An Investment Policy Statement (IPS) is an essential document that establishes a framework for investment decisions between a portfolio manager or financial advisor and their client. It serves as a formal agreement that articulates the client’s investment goals, objectives, and the strategies that should be employed to achieve them. This article explores the key components, purposes, and importance of an IPS while providing guidance on what investors should consider when drafting one.
What is an Investment Policy Statement (IPS)?
An Investment Policy Statement is a formal document that defines the managing rules between a portfolio manager and a client. It outlines the client’s general investment goals and specifies the strategies that the manager should employ to meet these objectives.
Key Components of an IPS
An effective IPS includes detailed outlines on several core components, such as:
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Investment Objectives: The primary goals of the investor, often categorized by time horizon (short-term, medium-term, long-term).
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Asset Allocation: The planned distribution of investments across multiple asset classes (stocks, bonds, real estate, etc.). It should specify target allocations along with a permissible range for deviations, indicating levels at which rebalancing takes place.
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Risk Tolerance: A critical section that describes the investor’s willingness and ability to endure fluctuations in investment value, providing guidelines on asset classes to avoid or prefer.
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Liquidity Requirements: An assessment of the cash needs of the investor and the timeframe within which they expect to access their investments.
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Monitoring and Control Procedures: Specifies how often the portfolio will be reviewed, the benchmarks against which performance will be compared, and the procedures for amending the IPS if necessary.
The Purpose of an IPS
The main purpose of an IPS is to keep both the portfolio manager and the investor focused on long-term objectives rather than allowing emotional reactions to short-term market fluctuations to dictate investment decisions. By creating a systematic and structured approach to investing, an IPS facilitates:
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Informed Decision-Making: With clearly defined goals and procedures outlined, both parties can make informed choices concerning the portfolio.
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Consistency: Regardless of market conditions, an IPS provides clarity and consistency, which helps to mitigate potential impulsive decisions.
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Performance Measurement: An IPS establishes benchmarks for monitoring investment performance over time, ensuring accountability.
Additional Information to Include in an IPS
To maximize the effectiveness of an IPS, additional information should be considered:
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Account Information: Clearly outline all current accounts, asset distributions, total accumulated wealth, and ongoing investments.
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Triggers for Change: Define specific circumstances under which the IPS should be reviewed or revised. This might include significant financial changes, major life events, or shifts in investment strategy.
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Reasons to Avoid Changes: Clearly state the reasons not to alter the IPS, particularly in response to short-term market volatility, to help maintain discipline during turbulent times.
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Educational Components: Include resources or sections that aid in educating the client about investment strategies, risk management, or market behavior to foster better understanding and alignment.
Example of an Investment Policy Statement
For a practical illustration of an IPS, consider the example provided by Napa Valley Wealth Management, located in Walnut Creek and Saint Helena, CA. Their IPS typically spans about a dozen pages and aims to ensure clarity and alignment between the firm and the client.
Sample Structure of a Napa Valley IPS:
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Introduction: A statement describing the purpose of the IPS and its role as a roadmap for ongoing investment decisions.
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Investment Objectives: A summary of the client's individual investment goals (e.g., retirement funding, education savings).
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Investment Strategy Overview: A detailed outline of the strategic asset allocation and risk tolerance.
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Monitoring Schedule: An agreed frequency for portfolio reviews and performance assessments.
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Appendices: Additional data, charts, or resources pertinent to the investment strategy.
Conclusion
An Investment Policy Statement is a critical tool for both investors and portfolio managers. It fosters clarity, consistency, and accountability in the investment process, making it easier for both parties to stay aligned with long-term goals. By thoroughly considering the elements to include and regularly reviewing the IPS, investors can navigate the unpredictable nature of financial markets with confidence, ensuring that their investment strategies remain focused on achieving their desired financial outcomes.