Importance of portfolio optimization in SRI and conventional pension funds

This study assesses the portfolio concentration of socially responsible investment (SRI) pension funds, which may be subject to a potentially limited asset universe and have a higher concentration and lower performance than conventional funds. Nonetheless, in contrast to previous studies on SRI funds, this study considers the information-advantage theory, positing that skilled managers should increase their concentration in assets in which they possess valuable information, departing from optimization models to achieve outperformance. This study first compares actual fund concentration with concentration obtained from several traditional and modern portfolio optimization techniques (minimum variance, global minimum variance, optimal portfolio, naïve diversification, risk parity, and reward-to-risk timing) to understand whether SRI pension funds concentrate portfolios and deviate from optimization model solutions. Unlike previous studies, the actual fund assets are considered in the optimization models to take into account the real investment profiles of SRI funds. The results indicate that SRI pension funds are less concentrated than conventional funds, and SRI and conventional pension funds largely diversify their portfolios, presenting lower concentration than portfolios formed with the optimization models. Furthermore, concentration strategies positively influence performance in SRI and conventional funds, revealing the use of information advantage. However, SRI and conventional fund managers present poor skills (picking, timing, and trading) to exploit information advantages due to overconfidence issues, which affect performance with concentration strategies. This situation may be modified if SRI funds follow modern optimization models and conventional funds follow traditional optimization models, improving managers’ performance and skills.