Before constructing a portfolio for a client, it is a must for an advisor to understand a few things about the client, including about their goals, resources, circumstances and constraints. Portfolio planning is described as the process of constructing a portfolio in order to meet the investment objectives of the client. The kind of written document governing this process is known as the Investment Policy Statement or IPS.
The Investment Policy Statement, which is also more known as IPS in short, refers to the communication between a client and their advisor. This one explains the plan for achieving investment success. Before working on the IPS, the advisor will team up with the client to articulate the risk tolerance and certain circumstances of the client. It focuses on liquidity requirements, time horizons, regulatory requirements, tax status, and some other unique needs. Besides, it is also possible for the IPS formulation to involve asset-liability management studies, identification of liquidity requirements and a range of tax and legal matters. It usually happens in the case of institutional clients. Aside from that, it may also involve the governance arrangements in the case of an endowment or pension plan. In order to corporate governance and the way shareholder voting will be approached and conducted, it is also possible to set out the approach of the institution.
Once again, Investment Policy Statement or IPS is the name of the document. It is the kind of document that the advisor refers to when exploring the feasibility of a certain investment. In a few countries, it is considered as a legal or regulatory requirement. In order to keep it in tune with the client based dynamics, it will be needed for this document to be reviewed regularly. By doing so, its relevance will be maintained and it can continue to be appropriate for the client objectives.
Talking about Investment Policy Statement or IPS, there are four considerations that can help determine how strong an IPS is, these include:
- The Definition of Responsibilities
The Investment Policy Statement or IPS should identify who does what. For instance, there should be no ambiguity as to who is responsible for some different kinds of tasks related to the investment program for board or investment committee members serving as fiduciaries for an institutional investor.a few assignments that have to be made include:
- Who is responsible for governance, oversight, and maintenance of the IPS?
- Who will set the investment and distribution objectives for the fund?
- Who will make asset allocation, manager selection, and other portfolio management decisions?
- Who will evaluate how well the investment program meets its objectives?
Among the others, it is needed for these responsibilities to be identified and assigned to certain owners, in writing. To why they should be like that is because expectations are clear. There is a possibility that these key owners include the asset owners, board members, trustees, and investment committee members aside from financial service providers such as investment advisers, custodians, and so on. Just do it right and it will give you clarity on the responsibilities of every party, especially the ones with fiduciary duties, and accountability around the completion of those tasks.
- Objectives and Constraints
Make sure to consider a number of things such as return objectives, risk tolerance, time horizon, taxes, liquidity, legal or regulatory requirements, responsible investing and unique circumstances when making an investment portfolio. Remember to explain these things and define and share all of them with the managers of investment program. Below are some questions to ask when considering these principal objectives and constraints:
- Return Objective: What is the purpose of these funds? If the goal is to make a distribution while preserving purchasing power, does the return objective account for this?
- Risk Tolerance: What is an appropriate level of risk for the portfolio?
- Time Horizon: How long will these assets be invested? In perpetuity, or for a set period of time?
- Taxes: Are there any tax impacts or implications that should be considered as they relate to the investment portfolio?
- Liquidity: What are the portfolio’s cash flow needs (e.g., to fund distributions)?
- Legal or Regulatory Requirements: Are there any federal or state regulations that are applicable? What about other considerations?
- Responsible Investing: Does the portfolio’s construction and management require responsible investing factors be incorporated?
- Unique Circumstances: Are there any specific policies, such as special rules around approving alternative investments that need to be integrated into the management of the portfolio?
Bear in mind that it is a must for an investment program to be built on these factors. Besides, it should also be designed to adapt as they evolve.
- Benchmarking the Plan
In order to make investment program strategy successful, it is important for you to measure progress. Measuring the performance of the investment program against defined benchmarks is useful to determine if it is on track to meet its objectives or if strategy adjustments might be required. The first thing that you have to do is to define success in certain terms, through a relative or absolute benchmark. After that, you can measure the investment program’s performance relative to the definition of success on a periodic basis. Keep in mind that a relative benchmark applies an index or blend of indices to compare the performance of the investment program.
The circumstances, decision-makers, and financial services vendors related to a policy may change over time. If the team that is in charge is changed, IPS can help you to keep the investment program on track. Several important factors to consider include:
- Does the IPS include the common sections mentioned above?
- Have you defined responsibilities for key decision makers?
- Have you defined the objectives and constraints?
- Have you defined what success looks like (i.e., established benchmarking guidelines)?
- Have you defined how you are going to monitor the portfolio and with what frequency?
If your answers to these questions above are yes, there is a chance that your Investment Policy Statement or IPC can take care of inherent uncertainties of the investing.