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Preference direction-based approach for sustainable portfolio construction

Author

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  • Adolfo Hilario-Caballero
  • Ana Garcia-Bernabeu
  • José V. Salcedo
  • David Pla-Santamaria

Abstract

This paper aims to provide a novel framework for incorporating investor preferences that integrate sustainability criteria as a third objective in portfolio optimization problems. The approach is based on the concept of preference directions, changing the geometric properties of the objective space and guiding the direction of the multi-objective optimization. This reinterpretation of the dominance concept aids in obtaining the Pareto front solutions. Investors' preferences can be integrated before the optimization process without modifying the algorithm, or at the decision-making stage after obtaining the efficient frontier. We empirically test our approach’s performance on actual socially responsible funds and on the S&P 500 index. Our findings suggest that this approach provides a better understanding of ESG preference integration by refocusing the region of interest, facilitating more effective investor decision-making. The benefits of our approach include improved portfolio sustainable construction and a more comprehensive understanding of investor preferences in sustainable investing.

Suggested Citation

  • Adolfo Hilario-Caballero & Ana Garcia-Bernabeu & José V. Salcedo & David Pla-Santamaria, 2026. "Preference direction-based approach for sustainable portfolio construction," Journal of Sustainable Finance & Investment, Taylor & Francis Journals, vol. 16(2), pages 467-489, April.
    • Handle: RePEc:taf:jsustf:v:16:y:2026:i:2:p:467-489
    DOI: 10.1080/20430795.2026.2645368
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