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Investment Policy Statement

Updated on April 4, 2024
Article byRutan Bhattacharyya
Edited byRutan Bhattacharyya
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Investment Policy Statement (IPS)?

An Investment Policy Statement or IPS refers to a document drafted between investors and portfolio managers. It outlines the guidelines and rules that the latter must follow to fulfill the former’s investment objective. In other words, portfolio managers manage their client’s money based on the information in this document.

Investment Policy Statement

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This document consists of investors’ financial goals and provides insight into the portfolio manager‘s strategies to fulfill the objectives. One can find details concerning liquidity requirements, asset allocation, and risk tolerance in this policy. Drafting this document is standard practice when dealing with institutional clients. Nevertheless, financial advisors also prepare it for individual investors.

Key Takeaways

  • The Investment policy statement definition refers to a formal document signed between investors, portfolio managers, or investment advisors.
  • This document specifies various details regarding the investment plan, for example, information concerning the client’s investment objective, the responsibilities of the portfolio manager, etc.
  • There are four elements of an investment policy statement. Two of them are governance and scope and purpose.
  • There are multiple benefits of investment policy statements. For example, it keeps investors from making emotional investment decisions in volatile markets and ensures that the portfolio manager primarily focuses on investors’ financial goals.

Investment Policy Statement Explained

The investment policy statement definition refers to a document that outlines an investor’s financial goals and describes the roles and responsibilities of their portfolio manager or financial advisor. Also, it specifies the strategies that the portfolio manager should utilize to fulfill the predetermined objectives.

Both the investor and the investment advisor sign this document; it ensures that both parties are on the same page. One can find information related to foreign security investment restraints, liquidity requirements, risk tolerance, etc., in an IPS.

A well-constructed policy statement mentions the asset allocation goals. For example, an IPS may specify the allocation between different types of assets, such as equity and bonds. Additionally, it may further break down the asset allocation target into sub-classes. One must note that the targets usually have a minimum and maximum deviation limit. If exceeded, the portfolio manager must do portfolio rebalancing.

Besides offering a framework for making informed investment-related decisions, a well-conceived IPS helps investment advisors to commit their clients to a long-term strategy. Thus, by drafting this document, one can minimize the chances of making emotional decisions in volatile markets, which can lead to significant losses. In other words, it helps investors avoid emotional bias and focus on the original goal.

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Elements

The elements of an investment policy statement are as follows:

#1 – Scope And Purpose

  • Defining and identifying the investor.
  • Identifying a process of risk management.
  • Defining the portfolio manager’s roles and responsibilities.
  • Assigning the responsibility for tracking the portfolio performance and reporting.

#2 – Governance

  • Describing the authority responsible for appointing and terminating vendors associated with the investment portfolio.
  • Allotting the responsibility for reporting, risk management, and monitoring.
  • Assigning the responsibility for deciding the portfolio’s asset allocation, including the inputs utilized and the parameters used for developing the inputs.
  • Describing the procedure related to evaluating and updating the policy.
  • Stating the responsibilities in monitoring the investment plan’s execution.

#3 – Investment Risk Objectives And Return

  • Clearly defining the client’s risk appetite.
  • Outlining the investor’s overall financial goals.
  • Specifying all assumptions regarding returns, risk, and the investor’s spending distribution.
  • Stating the related constraints, for example, tax considerations, liquidity requirements, limitations on particular investments, or other legal constraints.
  • Providing details relevant to the documented strategy and specifying other constraints.

#4 – Risk Management

  • Describing the portfolio rebalancing procedure and targeting asset allocations.
  • Specifying the financial metrics that one uses to measure and assess portfolio risk.
  • Establishing metrics used to measure performance and reporting them.

Examples of Investment Policy Statement

Let us look at a few investment policy statement examples to understand the concept better.

Example #1

On January 25, 2023, Indian senators, in a bill, stated that the state’s pension system must focus on return on investment rather than social and environmental concerns. Therefore, Senate Bill 292 would need the INPRS or the Indiana Public Retirement System to make investments to maximize investors’ returns instead of influencing governmental, social, or environmental policies — called ESG investing.   

Author Sen. Travis Holdman said that the ESG ban’s purpose was not to tie the hands of the retirement fund’s investors. Instead, it ensured that the investment decisions were not based on governance, social, or environmental standards. The deputy executive director of INPRS, Tony Green, said that the fund’s main focus is on generating significant returns while minimizing risk, not ESG considerations. According to him, this codifies what is stated in INPRS’s investment policy statement.

Example #2

Let us say that David drafted an IPS with his portfolio manager. The document clearly stated that the latter must not make speculative investments associated with high risk. After some time, much speculation began regarding the possibility of the federal legalization of cannabis. With the belief that the cannabis space will soon outperform other sectors, David asked the portfolio manager to allocate a significant portion of his funds to cannabis stocks.

That said, the latter made him understand that the IPS restricts him from making such speculative investment decisions. In addition, the portfolio manager explained that although David’s move might boost short-term returns, the portfolio value might get impacted significantly over the long term. This, in turn, would not allow David to fulfill his long-term financial goals. Considering the portfolio manager’s opinion, David decided to stick to the IPS.  

Template

Individuals can download an IPS template to get an idea of the information in the document. Let us look at an example of such a template.

Investment Policy Statement Template
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Typically, this document consists of the following details:

  • Purpose of the investment policy.
  • Duties of the investment staff.
  • Client’s investment objective.
  • Factors to be considered when making investment decisions, etc.

Importance

Let us look at the benefits of investment policy statements to get a clear idea of their importance.

  • It provides useful guidance on portfolio construction and ongoing management.
  • This document helps portfolio managers or investment advisors to stay focused on the investor’s financial objectives.
  • It helps a portfolio manager avoid deviations caused by the dynamic economic environment.
  • By drafting an IPS, investors and portfolio managers can avoid emotional bias.
  • Investors always know what their portfolio manager is doing on their behalf.
  • It helps contextualize an investor’s spending outlook.

Frequently Asked Questions (FAQs)

How to create an investment policy statement?

Individuals can create an IPS by following these steps:
1. Document the investment goals
2. Outline the portfolio manager’s investment strategies to fulfill the financial goals.
3. Document current investments.
4. Specify the target asset allocation.
5. Document the investment selection parameters.
Lastly, one must specify the monitoring parameters.

Are investment policy statements required?

Creating an IPS is crucial to construct a portfolio judiciously. Moreover, drafting it is essential to monitor the portfolio’s performance regularly and measure its success.

How often should an investment policy statement be reviewed?

Reviewing an IPS in full every year is crucial to update any outdated information. If an IPS is sufficiently old, the portfolio manager and the client may consider the document invalid. Also, portfolio managers may consider rewriting the IPS every 3 to 5 years to remind their client that it accurately reflects the market circumstances and their client’s current thinking.

What are the two parts of the investment policy statement?

This strategic document’s first Part includes the investor’s broad investment goals. The next section outlines the path the portfolio manager in coloration with their client must follow to fulfill the objectives.

This has been a guide to what is Investment Policy Statement. Here, we explain its examples, template, importance, and elements. You can learn more about finance from the following articles –

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