ESG portfolio for TDFs with time‐varying higher moments and cardinality constraint

Abstract

AbstractPension funds are crucial in supporting environmentally sustainable and socially responsible investments. This paper focuses on an essential product of pension funds, target date funds (TDFs), constructing its portfolio model that considers environmental, social, and governance (ESG) investment. Our model utilizes the mean–variance–skewness–kurtosis optimization framework and accounts for the time‐varying relationship between realized higher moments and subsequent TDFs performance. A cardinality constraint is included to prevent over‐diversification and reduce costs, controlling the number of constituent funds in the TDFs. Since the model is multiobjective, we transform it into a single‐objective optimization through the investment manager's preferences. The numerical experiments represent the most suitable time‐varying higher moment strategy for the Chinese market and demonstrate the model's applicability to managers prioritizing risk over returns, which resonates well with the conservative investment of pension funds. We prove that controlling the number of constituent funds with cardinality constraint is advantageous for improving TDFs' performance. By selecting ESG funds as underlying assets, we highlight that green TDFs have better long‐term performance in terms of higher moment risk.