An investment policy statement (IPS) will be probably the most necessary documents for retail and institutional investors alike. However, not all IPS are of the identical quality.
Which of those statements describes your IPS higher?
A. The IPS is the backbone of our successful investment program.
B. I do know there may be an IPS around here somewhere.
If you answered B, you will not be alone. But you’re probably missing out on the advantages that a well-documented IPS can create in your investment program.
If you were to emphasize test your IPS, would it not be robust enough to face up to the pressure?
Four elements will help determine the robustness of an IPS. The overarching theme is thoroughness: thoroughness by way of the governance, oversight, investment management and monitoring/evaluation functions of the investment program.
Current landscape
But before we address these 4 considerations, we want to research the present IPS landscape.
Simply put, there are more “bad” investment policies than “good” ones. The IPS is maybe crucial governance and oversight document of an investment program and may due to this fact cover all details relevant to the administration, execution and monitoring of this system and its portfolios. In our view, that is the important thing difference between a “good” and a “bad” IPS: again, thoroughness.
General IPS sections
An intensive IPS should include as most of the sections listed above as are relevant to the precise investment program. For example, a nonprofit may use an investment program to sustain its mission. The IPS should document how that investment program is constructed to support the mission and relate to the general goal of the assets, whether to support a distribution, a budget, specific capital projects, etc.
The six predominant sections within the graphic above cover a broad range of responsibilities within the areas of governance, portfolio execution, and monitoring and oversight. These are relevant to board or investment committee members who serve in a fiduciary capability.
In our experience, that is where organizations with a “bad” CMMS fail. In some cases they omit sections, in others they include them, but not with sufficient specificity to drive the intended behaviors, processes and results. These deficiencies typically fall into one in every of our 4 areas of consideration.
1. The definition of responsibilities
It could seem obvious, however the IPS should specify who does what. For example, for board or investment committee members acting as trustees for an institutional investor, there ought to be no ambiguity about who’s answerable for the assorted tasks related to the investment program. The following assignments should be made:
- Who is answerable for managing, monitoring and maintaining the IPS?
- Who sets the fund’s investment and distribution objectives?
- Who makes decisions about asset allocation, manager selection and other portfolio management measures?
- Who assesses the extent to which the investment program achieves its objectives?
These and other responsibilities ought to be identified and assigned in writing to specific owners in order that expectations are clear. These primary owners may include the asset owners, board members, trustees, and investment committee members, along with financial service providers similar to investment advisors, custodians, etc. If done appropriately, this provides clarity on the responsibilities of every party, particularly those with fiduciary duties, and accountability regarding the achievement of those duties.
2. Objectives and limitations
When creating an investment portfolio, you could consider return objectives, risk tolerance, time horizon, taxes, liquidity, legal/regulatory requirements, responsible investing and special circumstances.
Explain, define and communicate these aspects to the investment program managers. When considering these key objectives and constraints, ask the next questions:
- Purpose of return: What is the aim of those funds? If the goal is to make a distribution while maintaining purchasing power, does the return objective take this under consideration?
- Risk tolerance: What is an appropriate level of risk for the portfolio?
- Time horizon: How long will these assets be invested? Permanently or for a hard and fast period?
- Steer: Are there any tax implications or consequences that ought to be considered with regard to the investment portfolio?
- Liquidity: What is the portfolio’s money flow requirement (e.g. to finance distributions)?
- Legal or regulatory requirements: Are there any federal or state laws that apply? What about other considerations?
- Responsible investing: Is it essential to take responsible investment aspects under consideration when assembling and managing the portfolio?
- Special circumstances: Are there specific guidelines, similar to special rules for the approval of different investments, that must be integrated into portfolio management?
An investment program should construct on these aspects and be designed to adapt to their evolution.
3. Benchmarking the plan
Measuring progress is critical to a successful investment program strategy. In particular, measuring the performance of the investment program against defined benchmarks will help determine whether it’s on course to attain its goals or whether strategy adjustments could also be essential. Two steps are essential to this process:
- Define “success” concretely, using a relative or absolute standard.
- Regularly measure the performance of the investment program against the definition of success.
A relative benchmark uses an index or a mix of indexes to check the performance of the investment program. For example, a relative benchmark might compare an investment portfolio with a 60%/40% mixture of the S&P 500 and the Bloomberg Barclays Aggregate Bond Index.
An absolute benchmark or hurdle rate is an actual percentage return. For example, if the goal is to preserve the portfolio’s capital and buying power with an annual distribution of 4%, inflation of two%, and costs of 0.5%, a rough calculation would yield a return of 6.5%. Investment returns below this benchmark indicate that this system is just not meeting its goal. Returns above it indicate that the goal is being met.
The second necessary aspect of benchmarking is to be certain that the benchmarks are literally used. In particular, the performance of the investment program relative to the established benchmarks should be calculated frequently.
We recommend that the benchmarks be reviewed annually and when there are significant changes to the investment portfolio or the objectives of the investment program to find out whether or not they proceed to be appropriate for the objectives pursued by the investment program.
4. Portability
Over time, the circumstances surrounding a policy, the choice makers and the financial service providers can change. If there may be turnover within the team answerable for long-term goals, how do you retain the investment program on course? An effective IPS will help.
With this in mind, will someone have the option to grasp the IPS and understand the investment program without further guidance? Some key aspects to think about when answering this query are:
- Does the IPS contain the common sections mentioned above?
- Have you defined the responsibilities of key decision makers?
- Have you defined the goals and constraints?
- Have you defined what success looks like (i.e. established benchmarking guidelines)?
- Have you determined how and the way steadily you’ll monitor the portfolio?
If the reply to those questions is yes, your IPS may have the option to weather the uncertainties related to investing.
Diploma
A powerful IPS can provide a solid foundation for an investment program and provides investors the discipline they should persevere in difficult investment environments.
With these considerations in mind, we encourage you to work together with your clients, decision makers, legal firms and investment managers to be certain that your investment policies meet the essential rigor requirements.
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