Title: ESG PORTFOLIO OPTIMIZATION IN MALAYSIA USING GARCH, EWMA

and EQUALLY WEIGHTAGE FORECASTING MODELS.

(intro link between esg sri and csr. Define and evidence)

ESG can be define to the criteria in evaluating the ability of the company to sustain their
business. ESG also refer to the criteria in measuring company's investment ethics. This
criterion very useful in order to measure the company's future financial performance (returns
and risks). CSR refers to corporation's initiatives to evaluate and acknowledge the
responsibility regarding in influencing all stakeholders. CSR works by about regulating itself,
and exposing itself to the principles of guidance, operational philosophy, and behaviour of a
company towards all stakeholders and the goal is to ensure that the company's actions have a
positive impact on all stakeholders. Investment Social Responsibility (SRI) is a investment
process that coordinates social, environmental, and ethical contemplation that involving in
investment decision . As SRI not similar to conventional investment types, SRI utilizes an
arrangement of investment screens to choose or exclude asset based on environmental, social,
corporate administration or moral criteria, and are frequently engaged with nearby networks
and investor activists to pursue corporate strategy towards the above goals.

These changes are forcing companies to engage in a diverse range of activities to remain
competitive. Many companies now realize that the intangible aspects are as important as the
tangible aspects of conducting business. Moreover, all stakeholders are placing significantly
more emphasis on socially responsible practices. Consumers, investors, businesses, and
governments are the main stakeholders, which are stimulating this change with their changing
expectations from businesses (Carroll and Schwartz 2003). As a result, the concept of CSR is
growing in importance and attracting the attention of sch addition, there are differences across
the findings of CSR studies conducted in different countries, which makes it difficult to arrive
at universal conclusions (Forte 2013; Lambooy 2010). Most of the previous studies in this area
focused on financial performance as a measure of firm performance. However, the economic
performance of the firm has received less attention, despite the fact that environmental, social
and governance (ESG) dimensions are critical elements of the CSR concept (Sacconi 2006).

Research Questions

The research question based on this study are as below:

1) How will the company be sort out into groups?

2) What are the forecasting model use to forecast the portfolio optimization?
3) Which forecasting model can gives highest return?

Research Objectives
 The main purposes of this study are as below:

1) To rank the portfolio based on the volatility by dividing the stocks into three
level volatility group.
2) To find portfolio optimization by using GARCH,EWMA AND Equally
Weighted
3) To identify which method can provide the highest return based on portfolio

Background of Study:

Most investors are more inclined to use traditional investments since it is said to give a higher
return compared to alternative investments. However, a study shows that alternative
investments contribute higher return during financial crisis compared to conventional
investments (Nofsinger & Varma, 2014). A study shows that since financial market crisis
occurred in 1997 and 2007, most industrial investors have sought for alternative investments
such as private equity, hedge funds, managed futures, real estate, commodities and derivatives
contracts. According to a survey by LGT Capital Partners and Mercer, the majority of the
institutional investors have actively pondered on Environmental, Social and Governance (ESG)
when making alternative allocations. The results show 97 institutional investors in 22 countries
mostly believe ESG improves risk-adjusted returns. This can be one of the reasons investors
tend to withdraw their traditional investment and invest to the alternative investment such as
SRI which consists of ESG elements. In recent years, there has been expanding utilization of
ESG information by stakeholders, particularly investor. (Tarmuji, Maelah, & Tarmuji, 2016).
Nowadays, companies are more aware that ESG disclosure is important in order to portray
good reputation and image regarding green issues to the stakeholders. Hence this leads to the
expansion of disclosing ESG practices in the global data stream throughout the year.

The question is how do these investors can take advantage of this alternative investments in
order to maximize their returns, especially on ESG products? This research will explore further
regarding portfolio optimization model that could be used to measure the weight of the stocks
in ESG products based on its volatility of return.

There are two steps (Markowitz, 1952), in order to optimize a stock portfolio. The first step
requires to forecast the volatility of future returns of the underlying asset. The models that been
used for this step are the generalized autoregressive conditional heteroscedasticity (GARCH)
extreme value theory (EVT) copula (Longin,1996). The second step consists of optimal
portfolio allocation, which is achieved by defining each asset’s weight in the corresponding
portfolio. There are two main methods that are used in this step: Exponentially weighted
moving average (EWMA), and Equally-weighted.

Problem statement:

Issues regarding social concerns among all affected communities during the global financial
crisis has caused quite disruptions in the USA, Europe and the Pacific region in 2008
(Aizenmanet al. 2010). According to Galbreath (2013), financial crisis arises has caused a
significant concerns over companies’ ethical, social, environmental and accountability
performances. ESG based investment such as SRI is said cannot outperformed conventional
investments. This is because of the higher cost associated in this type of investment (Fatemi,
Glaum, & Kaiser, 2017). Evidence can be found from the underlying assumption which is the
returns from the ESG activities are lower than their costs. As Kim and Lyon (2015) note, a few
recent papers (Fisher-Vanden & Thorburn, 2011; Jacobs, Singhal, & Subramanian, 2010;
Lyon, Lu, Shi, & Yin, 2013) continue to find that firms reporting engagement in
environmentally friendly activities or winning green awards experience negative abnormal
returns. This results suggest that most of investors avoid to invest their money into an expensive
investments. In addition, research also showed that in a competitive market, firms usually lower
their profit margins in order to pursue the ESG goals. This could become one of the reason why
it could not survive in the competitive market. (Renneboog, Ter Horst, & Zhang, 2008)

Markowitz (1952) said that the conventional formulation of a typical single- period portfolio
selection issue was expressed as a non- linear bi- criteria optimization process, the risk is
minimized and expected return is maximized. Based on the details given by economic and
financial environment, the optimal portfolio decisions are that the financial assets that is still
available, risks and returns expectancy, and the investor circumstances and preferences. These
decisions applicable for long- term investors. Other than that, investors usually concerning
about expected returns and risk for current time, but they also need to know the changes of
expected and returns throughout the time. Merton (1969), Merton (1971), Merton (1973)
and Samuelson (1969) stated that result to a static portfolio choice problem are different with
result to a multi period portfolio. Usually when an investment opportunity that varies over time,
long- term investors will concern about future investment opportunities. This is because the
investors may create intertemporal hedging claims for financial assets and lead to strategic
asset allocation as a result of investors' far-reaching responses to verifying investment
opportunities. But, the intertemporal asset allocation model is difficult to solve in closed form
except for a strong assumption about the objective function of the investor or the distribution
of asset return statistics. The obvious exception is when an investor exhibits a log utility with
a relative risk aversion that remains the same.

Issue specific optimization

There’s also study esg is good. Forecasting. Esg add more confidence. However donnow how
to diversify bape byk nk invest. What is the best proportion for this portfolio. Hence investor
in Malaysia tak tahu kat mana nk invest. this study portfolio optimization will be in order to
solve the question.

How does the performance of esg give impact since it have beem established. Does esg give
opportunity are more liquid (senang to turn to cash, beli-jual)? Bagus lah. There are still lack
of research

Portfolio allocation. Issue on esg portfolio optimization. There’s so many study into its
performance. How good is esg.

SRI>ESG cari sri related dgn esg give impact.

Significance of Study:

This study is to help investor in making right decision to know how many percentage they
should invest in the company to avoid from causing loss in the future. This also can determine
how much to allocate in each of the ESG products. On the other hand, is to gain highest possible
return when investing in ESG companies listed by ftse4good bursa Malaysia. Besides, from
this study investor can reduce risk of losing higher expected losses. For example, instead of
losing 50%, investor will only lose 20% from the company that they have invested. Moreover,
this research helps the industry to determine which model is the best for portfolio selection in
ESG scope of study.

Limitation of the study:

This study focused in Malaysia. We are investigating on value at risk and conditional

value at risk of ESG stocks. Besides, the data set that used in this study covers the ESG closing

price stocks. The range of the data sets is from January 2006 to December 2016. Unfortunately,
this study has several limitations. One of it was this research only included 18 ESG companies
although there are actually more than that.

Fatemi, A., Glaum, M., & Kaiser, S. (2017). ESG performance and firm value: The moderating role of
disclosure. Global Finance Journal. doi:https://doi.org/10.1016/j.gfj.2017.03.001
Renneboog, L., Ter Horst, J., & Zhang, C. (2008). Socially responsible investments: Institutional aspects,
performance, and investor behavior. Journal of Banking and Finance, 32(9), 1723-1742.
doi:10.1016/j.jbankfin.2007.12.039