A document that outlines the rules and guidelines governing asset allocation in a client’s portfolio
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An investment policy statement (IPS), a document drafted between a portfolio manager and a client, outlines the rules and guidelines that the portfolio manager must follow when considering asset allocation in the client’s portfolio. In other words, an investment policy statement outlines how a portfolio manager is to manage the client’s money.
Summary
- An investment policy statement is a document drafted between a portfolio manager and a client that outlines the client’s portfolio objectives and information relevant to achieving the objectives.
- The components of an investment policy statement are scope and purpose, governance, investment, return and risk objectives, and risk management.
- An IPS provides guidance to portfolio managers when making portfolio decisions and helps keep clients from making emotional decisions related to their portfolio.
Understanding an Investment Policy Statement
An investment policy statement provides guidance to portfolio managers when making portfolio decisions. Asset allocation decisions, client risk tolerance, leverage, liquidity requirements, and foreign security investment restraints are some examples of issues that are addressed in an IPS.
A well-constructed investment policy statement provides a framework for investment decisions made by the portfolio manager and also helps commit the client to a long-term investment strategy. Emotional decisions made by the client to the portfolio can be avoided – an IPS acts to remind clients regarding the overarching goals and strategies of the portfolio.
Components of an Investment Policy Statement
Referencing a document published by the CFA Institute, the components of an investment policy statement are as follows:
1. Scope and Purpose
- Establishing and building context regarding the investor’s source of wealth
- Identifying and defining the investor
- Setting forth roles and responsibilities of the portfolio manager
- Identifying a risk management structure
- Assigning responsibility for portfolio monitoring and reporting
2. Governance
- Specifying responsibilities in determining, executing, and monitoring the results of the implementation of the investment policy statement
- Describing the process related to reviewing the updating the IPS
- Describing authority in the hiring and firing of vendors associated with the portfolio
- Assigning responsibility in determining the asset allocation of the portfolio, including inputs used and the criteria used to develop the inputs
- Assigning responsibility for risk management monitoring and reporting
3. Investment, Return, and Risk Objectives
- Describing the overall investment objective
- Stating the return, risk, and spending assumptions (outflows in the portfolio)
- Defining the investor’s risk tolerance
- Describing relevant constraints (liquidity requirements, tax considerations, restrictions on certain investments, legal constraints)
- Describing any other considerations that may be relevant to the investment strategy
4. Risk Management
- Establishing performance measurements and reporting accountabilities
- Specifying metrics used to measure and evaluate risk
- Defining the process for portfolio rebalancing and target asset allocations
Theoretical Example
Following is a theoretical example of how an investment policy statement might prevent emotional decisions.
In 2018, an elderly client drafted an IPS with her portfolio manager. The investment policy statement outlines, among other things, that the portfolio is restricted from investing in high-risk speculative investments.
With the impending legalization of cannabis in Canada and seeing the buzz created by cannabis stocks, the client meets with her portfolio manager and outlines her idea to shift the entire equity asset allocation of the portfolio into cannabis stocks to ride the wave. The client believes that the industry will continue to rise and outperform other industries.
With a drafted IPS, the portfolio manager indicates to the client that the portfolio is restricted from investing in high-risk speculative investments. The portfolio manager outlines that cannabis stocks are highly speculative as they include revenue growth assumptions that are unrealistic and are currently trading at extreme valuation multiples.
Additionally, the portfolio manager states that while marijuana stocks may perform well in the short term due to constant headlines, it would significantly increase the portfolio risk and potentially jeopardize the portfolio from achieving its long-term goal.
Understanding the facts presented by the portfolio manager, the client decides to follow along with the portfolio’s investment policy statement and to avoid the cannabis space.
More Resources
Thank you for reading CFI’s guide on Investment Policy Statement (IPS). To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below:
- Dynamic Asset Allocation
- Investing: A Beginner’s Guide
- Prospectus
- Types of Due Diligence
- See all wealth management resources
FAQs
An investment policy statement (IPS) is a document drafted between a portfolio manager and a client that outlines general rules for the manager. This statement provides the general investment goals and objectives of a client and describes the strategies that the manager should employ to meet these objectives.
What is the IPS investment policy? ›
An investment policy statement provides guidance to portfolio managers when making portfolio decisions. Asset allocation decisions, client risk tolerance, leverage, liquidity requirements, and foreign security investment restraints are some examples of issues that are addressed in an IPS.
What are the components of the investment policy statement IPS? ›
Key Learning Points. An Investment Policy Statement (IPS) outlines the principles that guide the management of a client portfolio. The IPS includes information about the client's investment horizon and objectives, risk tolerance, specific requirements, and/or restrictions.
What is the statement of purpose for investment policy statement? ›
In summary, an Investment Policy Statement is a critical tool for successful investing and reaching your goals. It provides clarity and focus, establishes consistency and discipline, helps manage investment risk, promotes accountability and monitoring, and facilitates communication and collaboration.
Who creates an investment policy statement? ›
Financial advisors often prepare complicated investment policy statements for their clients, complete with appendixes, footnotes, and legal disclaimers. But yours needn't be overwrought.
What is an example of an IPS statement? ›
An IPS lists the investor's investment objectives, along with his time horizon. For example, an individual may have an IPS stating that by the time they are 60 years old, they want to have the option to retire, and their portfolio will annually return $65,000 in today's dollars given a certain rate of inflation.
What is the investment policy statement of a 401k plan? ›
The investment policy statement is designed to guide the sponsor's retirement plan committee as it decides, with the plan's financial services provider, on investment options to include in the plan, and to evaluate the performance of those investments over time.
What are the 2 key parts to an investment policy statement? ›
The items that follow are essential areas that should be addressed when creating a properly crafted IPS. It is imperative to lay out the purpose of the funds as well as the risk tolerance for the investment.
What are the guidelines for investment policy statement? ›
The IPS should describe the investor's general philosophy regarding tolerance for risk. The IPS should acknowledge that the portfolio will be subject to the assumption of risk, and have the potential for returns associated with risk to be both positive and negative over time.
What are the features of investment policy statement? ›
Features of Investment Policy Statements:
An IPS will contain all information related to the accounts, asset allocation, and the amount accumulated and the extent of the allocation made towards different assets.
An intrusion prevention system (IPS) is a network security tool (which can be a hardware device or software) that continuously monitors a network for malicious activity and takes action to prevent it, including reporting, blocking, or dropping it, when it does occur.
What best describes the use of an investment policy statement? ›
An investment policy statement describes a client's financial goals and investment objectives, while documenting the roles and responsibilities of all parties involved in managing portfolios, including the client's outsourced chief investment office (OCIO), board members, investment committee, investment managers and ...
What are the benefits of investment policy statement to clients? ›
The primary goal of the IPS is to establish guidelines within which the client can obtain its investment objectives. These guidelines should limit excessive risk taking while necessitating that the client assume sufficient risk to generate the targeted return.
How often should an IPS be updated? ›
Updating an Investment Policy
Updating the IPS should be repeated at least annually and also prior to material changes to any specific investment recommendations or decisions on behalf of the client. The effort to determine the needs and circ*mstances of each client is not a one-time occurrence.
What is an example of a policy statement? ›
Policy Statement: “Employees are expected to be punctual and reliable” Responsibilities: “Employees are responsible for arriving to work on time” Procedures: “Employees must notify their supervisor if they are going to be late” Compliance and Enforcement: “Employees who are late will be subject to disciplinary action”
What are the constraints of the investment policy statement? ›
Constraints include factors that need to be taken into account when constructing a portfolio. These include liquidity requirements, time horizon, regulatory requirements, tax status, and unique needs.
What is a personal investment policy? ›
An investment policy statement is a strategic document that outlines guidelines for achieving a client's investment goals. It lays the foundation for the client-financial advisor relationship and details how the financial advisor will make investment decisions.
What is this investment policy? ›
An investment policy describes the parameters for investing government funds and identifies the investment objectives, preferences or tolerance for risk, constraints on the investment portfolio, and how the investment program will be managed and monitored.
What is the policy of responsible investing? ›
Responsible investment involves considering environmental, social and governance (ESG) issues when making investment decisions and influencing companies or assets (known as active ownership or stewardship).
What is the family office investment policy statement? ›
An Investment Policy Statement (IPS) defines the investment goals and objectives of a family. It is a financial roadmap drawn in collaboration with a financial advisor. An IPS forms the basis for a family's portfolio construction by describing the strategies to be employed, and processes to measure their outcome.
