Aversion and Statistical Risk 117

      5.3.1 Risk Aversion as Depending on the Investor's Utility 117

      5.3.2 Eliciting ARA in Arrow's Utility Scenarios 120

      5.4 Risk Aversion for Portfolio Random Returns: How to Elicit ARA Coefficients 121

      5.4.1 Mean-Variance Stochastic Goal Programming (MV-SGP) Model 123

      5.4.2 Markowitz E-V Model 124

      5.4.3 A Multiobjective Extension: The MV-SGP Model 124

      5.4.4 Two Objective Case 127

      5.5 Selecting SRI-Financial Portfolios: Stages in the Process 127

      Conclusions 128

      References 129

6 Selecting SRI Financial Portfolios Applying MV-SGP Model 131

Enrique Ballestero and Ana Garcia-Bernabeu

      6.1 Goal Statement Under Uncertainty from Financial and SRI Perspectives 131

      6.2 Analytic Statement for the Financial-Ethical Bicriteria Model 133

      6.3 ModelTargets 134

      6.4 Estimating ARA Coefficients 135

      6.5 Meaning of the Model in Terms of Risk and Risk Aversion 139

      Conclusions 140

      References 140

7 An Actual Case of SRI Financial Portfolio Choice by MV-SGP 143

Enrique Ballestero, Ana Garcia-Bernabeu, David Pla-Santamaria, and Mila Bravo

      7.1 Introduction 143

      7.2 Defining Investor's Profiles 145

      7.3 Specifying and Solving the Model 146

      7.4 Results 147

      7.4.1 Achievement in Terms of Expected Return and Risk 148

      7.4.2 Portfolio Weights: A Comparison from the Green Perspective 150

      7.5 Sensitivity Analysis 150

      Conclusions 151

      References 151

Part III Compromise Programming and SRI Funds

8 Compromise Programming and Utility Functions 155

Enrique Ballestero and Ana Garcia-Bernabeu

      8.1 Introduction to CP Modelling 155

      8.2 Choice Problems and the Decision Maker's Utility 157

      8.3 Reviewing the CP Model 158

      8.3.1 An Example of CP Setting from Economic and Ethical Objectives 159

      8.3.2 CP Proxy for the Decision Maker's Utility Function 162

      8.3.3 SRI Example: Carbon Pollution from a Power Plant 162

      8.4 Linear-Quadratic Composite Metric: Advanced Approaches 165

      8.4.1 Utility Function: An Extended Approach 166

      8.4.2 Normalizing the Xj Criteria 167

      8.4.3 Normalizing the Objective Function 168

      8.4.4 Linear Quadratic CP Achievement Function 168

      8.4.5 A Case of Polymer Industry 169

      Conclusions 173

      References 174

9 Portfolio Selection by Compromise Programming 177

Enrique Ballestero, David Pla-Santamaria, Ana Garcia-Bernabeu, and Adolfo Hilario

      9.1 Using CP to Select Securities Portfolios 177

      9.2 A Real World Case of Stock Market Investment 181

      9.3 First Stage: Basic Statements 185

      9.4 Second Stage: Bounding the Investor's Utility Optimum 186

      Conclusions 194

      References 195

10 Ethically Constrained Portfolio Selection of Funds by CP Modelling: A Real World Environmental Case 197

Ana Garcia-Bernabeu, Blanca Perez-Gladish, and Adolfo Hilario

      10.1 Motivating the Problem 197

      10.2 The CP Model 199

      10.3 Actual Environmental Case 201

      10.3.1 Empirical Information 202

      10.3.2 Applying CP to the Portfolio Selection Process 203

      Conclusions 208

      References 209

11 Evaluating Fund Performance from Financial and SRI Criteria 211

Ana Garcia-Bernabeu, Blanca Perez-Gladish, and Adolfo Hilario

      11.1 Performance Composite Measures in Classic Financial Analysis 211

      11.2 Purely Financial Performance Analysis Regardless of the Investor's Preferences 212

      11.3 Purely Financial Performance and Combined SRI-Financial Performance from the Investor's Preferences 213

      11.3.1 Purely Financial Performance 214

      11.3.2 Combined SRI-Financial Performance 216

      11.4 Numerical Examples 216

      11.4.1 An Actual Case of Purely Financial Performance 217

      11.4.2 An Example of Combined SRI-Financial Performance 220

      Conclusions 223

      References 224

Part IV Other Decision-Making Support Methods

12 Ranking Socially Responsible Mutual Funds Based on the Particular Preferences of the Decision Maker 227

Ana B. Ruiz, Bouchra M'Zali, and Paz Mendez-Rodriguez

      12.1 Introduction 228

      12.2 Ranking SRI Mutual Funds Based on the Analytical Hierarchy Process (AHP) 229

      12.2.1 Socially Responsible Criteria 229

      12.2.2 Ranking Mutual Funds Based on Socially Responsible Criteria 238

      12.3 Ranking SRI Mutual Funds Based on Macbeth 243

      12.3.1 Evaluation of Mutual Funds' Socially Responsible Performance 244

      12.3.2 Weighting the Evaluation Criteria 251

      12.4 Discussion 258

      Conclusions 260

      References 260

13 Portfolio Selection with SRI Synthetic Indicators: A Reference Point Method Approach 263

Paz Mendez-Rodriguez, Blanca Perez-Gladish, Jose Manuel Cabello, and Francisco Ruiz

      13.1 Introduction 263

      13.2 The Reference Point Based Approach 264

      13.3 Synthetic Indicators of Stocks' Social Responsibility 269

      13.4 Portfolio Selection Model 271

      13.4.1 Banks and Financial Services 272

      13.4.2 Broadcasting, Advertising and Publishing 273

      13.4.3 Electric, Gas Utility andEnergy 273

      13.4.4 Heavy Construction and Logistics 273

      13.4.5 Rest of Stocks 274

      Conclusions 280

      References 281

14 Soft Computing Techniques for Portfolio Selection: Combining SRI with Mean-Variance Goals 283

Clara Calvo, Carlos Ivorra, and Vicente Liern

      14.1 Introduction 283

      14.2 Elements of Fuzzy Set Theory 284

      14.3 Fuzzy Measurement of Social Responsibility 286

      14.4 Portfolio Selection Under Cardinality and Semicontinuous Variable Constraints 289

      14.5 A Soft Computing Approach to SRI 292

      Conclusions 300

      References 300

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