Question

Explain succinctly the major elements of a well-crafted Investment Policy Statement in one page only.

Answer 1

An investment policy statement provides guidance to portfolio managers when making portfolio decisions. Asset allocation decisions, client risk tolerance, leverage, liquidity requirements, and foreign security investment restraints are some examples of issues that are addressed in an IPS.

A well-constructed investment policy statement provides a framework for investment decisions made by the portfolio manager and also helps commit the client to a long-term investment strategy. Emotional decisions made by the client to the portfolio can be avoided – an IPS acts to remind clients regarding the overarching goals and strategies of the portfolio

Components of an Investment Policy Statement

Referencing a document published by the CFA Institute, the components of an investment policy statement are as follows:

1. Scope and Purpose

• Establishing and building context regarding the investor’s source of wealth
• Identifying and defining the investor
• Setting forth roles and responsibilities of the portfolio manager
• Identifying a risk management structure
• Assigning responsibility for portfolio monitoring and reporting

2. Governance

• Specifying responsibilities in determining, executing, and monitoring the results of the implementation of the investment policy statement
• Describing the process related to reviewing the updating the IPS
• Describing authority in the hiring and firing of vendors associated with the portfolio
• Assigning responsibility in determining the asset allocation of the portfolio, including inputs used and the criteria used to develop the inputs
• Assigning responsibility for risk management monitoring and reporting

3. Investment, Return, and Risk Objectives

• Describing the overall investment objective
• Stating the return, risk, and spending assumptions (outflows in the portfolio)
• Defining the investor’s risk tolerance
• Describing relevant constraints (liquidity requirements, tax considerations, restrictions on certain investments, legal constraints)
• Describing any other considerations that may be relevant to the investment strategy

4. Risk Management

• Establishing performance measurements and reporting accountabilities
• Specifying metrics used to measure and evaluate risk
• Defining the process for portfolio rebalancing and target asset allocations