Crafting Your Investment Policy Statement: A Guide

An investment policy statement (IPS) is a document drafted by a portfolio manager or financial advisor and their client that outlines the rules and guidelines for managing the client's investment portfolio. It is a strategic document that lays the foundation for the client-advisor relationship and provides an objective course of action to prevent emotional decisions from impacting the investment strategy. The IPS includes information about the client's investment horizon, objectives, risk tolerance, specific requirements and restrictions, and the strategies the portfolio manager will employ to meet these objectives. It is a highly customised document that serves as a roadmap for the client's financial future and helps to keep all parties involved accountable.

Define the scope and purpose

An Investment Policy Statement (IPS) is a document drafted by a portfolio manager or financial advisor in collaboration with a client. It outlines the rules and guidelines that the portfolio manager must follow when considering asset allocation in the client's portfolio. The IPS is a crucial document that helps to ensure that all parties involved in the investment process are on the same page and understand the goals and risks involved.

The first step in creating an IPS is to define the scope and purpose of the document. This includes establishing and building context regarding the investor's source of wealth, identifying and defining the investor, and setting forth the roles and responsibilities of the portfolio manager. It is important to be clear about the investor's profile, including their financial situation, investment goals, and any relevant constraints or restrictions.

For example, an investor might want to outline their investment time horizon, such as their plan to retire by the time they are 60 years old, with a certain annual return on their portfolio. They might also specify their risk tolerance, such as their capacity for losses or their preference for avoiding certain types of assets or investments that conflict with their values.

Additionally, the scope and purpose section of the IPS should address any ethical or value-based considerations that may impact investment decisions. For instance, an investor might want to exclude companies involved in activities harmful to the environment, such as oil and gas exploration, from their portfolio.

By defining the scope and purpose of the IPS, the investor and portfolio manager can establish a clear framework that guides investment decisions and helps to keep the investor focused on their long-term objectives. It is important to tailor the IPS to the specific needs and circumstances of the investor, ensuring that all relevant factors are considered and addressed.

Detail governance

The investment policy statement (IPS) is a crucial document for any investment plan. It is a strategic document that outlines the guidelines, rules, and objectives that the portfolio manager or financial advisor must follow when making investment decisions on behalf of the client. The IPS is designed to keep both parties on the same page and provide a roadmap for achieving the client's financial goals while managing risks.

The IPS should be tailored to the client's specific financial situation, investment goals, risk tolerance, and investment preferences. It should include details such as the client's broad investing goals, asset allocation targets, risk profile, time horizon, and liquidity requirements. For example, specifying the target allocation between stocks and bonds and other asset classes, as well as the minimum and maximum deviations that will trigger portfolio rebalancing.

The IPS should also establish a clear decision-making framework by defining the roles and responsibilities of the portfolio manager and the client. This includes determining investment objectives and constraints, selecting investment managers, and outlining the criteria for their selection and ongoing evaluation. The IPS should be reviewed and approved by both parties and may require signatures to signal agreement.

Additionally, the IPS should include monitoring and control procedures that all involved parties must follow. This includes establishing the frequency of monitoring, specifying benchmarks for comparing portfolio returns, and outlining procedures for making any future changes to the IPS. It is recommended to review the IPS at least annually to ensure it remains aligned with the client's goals and market conditions.

The IPS also plays a vital role in preventing emotional decision-making during turbulent market conditions. It helps investors stay focused on their long-term objectives by providing a systematic review process. This process considers potential reasons for changing the IPS, such as financial or lifestyle changes, while also outlining reasons for maintaining the current strategy, such as short-term market performance.

Outline investment, return and risk objectives

When outlining investment, return and risk objectives in an investment policy statement (IPS), it is important to be succinct and focused. This section should provide a clear roadmap for achieving the client's investment goals and objectives. Here are some key points to consider:

Investment Objectives:

• Specify the client's broad investing goals and objectives, such as retirement planning or saving for college.
• Define the time horizon for the investments. For example, the client may want to retire by age 60 and need their portfolio to generate a certain annual return to achieve this.
• Outline any specific financial targets, such as the desired rate of return or the amount of money needed for a particular goal.

Investment Strategy:

• Describe the investment strategy that will be employed to meet the client's objectives. This may include strategies such as investing primarily in low-cost index funds or focusing on dividend-paying equities and bond mutual funds.
• Specify the asset allocation framework, including the target allocation between stocks, bonds, and other asset classes. For example, a conservative portfolio might allocate 60% to stock assets and 40% to fixed-income assets.
• Discuss the criteria for selecting specific investments, such as mutual funds, exchange-traded funds, or individual stocks and bonds.

Risk Tolerance and Return Profile:

• Provide details on the client's risk tolerance, including their ability to withstand losses and their comfort with volatility.
• Name any asset classes or investment types that should be avoided or preferred based on the client's risk/return profile. For example, some clients may want to avoid volatile investments, while others may be willing to take on more risk for potentially higher returns.
• Discuss how the investment strategy will be monitored and adjusted over time to manage risk and ensure the client's goals are still on track.

Liquidity Requirements:

• Specify any short-term or long-term liquidity needs the client may have. For example, they may need access to a certain amount of cash within the next year or want the ability to withdraw funds periodically.
• Outline any tax considerations that may impact the investment strategy, such as the client's tax bracket or the need for tax-efficient investments.

Remember, the investment, return, and risk objectives section of the IPS should be tailored to the client's specific financial situation, goals, and risk tolerance. It should provide a clear and concise roadmap for achieving their investment goals while managing risk effectively.

Risk management

Begin by defining your risk tolerance and capacity. Risk tolerance refers to the amount of volatility you are comfortable with, while risk capacity is the amount of risk you can afford to take given your financial situation and goals. Consider your time horizon, financial obligations, and emotional tolerance for market fluctuations. Are you comfortable with a more aggressive approach, or do you prefer a more conservative strategy? This will guide the types of investments you choose and the level of risk you are willing to accept.

Next, outline the specific types of risk you aim to manage. This includes market risk, the possibility of losses due to market fluctuations; liquidity risk, the potential inability to easily convert an investment to cash; credit risk, the chance of loss due to borrower default; and concentration risk, the potential for loss due to overexposure to a particular investment or asset class. You should also consider inflation risk, currency risk (if investing internationally), and regulatory risk, among others. Identify the primary risks associated with your chosen investment types and strategies, and outline methods to mitigate these risks.

Implement risk management strategies tailored to your needs. Diversification is a key tool, spreading your investments across various asset classes, sectors, and geographic regions to reduce the impact of specific risks. You might also consider setting stop-loss orders to automatically sell an investment if it falls to a certain price, limiting potential losses. Regular rebalancing ensures your portfolio remains aligned with your desired asset allocation, preventing overexposure to risky assets. Additionally, consider employing risk management tools such as options, futures, or currency hedging, especially if your portfolio has significant exposure to a particular risk factor.

Finally, outline a risk monitoring and review process. This includes setting performance benchmarks and regularly assessing your portfolio's performance against these standards, making adjustments as necessary. Define the parameters for making changes to your investment strategy, such as underperformance triggers or shifts in your risk tolerance. Regularly review and update your risk management strategies to ensure they remain effective and aligned with your goals, especially as market conditions and your financial situation evolve.

Monitoring and control procedures

The monitoring and control procedures section of an investment policy statement (IPS) is crucial as it outlines the steps that will be taken to ensure the investment process stays on track and adheres to the client's goals and objectives. Here are some detailed instructions and considerations for this section:

• Frequency of Monitoring: Determine how often the portfolio will be reviewed and monitored. This could be monthly, quarterly, or annually. Less frequent monitoring, such as annually, is often recommended to avoid making impulsive decisions based on short-term market fluctuations.
• Benchmarks for Comparison: Establish benchmarks or metrics that will be used to evaluate the performance of the portfolio. Compare the portfolio returns against relevant indices or similar investment funds to assess whether the investments are meeting expectations.
• Deviation from Benchmark: Define the acceptable level of deviation from the established benchmarks. Specify the amount of deviation that is tolerable and the time frame within which corrections should be made if the portfolio underperforms or deviates from the benchmarks.
• Rebalancing Triggers: Clearly state the minimum and maximum deviations from the target asset allocation that will trigger rebalancing. For example, if the target allocation for equities is 65%-75%below 65% or above 75%.
• Procedures for Future Changes: Outline the concrete procedures for making any future changes to the IPS. This includes documenting the reasons for potential changes, such as financial or lifestyle adjustments, and the reasons for maintaining the current strategy, such as short-term market performance.
• Performance Monitoring Guidelines: Specify the parameters that will be monitored during performance evaluations. This could include the overall portfolio performance, individual fund performance, fees, and expenses.
• Reporting and Review: Define the frequency and format of reporting to the client. This could include monthly, quarterly, or annual reports detailing the portfolio's performance, transactions, and any relevant updates. Ensure that the client has a clear understanding of the investment process and provides their consent to the IPS.
• Custodian Monitoring: If applicable, include procedures for monitoring the custodian, who is responsible for the safekeeping of the client's assets.
• Cost Monitoring: Regularly monitor all costs associated with the investments to ensure they do not exceed a certain percentage of the total investable assets.

Frequently asked questions