Socially responsible portfolios, environmental, social, corporate governance (ESG) efficient frontiers, and psychic dividends

The aim of this article is to evaluate the performance of investment portfolios built under environmental, social, and corporate governance (ESG) criteria or socially responsible portfolios, based on companies listed on three representative stock exchanges in Latin America (Chile, Colombia, and Peru) for the period 2011–2019. The performance of portfolios comprising high‐ESG stocks was compared with that of low‐ESG performance portfolios and with portfolios of companies that did not report such information, as well as against the main index of each market. A novel utility function was defined that allows evaluating different degrees of propensity to responsible investment, based on which restricted optimization processes were conducted to build efficient frontiers that combine traditional mean–variance aspects with ESG elements. Based on these frontiers, a measure of the psychic dividend or ESG utility premium generated by investing in high‐ESG portfolios is proposed. Results obtained in risk and return rates and Jensen, Treynor, alpha, VaR, tracking error, information coefficient, efficient frontiers, and utility premium show the value of following responsible investment criteria and the clear disadvantages in investing in companies that do not report ESG information. This research contributes to the debate on the importance of socially responsible investment guided by ESG criteria, filling a gap in the literature regarding Latin America and confirming the better performance by calculating a wide range of portfolio evaluation indicators. We proposed a novel approach to optimization with sustainability constraints, incorporating the utility premium derived from investing in stocks with better ESG performance.