An investment policy statement, or IPS for short, is a governing document for an investment portfolio. It outlines the purpose and goals for the assets, describes any limitations in place, and includes a recommended asset allocation. In some cases, investment policy statements define the roles and responsibilities of the parties associated with the investment portfolio. In this article, we will explain what is an investment policy statement, highlight key types and components of IPS documents, and describe the benefits of a well-written IPS.
Why Investment Policy Statements Are Important
Investment policy statements are like other policy documents – they outline what is and is not allowed, and they provide a set of procedures to guide action. While the type of instruction provided in an IPS is useful in many contexts, it is particularly important for investment assets for two key reasons. First, an IPS governs financial assets which are naturally highly visible and critical to an organization’s success. Second, there are often multiple parties involved in an organization’s investments. The IPS puts staff members, investment advisors, asset managers, and committee members on the same page. Alignment of these groups is critical to the success of an investment portfolio.
Types of Investment Policy Statement Formats
There are three key approaches to structuring investment policy statements.
- Individual documents for each portfolio. In this approach, each portfolio has its own complete, standalone IPS. This avenue allows for the most flexibility but is the most onerous to draft and maintain.
- Primary policy over all portfolios. The second tactic for assembling investment policy statements is to have one document that addresses the necessary terms for all portfolios. The document may contain sections describing additional details of specific asset pools. When uniformity is desired across an organization’s investment program, the primary policy format can be useful.
- Primary and supporting documents. The third approach represents a hybrid of the prior two. In the primary-supporting format, a primary policy outlines elements that are consistent across all portfolios. Paired with the primary document are supporting summaries that describe factors unique to each portfolio.
Components of an Investment Policy Statement
While there are different viable approaches to structuring an investment policy program, there are a number of elements that must be covered. These components are discussed below.
- Background and purpose. This section serves as an introduction and describes the nature of the assets covered by the policy.
- Objectives. The objectives portion of the IPS outlines the goals for the portfolio’s long-term average return and for the standard deviation of those returns.
- Constraints. Broadly speaking, constraints are factors that must be considered when investing. Some constraints such as regulatory and tax considerations are common across many portfolios. However, others, such as the need to screen investments or reach a certain level of dividend income, may be relatively specific.
- Governance. Some but not all investment policy statements outline roles and responsibilities for the various parties involved in the portfolio.
- Allowed asset classes. This section outlines what can and cannot be used in the portfolio. For example, a short-term reserves fund generally should not allow alternative assets with a multi-year lockup.
- Asset allocation. Many of the factors documented in investment policy statements influence the asset allocation (i.e. the mix of assets making up the portfolio). In fact, the IPS should outline the target asset allocation itself.
Impact of an Investment Policy Statement
Organizations which utilize well-constructed investment policy statements benefit in several ways. First, IPS documents are a key component of fiduciary compliance. Investment policy statements provide evidence that key investment matters have been considered and decided upon, therefore reducing legal and regulatory risks. Second, IPS documents make clear the goals for each portfolio and drive how each portfolio is invested. Clearer goals are met more often. Third, investment policy statements enforce discipline and consistency, supporting a long-term focus.
For investment policy statements to have their fullest impact, investment philosophy should be integrated into the IPS documents. Investment philosophy is the key overarching investing beliefs of an organization that influence every portfolio. Philosophy decisions should be carefully considered because of their significance and their long-standing nature. When investment policy statements are informed by investment philosophy, an organization’s investment program is more likely to have proper focus and therefore an improved chance of success.
Investment policy statements are essential to organizations’ investment programs. While they may seem intimidating to those who are not investment professionals, IPS documents can be understood with a little training. Any organization that currently has gaps in IPS coverage among its various portfolios should have documents drafted as soon as feasible. In some cases, a committee of an organization’s board leads the drafting. However, the best documents result from a collaborative process between the outsourced chief investment officer (OCIO), a board committee, and financial staff leadership.