Balancing Financial and Sustainable Objectives in Sovereign Bond Portfolios Using Multi-Objective Optimization

This article introduces a novel model that examines how sustainability influences asset allocation decisions, based on the objectives and preferences of investors seeking to maximize both financial and non-financial goals simultaneously. By applying various utility functions and levels of risk aversion, we analyze how market information, combined with investor preferences, affects portfolio allocation. A multi-objective optimization approach utilizing the non-dominated sorting genetic algorithm (NSGA-II) is implemented to generate the Pareto front of non-dominated portfolios. An optimal solution is then selected through two alternative approaches: the explicit incorporation of investor constraints and the application of various multicriteria decision-making (MCDM) methods. The framework is applied to a portfolio of international sovereign bonds, integrating climate and financial returns. It demonstrates how different investor profiles result in varied portfolio compositions and illustrates that sustainability objectives can not only coexist with financial goals but may also enhance portfolio performance. Our research provides a robust framework for institutional investors to balance financial, diversification, and sustainability goals. Tailored to different investor preferences, it is highly applicable to both asset management and the mutual fund industry.