Trustee Education Series: Critical Components of an Investment Policy Statement

Posted on May 10, 2016

Author Name By Troy Brown, CFA

The investment world is one that does not come without risk. Many of us remember the crisis of 2007-08 all too well, and have become more wary and cautious with our personal investments along with those investments we may oversee as a Trustee on an institutional level. Though we are now enjoying a healthier economy, valuable lessons regarding the importance of developing and maintaining a written long-term strategic framework for an investment portfolio were reinforced during the last market crisis. Astute organizations now find the inclusion, and more importantly the review, of an investment policy statement (IPS) a mandatory method of displaying a game plan, prudent due diligence and a unified vision for a portfolio, regardless of the economic climate. An IPS provides a level of governance oversight and portfolio structure that is priceless to those who entrust others with their investments.

An IPS is, in its simplest form, a roadmap that details the “rules of the road” for an investment portfolio. It’s like a business plan for entrepreneurs who are starting new companies.  The document provides the governance structure of the portfolio as it relates to oversight, objectives, risk tolerance, various investment decisions and restrictions as well as other critical responsibilities. While the IPS will obviously vary depending on the organization and objectives of the portfolio in question, there are some fundamental elements common to all IPS documents.

Framework of an Investment Policy Statement (IPS)

  • Information about the portfolio and who it ultimately serves
  • Definition and description of duties and responsibilities
  • Identification of Fiduciaries, legal constraints, unique conditions, and conflicts of interest
  • Statement of investment objectives, risk tolerance, time horizon, and liquidity requirements
  • Clearly defined performance objectives so oversight committees clearly understand how the portfolio is doing relative to stated performance and risk targets
  • Asset allocation definitions, strategic structure, and underlying investment guidelines
  • Identification of rebalancing and/or spending policies
  • Framework for selecting, monitoring, and potentially replacing investments
  • Process for IPS review and modification

These steps detailing critical and common components of an effective IPS, regardless of organization or portfolio type, provide a solid framework for evaluating a current, or developing a new, IPS for a portfolio. Always remember, setting guidelines of success and failure, defining acceptable risk and setting specific time periods to monitor your investments are all touchstones of a well-developed IPS. Of course, you do not have to face this development alone. As we discussed in an earlier blog, individuals and committees who are typically charged with the oversight of institutional portfolios are not experts in investment planning but are required to act as experts. With immense responsibility on their shoulders, retaining an investment consultant to help administer the portfolio and maintain long-term fiduciary astuteness is a sound practice to maximize the probability of the portfolio achieving its long term objectives.

It is not enough to simply create an IPS for an investment portfolio. An effective IPS is one that is clearly understood, followed, and continues to evolve as a portfolio’s needs and objectives shift over time. A static, disregarded IPS is potential evidence that a portfolio may not be managed effectively or efficiently. Understanding and communicating the IPS to the committee, other portfolio professionals, and potentially beneficiaries, is important to ensure all parties are aware of various objectives and constraints that govern the investment portfolio.