mathematics

Article
Multi-Objective Portfolio Optimization Using a Quantum Annealer
Esteban Aguilera 1 , Jins de Jong 1 , Frank Phillipson 1,2, * , Skander Taamallah 3 and Mischa Vos 3

1 TNO, P.O. Box 96800, 2509 JE The Hague, The Netherlands

2 School of Business and Economics, Maastricht University, P.O. Box 616, 6200 MD Maastricht, The Netherlands
3 Rabobank, P.O. Box 17100, 3500 HG Utrecht, The Netherlands
* Correspondence: frank.phillipson@tno.nl

Abstract: In this study, the portfolio optimization problem is explored, using a combination of
classical and quantum computing techniques. The portfolio optimization problem with specific
objectives or constraints is often a quadratic optimization problem, due to the quadratic nature of,
for example, risk measures. Quantum computing is a promising solution for quadratic optimization
problems, as it can leverage quantum annealing and quantum approximate optimization algorithms,
which are expected to tackle these problems more efficiently. Quantum computing takes advantage
of quantum phenomena like superposition and entanglement. In this paper, a specific problem is
introduced, where a portfolio of loans need to be optimized for 2030, considering ‘Return on Capital’
and ‘Concentration Risk’ objectives, as well as a carbon footprint constraint. This paper introduces
the formulation of the problem and how it can be optimized using quantum computing, using a
reformulation of the problem as a quadratic unconstrained binary optimization (QUBO) problem.
Two QUBO formulations are presented, each addressing different aspects of the problem. The QUBO
formulation succeeded in finding solutions that met the emission constraint, although classical simu-
lated annealing still outperformed quantum annealing in solving this QUBO, in terms of solutions
close to the Pareto frontier. Overall, this paper provides insights into how quantum computing can
address complex optimization problems in the financial sector. It also highlights the potential of
quantum computing for providing more efficient and robust solutions for portfolio management.

Keywords: quantum computing; portfolio management; quantum annealing

Citation: Aguilera, E.; de Jong, J.;
Phillipson, F.; Taamallah, S.; Vos, M. MSC: 91G10; 68Q12; 81P68
Multi-Objective Portfolio
Optimization Using a Quantum
Annealer. Mathematics 2024, 12, 1291.
https://doi.org/10.3390/ 1. Introduction
math12091291 Portfolio management is the classical problem of selecting assets, such as stocks, bonds,
Academic Editor: David Carfì commodities, and loans, in an optimal way. Classical portfolio management was introduced
by Markowitz [1]. He focused on efficient (expected) mean-variance combinations. His
Received: 21 March 2024 work has led to a broad spectrum of optimization problems, with variations of the problems,
Revised: 11 April 2024
such as single and multi-objective [2,3], single and multi-period [4,5], with and without [5,6]
Accepted: 18 April 2024
transaction costs and deterministic or stochastic variables [7,8], in all possible combinations
Published: 24 April 2024
and also called portfolio optimization.
The fundamental challenge in portfolio optimization revolves around a single objective:
maximizing the expected return, while adhering to budget constraints and managing risk.
Copyright: © 2024 by the authors.
In this context, risk is often quantified using the covariance matrix of all assets, introducing
Licensee MDPI, Basel, Switzerland.
a quadratic element into the model. Solving such problems with binary or integer variables
This article is an open access article is far from straightforward. Integer quadratic programming (IQP) problems are known
distributed under the terms and to be NP-hard, with the decision variant of IQP being NP-complete [9]. Binary quadratic
conditions of the Creative Commons programming problems are also generally NP-hard [10], although specific instances can
Attribution (CC BY) license (https:// be solved in polynomial time [11]. Conventional solvers like IBM-CPLEX, Gurobi, and
creativecommons.org/licenses/by/ Localsolver are continually improving their ability to handle larger instances of these
4.0/). problems. In addition to these traditional solvers, heuristic methods have been developed,

Mathematics 2024, 12, 1291. https://doi.org/10.3390/math12091291 https://www.mdpi.com/journal/mathematics

Mathematics 2024, 12, 1291 2 of 18

leveraging meta-heuristics such as particle swarms [12], genetic algorithms [13], ant colony
optimization [14], and simulated annealing [15]. For a comprehensive overview of these
approaches in the context of portfolio optimization, the reader is referred to [16].
Quadratic optimization problems involving binary decision variables are poised to
become an ideal application area for upcoming quantum computing technologies [17].
These problems can be efficiently tackled through techniques like quantum annealing [18]
or with the quantum approximate optimization algorithm (QAOA), when employing
gate-model-based quantum computers [19]. Quantum computing harnesses the power of
quantum mechanical phenomena, including superposition, entanglement, and interference,
to perform complex computational tasks. Quantum computers, which are still in active
development, are specialized devices capable of leveraging these quantum operations.
There are two primary paradigms in quantum computing devices: digital (gate-model-
based) and analogue (e.g., quantum annealers). The development of a practical and usable
quantum computer is anticipated within the next few years. It is expected that in less than
a decade, quantum computers will surpass the capabilities of conventional computers,
leading to significant advancements in fields like artificial intelligence [20], pharmaceutical
discovery, and beyond [21,22].
At present, multiple entities, including Google, IBM, Intel, Rigetti, QuTech, D-Wave,
and IonQ, are actively involved in the development of quantum chips, which will serve as
the fundamental building blocks of quantum computers [23]. These quantum computers
are still limited in size, with the state of the art featuring approximately 433 qubits for
gate-based quantum computers and 5000 qubits for quantum annealers. In the meantime,
progress is being made on the development of algorithms suitable for execution on these
quantum computers, as well as the software stack necessary to enable the implementation
of quantum algorithms on quantum hardware [24–26].
Portfolio optimization, having quadratic objectives or constraints, is seen as a promis-
ing application of quantum computing in finance [27]. The study conducted by [28] entailed
the implementation of Markowitz’s portfolio selection on a D-Wave quantum computer.
The primary goal was to maximize the expected return, while simultaneously minimiz-
ing the covariance (risk) of the portfolio, all while adhering to a budget constraint. This
problem was formulated as an Ising problem and solved on the D-Wave One, which boasts
128 qubits. Remarkably, they managed to handle 63 potential investment options within a
mere 20 ms on the quantum processor. It is important to note that the solution obtained
was contingent upon the specific weights assigned to each of the objectives and constraints.
Similarly, ref. [29] adopted a reverse quantum annealing approach to optimize risk-adjusted
returns using metrics like the Sharpe ratio. In another study by [30], the modeling of stock
returns, variances, and covariances was carried out within the framework of graph-theoretic
maximum independent set and weighted maximum independent set structures in the realm
of combinatorial optimization. These structures were subsequently mapped to an Ising
physics model representation compatible with the D-Wave One system. The effectiveness of
this approach was benchmarked against the MATLAB standard function quadprog. In [31],
a more recent iteration of D-Wave hardware was employed. The researchers focused on
stock selection from a set of U.S.-listed, highly liquid equities, utilizing both the Markowitz
formulation and the Sharpe ratio. Initially, they adopted a classical approach, followed by
an approach that leveraged the D-Wave 2000Q. The findings of the study demonstrated
that practitioners can utilize a D-Wave system to identify attractive portfolios from a pool
of 40 U.S. liquid equities. Moreover, the research was extended to encompass 60 U.S. liquid
equities in a subsequent study [32]. In addition, [33] looked at a portfolio that maximized
the Sharpe ratio. They used the quantum approximate optimization algorithm (QAOA)
on a gate-based quantum computer. Additionally, there have been multiple works on the
fundamental problem with a single objective: minimizing risk while adhering to return
and budget constraints [34,35] on the latest D-Wave hardware.
In this paper, multi objective portfolio optimization is studied. Real-world investment
decisions involve multiple conflicting objectives that need to be balanced. In the context of
Mathematics 2024, 12, 1291 3 of 18

classic portfolio management, the main objectives are usually to maximize returns, while
minimizing risks. These two objectives are often in conflict. Higher returns are typically
associated with higher risks, and lower risks may lead to lower potential returns. However,
in the current financial industry the objectives are becoming much broader. Besides return
and risk, there is environmental, social, and governance (ESG) performance, which can be
measured by multiple indicators, where, e.g., sustainability, regulatory compliance issues,
and stakeholder management are key objectives, see for example [36,37]. This increase in
the number of objectives requires multi-objective and multi-disciplinary optimization. The
method considered in this paper has the following properties.
1. Balancing Risk and Return: Multi-objective optimization allows investors to find a
balance between risk and return that suits their risk appetite and investment goals.
This is not just about maximizing returns; it is about achieving the best trade-off
between risk and return that aligns with an investor’s preferences.
2. Diversification: Effective portfolio management involves diversifying investments
across different assets to reduce risk. Multi-objective optimization helps identify
diverse combinations of assets that can potentially provide higher returns, while
managing risk through diversification.
3. Handling Trade-offs: Multi-objective optimization helps investors explicitly address
trade-offs between conflicting objectives. For instance, an investor might be willing to
accept slightly lower returns in exchange for significantly lower risk. Multi-objective
optimization can quantify these trade-offs and help in making informed decisions.
4. Tailored Solutions: Different investors have different preferences and constraints.
Multi-objective optimization allows for the creation of personalized portfolios that
align with an individual investor’s specific goals and constraints.
5. Market Uncertainty: Financial markets are inherently uncertain and subject to volatil-
ity. By considering multiple objectives, investors can design portfolios that are robust
and adaptable to changing market conditions.
6. Flexible Decision-Making: Multi-objective optimization provides a range of possible
solutions, known as the Pareto frontier or Pareto front. This set of solutions represents
different combinations of risk and return that an investor can choose from based on
their preferences.
7. Stress Testing: Multi-objective optimization enables investors to stress test their portfo-
lios by examining how different market scenarios impact the trade-off between risk and
return. This helps in assessing the resilience of a portfolio under adverse conditions.
8. Long-Term Planning: Portfolio optimization is not a one-time task; it requires con-
tinuous monitoring and adjustment. Multi-objective optimization aids in making
informed decisions when rebalancing portfolios over time, considering changing
market dynamics and investor preferences.
The goal of this paper was, for a specific real-world case, to deduct a problem for-
mulation that fits the quantum annealer and to analyze the (expected) performance of
this formulation compared to the current solution approach. This formulation is tested
using simulated annealing, which gives an indication of the performance on a quantum
annealer, and where possible, given the current restricted size, on a real quantum annealer.
For this, a specific variant of multi-objective optimization is used that aims to find the
efficient (Pareto) frontier of a combination of return, diversification, and carbon equivalent
emissions (CO2e). A Pareto frontier is a set of Pareto-efficient solutions. In multi-objective
optimization, a feasible solution that optimizes all objective functions simultaneously does
not typically exist. A Pareto-efficient solution is a solution to a problem with multiple
objectives where no individual objective can be improved without making at least one other
objective worse off. In portfolio optimization, the efficient frontier or portfolio frontier
is the set of portfolios that have the highest return given the risk of the portfolio. The
problem under consideration in this work consists in finding this efficient frontier. We also
add an extra constraint on the carbon (CO2e) footprint of the portfolio. In our case, the
Mathematics 2024, 12, 1291 4 of 18

portfolio diversification adds a quadratic term, similar to the risk term in classical portfolio
optimization formulations.
The expected advantages of using quantum computing techniques compared to clas-
sical methods for solving multi-objective optimization problems are multiple. Quantum
computers can process multiple possibilities simultaneously through superposition and
entanglement, enabling them to efficiently explore a vast solution space in parallel. This
inherent parallelism can lead to faster convergence by evaluating multiple candidate solu-
tions concurrently, potentially accelerating the optimization process. Quantum annealing,
a specific quantum computing technique, can be particularly effective for optimization
tasks. By leveraging quantum fluctuations to escape local minima and explore a broader
solution space, quantum annealers offer the potential for finding globally optimal or near-
optimal solutions to multi-objective optimization problems. Lastly, quantum computers
can perform probabilistic sampling efficiently, enabling them to estimate objective function
values and gradients more accurately and rapidly compared to classical methods. This
capability is advantageous for handling complex objective functions with non-linearities,
discontinuities, or noise, as it allows for more robust and adaptive optimization strategies.
The remainder of this paper is structured as follows: In Section 2, we introduce
quantum annealing and the QUBO formulation. The specific problem of this study is
described in Section 3. Next, our portfolio optimization problem is solved through a
classical convex optimization approach in Section 4. Possible reformulations of the objective
function as a QUBO are given in Section 5. The results are discussed in Section 6 and,
finally, conclusions are drawn in Section 7.

2. Quantum Annealing and QUBO Formulation

Quantum computing leverages the principles of quantum mechanics, which govern
the behavior of subatomic particles. One key concept is superposition, where quantum
bits (qubits) can exist in multiple states simultaneously, and entanglement, where the
state of one qubit can be correlated with the state of another, even when separated by
great distances.
We can currently distinguish two paradigms in quantum computing: digital or gate-
based computers/computing (GBC) and analog quantum computing, of which quantum
annealers (QA) are an important example. GBC is most similar in operation to the current
generation of computers. They are capable of performing operations (gate operations, such
as AND, OR) on specific qubits or on multiple qubits at the same time. This allows for
actual programming, which is often visualized via circuit diagrams. QAs, on the other
hand, are single-purpose machines. This is a specialized quantum computing technique
designed to solve optimization problems. Many real-world problems involve finding the
best solution from a vast number of possibilities. These optimization problems can be
found in various fields, such as finance but also logistics, materials science, and artificial
intelligence. Quantum annealing aims to efficiently tackle these problems.
The goal of quantum annealing is to find the lowest-energy state of a system of qubits.
The problem is formulated in such a way that the energy of a state corresponds to the
quantity to minimize. The optimization problem is thus encoded in the Hamiltonian,
which describes the energy of all the quantum states. The lowest-energy state is the
optimal solution. Qubits are manipulated to minimize the energy of the system following
a predefined schedule or annealing process. This process explores the solution space to
attempt to find the global minimum. D-Wave Systems is a well-known company in the
field of quantum annealing. They have developed quantum annealers and made them
available to researchers and organizations interested in exploring the potential of quantum
computing for optimization problems.
Inputs for quantum annealing are the QUBO and the equivalent Ising formulations.
Modeling optimization problems as a quadratic unconstrained binary optimization (QUBO)
problem is a common approach in the field of optimization. QUBO is a mathematical
framework that represents optimization problems as quadratic functions of binary variables.
Mathematics 2024, 12, 1291 5 of 18

The steps to take here are the following: The first step is to define a set of binary variables.
Binary variables can take on only two values: 0 or 1. These variables represent the decisions
or choices in the optimization problem. For example, in a portfolio optimization problem,
each binary variable might represent whether a particular stock is in the portfolio (1) or
not (0). In addition, integer and real valued variables can be modeled as a specific sum of
binary variables.
Next, the objective function has to be defined, which is the mathematical expression
that needs to be optimized. This is typically a function of the binary variables. The goal is to
find the combination of binary variable values that minimizes (or maximizes) this objective
function. Constraints in the original optimization problem can also be incorporated into
the QUBO model via penalty terms within the objective function. When the constraints
are met, these terms should be equal to zero. When a constraint is not met, this term gives
a value that works in the opposite direction of the optimization. This ensures that most
solutions satisfy the problem constraints.
In mathematical terms, the QUBO is expressed as the problem

min x T Qx , (1)
x ∈{0,1}n

where x is a n-dimensional binary vector and Q the objective function is translated to an

n × n-matrix.
For many problems the QUBO or Ising formulation is known [38,39]. Outside financial
applications, QUBO-based quantum annealing use cases can be found in logistics [40–42],
smart city planning [43], telecommunications [44], healthcare [45,46], and many more.

3. Problem Description
In this section, we provide a comprehensive overview of the problem at hand, focusing
on portfolio optimization within the financial domain. Portfolio optimization involves the
strategic management of a collection of assets with the aim of maximizing returns, while
minimizing risks. We begin by outlining the fundamental aspects of the problem, including
asset characteristics such as expected returns, risks, and correlations. Subsequently, we
introduce the optimization framework and highlight the key objectives and constraints
involved. Furthermore, we present a specific real-world financial case study that serves
as the basis for our analysis. This case study involves the optimization of a portfolio of
outstanding loans, taking into account various financial and environmental considerations,
such as return on capital, concentration risk, and carbon footprint reduction targets in
alignment with the Paris Agreement. Finally, we define the input variables and decision-
making parameters essential for formulating and solving the optimization problem.

3.1. Basic Problem

The basic problem in portfolio Optimization involves managing a collection of N
assets available for investment, denoted as P1 , P2 , . . . , PN . Each asset has an expected return
µi and a corresponding risk σi , which is the standard deviation of the returns. The returns
of these assets are interrelated and depend on their correlation, denoted as ρij , where ρij
signifies the correlation between assets i and j. The vector of returns is denoted as µ = µi ,
and the risk matrix as Σ = (σij ), where

σi2 ,

if i = j,
σij = (2)
ρij σi σj , if i ̸= j.

One example of the problem is to select precisely n assets from the pool of N, such
that the portfolio achieves a return higher than a specified value R∗ , with minimal risk. To
Mathematics 2024, 12, 1291 6 of 18

address this, we introduce binary variables xi , where xi equals 1 if asset i is chosen and 0
otherwise. This gives rise to the optimization problem

N N
min ∑ ∑ xi x j σij , (3)
i =1 j =1
N
such that ∑ xi = n, (4)
i =1
and µ x ≥ R∗ .
′
(5)

This problem was studied in [34]. We will now focus on a more specific problem that is
found in practice.

3.2. Our Financial Case

In this paper a specific real-world banking problem is studied. Our primary objec-
tive is to determine the optimal allocation of the bank’s finite resources, i.e., specifically
focusing on the distribution of credit loans portfolios by 2030 across industry sectors, sub-
sectors, and countries, while aligning with the bank’s mission, vision, and sustainability
commitments, including those outlined in the Paris Agreement (i.e., pathways towards
low greenhouse gas emissions and climate-resilient development). To achieve this, our
goal can be reframed as solving an optimal asset allocation problem. Specifically, this
involves developing the bank’s business growth strategy to effectively balance risk, reward,
and CO2e emissions.
Therefore, we look at a portfolio of outstanding loans that existed in the year 2021,
and we want to set a target for this portfolio, in the year 2030. This portfolio has to optimize
the trade-off between ‘Return on Capital’ (ROC) and ‘Concentration Risk’. In our case, the
standard portfolio optimization risk metrics, such as standard deviation, value at risk (VaR),
and conditional value at risk (CVaR), are not suitable, due to the unique characteristics
of our problem. Unlike traditional financial assets that may experience significant price
fluctuations, credit loans and regulatory capital requirements do not exhibit substantial
monthly variability. Indeed, standard portfolio risk metrics are designed to capture the
volatility of financial assets, which may not accurately reflect the risk profile of our portfolio
consisting primarily of relatively stable credit loans and regulatory capital requirements.
In the realm of banking in this sense, ROC stands as one of the three primary prof-
itability metrics, alongside risk-adjusted return on capital (RAROC) and commercial return
on invested capital (CROIC). ROC serves as a crucial indicator of a bank’s financial per-
formance by measuring the net income generated relative to the amount of regulatory
capital invested, where regulatory capital represents the amount of capital a bank has to
have, as required by its financial regulator. The ROC metric provides valuable insights
into the efficiency of capital utilization and the overall profitability of a bank’s operations.
Furthermore, in our case, the traditional notion of expected return, commonly used in stan-
dard portfolio optimization may not adequately capture the returns associated with credit
loans. Indeed, ROC emerges as a more appropriate metric for evaluating the performance
of credit loans, which generate returns primarily through interest payments and fees over
the loan term.
Next, the approach must comply with a reduction target on the total (relative) car-
bon footprint of the portfolio, in order to conform with the Paris Agreement (The Paris
Agreement is a legally binding international treaty on climate change. It was adopted by
196 Parties at the UN Climate Change Conference (COP21) in Paris, France, on 12 December
2015). For this, a Pareto frontier has to be calculated. In turn, this will provide insights into
the possible directions of the future portfolio. We first define the input of the model, as
listed in Table 1.
Mathematics 2024, 12, 1291 7 of 18

The decision variables are now denoted by

N
xi = amount invested in loan i in 2030, with X = ∑ xi , (6)
i =1

for loans i = 1, ..., N. For each asset, the current outstanding loan and the corresponding
regulatory capital and income return are known. Furthermore, the loan can develop within
a fixed range of a given upper and lower bound over the period 2021 to 2030. Finally, the
emission intensity of the asset in 2021 and the overall required emission intensity reduction
are given.

Table 1. An overview of the variables of the portfolio optimization problem.

Description Notation
Outstanding amount in 2021 per asset (€) yi
Return (i.e., income) in 2021 per asset (€) ri
Regulatory capital in 2021 per asset (€) ci
Lower bound outstanding amount in 2030 per asset (€) LBi
Upper bound outstanding amount in 2030 per asset (€) UBi
Emission intensity total reduction in 2030 (fixed) 24%
Emission intensity in 2021 per asset (kg CO2e/€) ei

We will use three main performance indicators. These are the Herfindahl–Hirschman
index (HHI) for risk, the return on capital (ROC) for return, and the relative emission
intensity. For the purpose of measuring credit portfolio or market concentration risk, the
HHI is defined as the sum of all squared relative portfolio shares of the exposures [47]
!2
N
xi
HH I ( x ) = ∑ ∑N
. (7)
i =1 j =1 x j

The lower the HHI, the more diversified the portfolio. For a portfolio of size S = ∑iN=1 xi ,
the HHI is minimal when xi = S/N for all i. It follows from the symmetry of the formula
that all entries should be equal and from the convexity that this is the minimum. The
second performance indicator is the return on capital (ROC), defined as

∑iN=1 xi ri /yi
ROC ( x ) = . (8)
∑iN=1 xi ci /yi

Lastly, the emission intensity of the 2021 portfolio is defined as

∑iN=1 ei yi
E= . (9)
∑iN=1 yi

This constraint tries to ensure that the emission in 2030 has an overall reduction of 30%
relative to 2021. This will be partially achieved by portfolio selection and partially by more
efficient production. We anticipate that a 24% reduction rate will be achieved by the bank’s
clients through their transition to more sustainable practices from 2022 to 2030 (averaging a
3% reduction annually). In a formula, the constraint is given by the inequality

N N
∑ 0.76xi ei ≤ 0.7E ∑ xi . (10)
i =1 i =1

Now, the total problem is defined by

min ϕHH I ( x ) − (1 − ϕ) ROC ( x ), (11)

Mathematics 2024, 12, 1291 8 of 18

under the constraints

LBi ≤ xi ≤ UBi ∀i ∈ {1, ..., N }, (12)

N N
∑ 0.76xi ei ≤ 0.7E ∑ xi , (13)
i =1 i =1

for a specific value of ϕ, which depicts the preference between ROC and HHI. By varying
the value of ϕ the Pareto or efficient frontier can be created.

4. Classical Convex Optimization

Over the years various optimization methods, from traditional quadratic program-
ming to convex optimization and heuristic algorithms, have been developed to address the
complexities of portfolio optimization problems. In this paper, we first investigate a classical
convex optimization approach, serving as a benchmark for comparison with the subse-
quent quantum-derived results. Indeed, convex portfolio optimization problems [48,49]
are efficiently solved by first expressing the problems as linear matrix inequality (LMI)
optimizations [50]—subsequently formulated as semi-definite programs (SDP) [51]—for
which there are several powerful numerical solutions [52,53].
The algorithm to determine the Pareto frontier (or Pareto front) for our classical convex
optimization approach is basically a simple iterative LMI search, structured as follows
(Algorithm 1):

Algorithm 1: Classical Convex Optimization

Data: Input data given by Table 1
Result: Pareto Frontier
1 From (8) define LBROC ≤ ROC ( x ) ≤ UBROC
2 From (6) and (12) define LB ≤ X ≤ UB
3 for R ← LBROC to UBROC do
4 Set γ̄ = L with L a large positive number
5 for X ← LB to UB do
6 Create column vector x with components xi as N-dimensional LMI variable
7 Create γ as scalar LMI variable
8 Add individual outstanding loans constraint as defined in (12)
9 Add total outstanding loans constraint: ∑iN=1 xi = X
10 Add constraint: γ > 0
11 Add ROC constraint from (8) as: R. ∑iN=1 xi ci /yi = ∑iN=1 xi ri /yi
12 Add emission constraint as defined in (10)
13 Add HHI constraint by linearising (7) through Schur Complement [50]
(x/X )T
 
γ
> 0, with I the identity matrix of size N
(x/X ) I
14 Solve for x̂ and γ̂ such that x̂ = arg min γ, subject to constraints (8)–(13)
x
15 If γ̂ < γ̄ store x̂ and set γ̄ = γ̂

This algorithm outputs the Pareto frontier depicted using the green diamonds in
Figure 1. Note that here the problem is actually solved multiple times with a certain
target ROC improvement, resulting in a solution for each target ROC improvement with a
step-size of 0.5.
Mathematics 2024, 12, 1291 9 of 18

Figure 1. The classical solution frontier with the reformulation (17) of the HHI (red) is virtually
identical to the solution frontier of the problem with the original (7) objective (green).

5. Reformulation to QUBO
To be able to find solutions to this problem with a quantum annealer, the problem
must be reformulated into a QUBO formulation. This means that only linear and quadratic
terms in x are permitted. Furthermore, the constraints must become either a part of the
objective function or must be eliminated in another way.
First, we make use of another formulation to remove the constraint on the bounds
(12). Here, we define xi as one out of a set of discrete points between the upper- and
lower bounds
wi
xi = LBi + (UBi − LBi ), (14)
wmax
wi ∈ {0, .., wmax }, wi ∈ N0 . (15)

In addition, the decision variables have to be binary, so we write wi as

K −1
wi = ∑ 2k zi,k , zi,k ∈ {0, 1} (16)
k =0

and now wmax = 2K − 1.

Second, the definition of the HHI in (7) does not meet the requirements of the QUBO
formulation. We may attempt to replace the denominator ∑ N j=1 x j , which represents the
total outstanding loan in 2030, by the simple approximation 12 ∑ N j=1 ( LB j + UB j ) of this
amount. As this is a constant of the problem, it may be absorbed into the weight λ1 in
(18) and (26). As a consequence of this, any inaccuracy of this approximation will result in
relative weight differences in the objective function. This results in the reformulation of the
HHI as
 2 2 N
HH I1 = N
∑ j=1 LBj + UBj i=1
∑ xi2 . (17)

In this formulation, the HH I term is minimal when all terms are equal, as is the case in (7).
The reformulation of the HHI has little effect on the resulting solutions, see Figure 1.
Mathematics 2024, 12, 1291 10 of 18

Third, the same holds for the ROC term, which is not expressed as a quadratic function.
A first option is to estimate this by replacing it with

N
xr
ROC1 = ∑ ciiyii .
i =1

Lastly, the constraint of (13) should be in a form that can be translated into a penalty
term. Here, we assume that the optimal portfolio will be a case where an equality holds,
so that
N N
(0.76 ∑ xi ei − 0.7E ∑ xi )2
i =1 i =1

can be used as as penalty term.

This leads to the first QUBO reformulation
N N N N
QUBO1 = min λ1
z
∑ xi2 − λ2 ∑ θi xi + λ3 (0.76 ∑ xi ei − 0.7E ∑ xi )2 , (18)
i =1 i =1 i =1 i =1

wi
xi = LBi + (UBi − LBi ), (19)
2K −1
ri
θi = , (20)
ci yi
K −1
wi = ∑ 2k zi,k , (21)
k =0
zi,k ∈ {0, 1}, (22)

and λ1 , λ2 and λ3 are penalty or preference parameters.

The second QUBO formulation follows from a different formulation of the ROC. For
this, we assume a fixed growth in the regulatory capital. If we assume a capital growth
factor GC , which is the same for all assets, we can reformulate the ROC objective with the
following combination through a new objective

N
1 r
ROC2 ( x ) =
GC C21 ∑ xi yii (23)
i =1

and a new constraint-promoting objective

!2
N N
c
∑ xi yii − GC ∑ ci (24)
i =1 i =1

The total amount of regulatory capital in 2021 is here denoted by C21 = ∑iN=1 ci . This leads
to the following QUBO formulation

N N
QUBO2 = min λ1
z
∑ xi2 − λ2 GCinv (x) ∑ θˆi xi (25)
i =1 i =1
!2
N N N N
ci
+λ3 (0.76 ∑ xi ei − 0.7E ∑ xi ) + λ4 2
∑ i yi
x − GC ( x ) ∑ ci , (26)
i =1 i =1 i =1 i =1
Mathematics 2024, 12, 1291 11 of 18

where
wi
xi = LBi + (UBi − LBi ), (27)
2K − 1
r
θˆi = i , (28)
yi
K −1
wi = ∑ 2k zi,k , (29)
k =0
zi,k ∈ {0, 1}, (30)

and λ1 , λ2 , λ3 and λ4 are penalty or preference parameters. The functions GC ( x ) and

GCinv ( x ) are defined in (31) and (32), respectively.
Two ways to implement QUBO2 have been considered. The first is to choose the
growth factor 1 ≤ GC ≤ 2 fixed for the computation. In this case, the prefactor ( GC C21 )−1
in (23) can be absorbed without consequences in the weight λ2 . The second way is to vary
GC between 1 and 2 using some additional qubits. In this case it is cleaner to implement
the prefactor GC−1 in the computation, since absorbing it into λ2 would implicitly vary the
effective weight by a factor 2 during the computation. This is the approach that was used
to generate Figure 2.

Figure 2. Simulated annealing for QUBO2 (26) yielded points that reconstruct the upper half of the
Pareto frontier.

If the amounts invested in loans are encoded in M = N × K qubits, an additional five

are reserved. The growth factor of the regulatory capital can been implemented on these
five qubits z M+1 , . . . , z M+5 as

5
GC ( x ) = 1 + ∑ z M + n 2− n (31)
n =1

and its approximate inverse as

5
GCinv ( x ) = 1 + ∑ z M + n 2− n (2− n − 1 ) . (32)
n =1
Mathematics 2024, 12, 1291 12 of 18

The quality of the approximation can be see in Figure 3.

Figure 3. The approximate inverse GCinv (32) in blue versus the true inverse of the capital growth
factor GC (31) in green.

6. Experimental Set-Up and Results

To test the approach and the two QUBO formulations, we used a synthetically gen-
erated dataset (The code and data can be found on https://github.com/TNO-Quantum
(accessed on 20 March 2024)), unrelated to Rabobank’s portfolio. The problem size for our
numerical experiment was N = 52. The experiments on this dataset and the result are
further described in this section.

6.1. Classical Approach: Convex Optimization

As a benchmark, we first solved our portfolio optimization problem using a classical
convex optimization approach, as outlined in Section 4. To this end, all linear matrix
inequality (LMI) problems were solved using the Matlab-YALMIP toolbox with the SeDuMi
solver. The resulting Pareto frontier is depicted using the green diamonds in Figure 1,
and is also shown using the green dots in Figure 4. Further, and for comparison, the red
dots in Figure 4 visualize the Pareto frontier without the emission constraint (13).

Figure 4. Random sampling of 18,000 portfolios yielded only one portfolio (orange) that met the
emission constraint. Furthermore, all sampled portfolios lay far from their respective Pareto frontiers.
Mathematics 2024, 12, 1291 13 of 18

6.2. QUBO1 Results

Solving the QUBO problem through an annealing approach may be considered a
sampling methodology. To illustrate the added value of the (quantum) annealing approach,
a basic comparison with naive sampling was made. A straightforward approach was to
sample from the total universe of solutions, where one of the two extreme values (xi = LBi
or xi = UBi ) is the amount invested in asset i in 2030. Note that this already gave us 252
solutions. In Figure 4, the blue and orange dots represent 18,000 random solutions, where
only the one orange dot met the emission constraint. In addition, the blue dots are far from
the red Pareto frontier and the orange dot is far from the green Pareto frontier.
Next, we used simulated annealing to generate solutions from the QUBO formu-
lations, to see whether these formulations gave the desired outcomes. Simulated an-
nealing is a classical probabilistic optimization algorithm inspired by the annealing pro-
cess in metallurgy. It is used to find approximate solutions for a range of optimization
and search problems. The algorithm explores the solution space by iteratively making
random moves and accepting or rejecting these moves based on a probabilistic crite-
rion. Simulated annealing is particularly effective in solving complex problems where
finding an exact solution is difficult or computationally expensive. We used the im-
plementation from D-Wave, as can be found in the python package dwave-neal (https:
//docs.ocean.dwavesys.com/projects/neal/en/latest/index.html (accessed on 20 March
2024)). To generate solutions, the simulated annealing approach was run 10 times for each
parameter setting. For the QUBO1 formulation, the parameters λ1 − λ3 were varied in the
following way. We chose λ3 = 1 and varied λ1 and λ2 using the scheme λi = 10k−4 for
k ∈ {1, ..., 10} and i ∈ {1, 2}.
Figure 5 shows the result of the runs described in the previous section. In comparison
to the random solution of Figure 4, we see that there were many more solutions meeting
the constraint (13). In addition, more solutions close to the Pareto frontier were found.
However, there is room for improvement, as too few solutions with a ROC higher than 5
were obtained.

Figure 5. Simulated annealing of QUBO1 (18) yielded many more portfolios meeting the emission
constraint in comparison to random sampling. Furthermore, their risk and return characteristics
reconstructed a small section of the green Pareto frontier, which was the optimal solution for the
problem with the emission constraint.

Now, when running on the real quantum annealer by D-Wave, we obtained the results
depicted in Figure 6. On the real hardware, we were restricted to 100 assets, due to the
number of qubits. We can see that the quantum annealer gave a broader range of solutions,
compared to the simulated annealing results (for the case of similar parameters). However,
Mathematics 2024, 12, 1291 14 of 18

of all those results, only a few lay close to the Pareto frontier and most solutions did
not meet the emission constraints. Further, we can observe that the quantum annealer
and simulated annealer solvers could return different sample sets, even with the same
objective function.

Figure 6. Quantum annealing of QUBO1 found more portfolios meeting the emission constraints
than random sampling, but not as many as simulated annealing. Furthermore, the obtained portfolios
were concentrated within two clusters clearly separated from the (green) Pareto frontier.

6.3. QUBO2 Results

Now, for the QUBO2 formulation, the parameters λ1 − λ3 were varied in the following
k l
way. We chose λ3 = 1 and varied λ1 = 10 8 −4.25 for k ∈ {0, ..., 19}, λ2 = 10 8 −4 for
m
l ∈ {0, ..., 11} and λ4 = 10 8 −11 for m ∈ {0, ..., 11}. This resulted in the outcome as shown
in Figure 2.
Comparing Figure 5 to Figure 2 makes it clear that the second QUBO formulation gave
better results for our problem.
Remarkably, the results of Figure 2 show that the simulated annealing of a fine-
tuned Hamiltonian could even outperform classical algorithms in some regimes. This was
most likely caused by the parameter settings of the convex optimization numerical solver.
Due to the higher required number of qubits, we were not able to run this on the real
quantum annealer.
In Figure 7, an indication of the computational times is given. The solid lines represent
the results of experiments, whereas the dotted lines are trend-lines, based on an exponential
(classical methods) or linear (quantum approach) extrapolation. The simulated annealing
approaches were faster than the classical YALMIP approach for the N = 52 problem size,
although for larger datasets the performance would also deteriorate exponentially. For the
quantum annealing approach, its computational time will grow linearly, in expectation, as a
function of problem size. Its relatively high off-set was here caused by the initial embedding
that the D-Wave had to implement on its real hardware.The difference in the required
computational time originated from the term addition in (26) and the corresponding weight
λ4 that had to be varied during the computations.
Mathematics 2024, 12, 1291 15 of 18

Figure 7. The computation times to solve the problems as a function of the number of assets
in the portfolio. The solid lines are the results of experiments, the dotted lines are trend-lines,
based on an exponential extrapolation for the classical methods and linear extrapolation for the
quantum approach.

7. Conclusions and Further Research

In this study, we explored the application of quantum computing towards portfolio
optimization, with a specific focus on multi-objective optimization. We discussed the
classical challenges of portfolio management, including quadratic programming problems
with binary decision variables, and the limitations of conventional solvers. Quantum
computing is a promising alternative to overcome these challenges, by leveraging quantum
annealing and a quantum approximate optimization algorithm (QAOA) to efficiently tackle
complex optimization problems.
Our investigation of a real-world portfolio optimization problem in 2021, with a target
set performance for 2030, highlighted the importance of balancing return on capital (ROC),
concentration risk, and carbon footprint constraints. We formulated this problem as a
QUBO problem, providing two distinct QUBO formulations to address different aspects
of the problem. Using the simulated annealing approach, the second QUBO formulation
proved to be better suited to finding solutions near the Pareto frontier. Due to current
hardware restrictions, only limited results for the real quantum annealer were shown. Here,
both the low number of qubits and the limited annealing time restricted us from finding
better solutions for now.
Our experimental results revealed the potential of quantum computing in finding
solutions that meet stringent emission constraints. Sampling from the same Hamiltonian,
simulated annealing outperformed quantum annealing in terms of solutions near the Pareto
frontier. This suggests that further fine-tuning of the QUBO parameters in combination
with a better understanding of the solvers may yield even better outcomes. Note the QUBO
approach generated multiple sample solutions, where the original approach only generated
a small set of Pareto solution. This is already valuable in practice, where we unearthed
a rich tapestry of solutions beyond the original optimal set, offering a wealth of valuable
insights and alternative pathways worthy of exploration.
Recommendations for further research:
1. Refinement of QUBO Formulations: We recommend further refinement of the QUBO
formulations to better capture the nuances of the portfolio optimization problem. Fine-
tuning penalty and preference parameters, especially in the second QUBO formulation,
could lead to improved results.
Mathematics 2024, 12, 1291 16 of 18

2. Exploration of Alternative Quantum Algorithms: While quantum annealing has been

shown to be promising, it might be worthwhile to explore other quantum algorithms,
such as QAOA, for portfolio optimization. Comparative studies could help determine
the most effective approach.
3. Quantum Computing Hardware Development: As quantum computing hardware
continues to advance, we recommend staying up to date with developments from
leading companies like Google, IBM, and D-Wave. Newer, more powerful quantum
computers may provide even better solutions for portfolio optimization.
4. Integration with Traditional Portfolio Management: Quantum computing can be used
in conjunction with traditional portfolio management techniques. We recommend
exploring hybrid approaches that leverage the strengths of both classical and quantum
computing to enhance portfolio management strategies.
5. Validation on Diverse Datasets: It is crucial to validate the quantum computing
solutions on diverse datasets and real-world scenarios, to ensure their robustness and
practical applicability. Additionally, investigating the scalability of quantum solutions
for larger portfolios is essential.
6. Continuous Monitoring and Improvement: Portfolio management is an ongoing
process, and quantum solutions should be continuously monitored and improved to
adapt to changing market dynamics and investor preferences.
In conclusion, quantum computing holds great promise for portfolio optimization,
offering more efficient and robust solutions for the financial sector. However, ongoing
research and development, along with the careful consideration of formulation and hard-
ware advancements, are essential to fully harness the potential of quantum computing in
this domain.

Author Contributions: Conceptualization, F.P., E.A., S.T. and M.V.; methodology, J.d.J. and S.T.;
software, F.P., J.d.J. and S.T.; validation, F.P., S.T. and M.V.; formal analysis, J.d.J.; investigation, S.T.
and J.d.J.; resources, E.A.; data curation, S.T. and M.V.; writing—original draft preparation, F.P., J.d.J.
and S.T.; writing—review and editing, E.A., M.V. and S.T.; visualization, F.P.; supervision, M.V.;
project administration, E.A.; funding acquisition, E.A. and M.V. All authors have read and agreed to
the published version of the manuscript.
Funding: This research was funded by Rabobank and Stichting TKI High Tech Systems and Materials,
under a program by Brightland’s Techruption.
Data Availability Statement: The code and data presented in this study are openly available in
https://github.com/TNO-Quantum/problems.portfolio_optimization (accessed on 20 March 2024).
Conflicts of Interest: The authors declare no conflicts of interest. S.T. and M.V. work for Rabobank,
one of the funders. Their roles in the project are stated above.

Abbreviations
The following abbreviations are used in this manuscript:

HHI Herfindahl–Hirschman index (HHI)

IQP Integer quadratic programming
QAOA Quantum approximate optimization algorithm
QUBO Quadratic unconstrained binary optimization problem
ROC Return on capital

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