The Benefits of an Investment Policy Statement
03 June 2013
Paul Rabenowitz, LightBulb Learning and Training
An investment policy statement (IPS) is one of the most important tools an investment advisor can use to enhance the client relationship, reduce compliance risk and provide guidance on the process of implementing, managing, monitoring and reviewing a client’s investment portfolio. It is also the best practice in modern personal investment management and endorsed and recommended by the CFA Institute, The Institute for Wealth Management Standards, Fiduciary 360 and more.
It has been described as "a virtually indispensable tool for investment management and communication." The CFA Institute describes it as the "cornerstone of the portfolio management process."
An IPS is a written document that sets out: a client’s return objectives, risk tolerance over the time horizon; liquidity needs; tax considerations; regulatory requirements; unique circumstances; policies, procedures and responsibilities as agreed to by both advisor and client and acts as a ‘trust deed’ in the client relationship.
Effective weapon in an unpredictable market
When implemented successfully, the IPS anticipates issues related to governance of the investment which relates to planning for appropriate asset allocation, implementing an investment with investment managers, monitoring the results, risk management, and appropriate reporting.
The IPS establishes accountability for the various entities that work on behalf of an investor. It also offers an objective course of action to be followed during periods of market disruption when emotional responses might lead to less prudent actions.
The IPS provides the foundation of the portfolio management process and providing a comprehensive road map that can be executed by any adviser the client might subsequently hire. A properly developed IPS disciplines the portfolio management process and helps ensure against ad hoc revisions in strategy.
IPS in risk profiling
Risk profiling has limited application when selecting the best investment vehicle, determining liquidity requirements and managing the investment decision making process. Risk profiling is just one tool to use within a prudent decision making process and is a component of an IPS.
Creating an IPS, and more importantly, sticking to it, will established a plan to confront complex issues and identify a systematic discipline for investment decision-making. By doing so, advisor’s will have the advantage of clarity with clients regarding their expectations and goals. Clients will better understand what to expect in the advisory relationship and an advisor will be better prepared to meet their needs.
With an IPS, both the advisor and client can make prudent, rational decisions about investments with confidence. Investor and advisors can make inappropriate decisions due to a lack of information (or imperfect information) and a non-systematic (or prudential) approach.
Some of the benefits of using an IPS can be articulated as follows:
• The client gets what is expected. Clients always have some idea of what they want from a financial advisor and an IPS provides a road map for making future investment decisions as the investment environment and client circumstances change
• The client understands the various aspects of the engagement. They should understand the work an advisor is doing on their behalf.
• Enhances client communication thereby enabling the client to understands, accept and implement the advice more readily
• The relationship is beneficial for both parties as the problem solving and the results that stem from a partnership where everyone’s expectations and goals are addressed.
• Helps avoid overreacting to both bull and bear markets because investors' emotional tolerance for risk increases in the former and decreases in the latter, especially during turbulent markets.
An IPS provides the type of consistency in process, recommendations and decision-making that encourages clients to have confidence in and accept the advisor’s recommendations.
1. The Management of Investment Decisions , Donald Trone, William Allbright, and Philip Taylor, Irwin, 1996;
2. Managing Investment Portfolios: A Dynamic Process, 3rd edition. John L. Maginn, Donald L. Tuttle, Jerald E. Pinto, and Dennis w. McLeavey, eds. CFA Institute Investment Series. Hoboken, NJ : John Wiley & Sons.
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