When visiting a new country, the best way to find your way around is to map out the directions. You will also want to make an activity plan for all you’ll do once you get there. Your financial future is akin to visiting a new country, and your Investment Policy Statement is your map. It provides you with a guide on how you’ll invest your funds and how those investments will help you achieve the financial goals you have set, as well as other useful information.
Throughout this article, you will not only learn what an Investment Policy Statement is and why it is important, but also what it contains, and what an investment policy statement template looks like.
The Investment Policy Statement
An investment policy statement (IPS) is a document that is drafted between a financial adviser or portfolio manager and the client. It outlines the general rules for the manager and provides the client’s investment goals and objectives. The investment policy statement should also describe the strategies that the manager will employ in meeting these objectives. Some of the topics that the investment policy statement should cover include asset allocation, risk appetite, and requirements for liquidity.
Investment policy statements are usually used by financial advisors to document their investment plans with clients. The IPS provides guidance for making informed decisions and also provides a roadmap for successful investing. It can also provide a guide if either party wants to deviate from the plan, like taking a new road that wasn’t on the planned itinerary.
Foremost, the IPS helps guard against mistakes and misdeeds when managing a portfolio. When the investment portfolio statement is well formulated, it will have actionable provisions that will help the advisor “talk down” the clients from taking drastic actions that can be potentially harmful to their portfolio when the market shows signs of faltering.
Importance of Investment Policy Statement
Now that we’ve looked at what an investment policy statement is and how it can help in managing a financial and investment portfolio, next we need to understand what are the benefits of an investment policy statement, what are the likely consequences of not having one and why an investment policy statement is essential?
As we’ve stated earlier, the purpose of the investment policy statement is to have a written record of the investment plan and provide guidance for consistent and informed decision making.
For financial advisors, the first reason why an IPS is important is adherence to the fiduciary process. As fiduciaries, financial advisors are expected to, and even bound by law to, provide the best financial advice that they possibly can. In the event of a dispute, the financial advisor must prove that they did their job as a fiduciary. However, the answer to this will not come from the investment results, but rather the decision-making process behind the actions taken. The financial advisor will have to demonstrate the process that they followed, that the process was in their client’s best interest, and that their actions were consistent with their client’s best interest. It is difficult, almost impossible, for a fiduciary to prove that they had the client’s best interest at heart without a plan. With an IPS, however, the fiduciary can show that they were working with the client’s best interest at heart, even if the investment results did not turn out as expected.
Another reason why an investment portfolio statement is necessary is that clients occasionally want to make snap decisions on their investment portfolios, especially during heightened market volatility. Given that many clients do not have a deep understand on how the investment world works, they might make some unreasonable demands based on some “information” that they saw online, on TV, or from their friends or family. Their financial advisors must remind them what their financial goals were in the first place and show them why they are best suited, sticking to the laid down plan. What better way to do so then to show them a document that they agreed to well ahead of hearing this “information,” when their emotions were clear.
Investment Policy Statements: The Good, The Bad, and the Ugly
When it comes to creating an investment policy statement, there are good, bad, and ugly ones. It is vital that both the financial advisor and the client understand the types of policy statements that exist and how to identify good ones from the ugly. Let’s take a look at what a bad investment policy statement looks like:
Bad Investment Policy statements.
Bad investment policy statements:
- Are often written primarily to satisfy regulatory or compliance requirements
- Are usually vague and cannot be integrated into the process of constructing and managing a portfolio
- Will provide no way to test the success or effectiveness of the design portfolio with actual results.
- The client cannot effectively reconcile the emotional determination of a conservative and self-interest mandate to the quantitative portfolio results.
Both clients and financial advisers want to avoid bad investment policy statements. To do this, financial advisers must go beyond just as fine regulations and be specific about how they want to help their clients achieve their investment goals.
Ugly investment policy statements
Apart from the bad investment policy statements, there are also some ugly ones. Some of their attributes include:
- broad terms, such that the objective stated can have widely different interpretations from one client to another.
- a client comparing portfolio performance to asset-class and market benchmarks that may or may not be relevant to the objective stated by the client.
Good Investment Policy Statements
A good investment policy statement should:
- Provide the client with necessary guidance on how their portfolio is constructed and the ongoing management efforts.
- Maintain the focus on the client’s mandate and assist in deviations from the plan in changing market conditions
- Serve as a vital tool for keeping clients focused on their already stated objectives.
As you can see, good policy statements must be clear to both the client and the financial advisor, and every ambiguous term in the statement should be thoroughly explained to the client. The client must understand what the investment policy statement is saying about their investment portfolio and how it will be managed. It is a document that can be referred back to, and should be updated regularly when conditions permit.
Writing an Investment Policy Statement Template
Most of the time, you will want to work with Registered Investment Advisor (RIA) firms that have a fiduciary duty to their clients. Now that you know what an investment policy statement is, and that an RIA investment policy statement is necessary, let’s take a look at what exactly is an investment policy statement. Then we’ll look at an investment policy statement sample.
An Investment Policy Statement is usually prepared by the financial advisor on behalf of the client. The statement is prepared based on the client’s information about their financial situation and their intended investment goals. Here is what you’ll find on an Investment Policy Statement template.
The first section that you can expect to find in an investment policy statement template word document is the purpose of the statement. This section will show why the IPS was written, as well as the various sections that are covered in the IPS. For example, if it was a pension plan investment policy statement or a trust investment policy statement, then it would be shown in this section
This is a concise section that states the legal name of the client whom the IPS was prepared for. it will also state the approximate value of the assets that the client owns.
The Executive summary gives a brief but detailed look at the major information contained by the IPS. It covers the reason for the IPS was written, the worth of the assets that the IPS was written to protect, the risk tolerance of the client, and other pertinent information.
This section is short and lays out the major goal that the financial advisor and client wish to achieve. If the purpose, for example, was to build a retirement portfolio, then the IPS could be a 401k investment policy statement.
This section will give a brief view of how the client’s investment portfolio will be modeled. It can be divided into Fixed Income, Equity, and Alternatives. Also, a percentage of the portfolio value may be kept in domestic assets, while another percentage in the internatinoal assets.
The investment policy statement will take into consideration the risk appetite of the client. Risk tolerance refers to how much risk the client is willing to take. The financial advisor, after meeting with the client (likely several times at minimum) will assign the client a score based on how risk-averse or risk-prone the client is. This can be on a scale of 5, 10, or 100, or an alternative agreed metric. Some areas to be covered could include Tail Event Risk, Volatility, Concentrated Stock Risk, and the Diversification Risk Rating. The client’s rating under these sectors is scored, and an average score is calculated.
Asset Class Preference
Asset allocation is a crucial part of financial planning and investment portfolio management. This section will describe how the client’s portfolio is currently being managed and describe how the financial advisor plans to reallocate the assets in the portfolio to invest them more efficiently.
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In this section, the IPS will show how the statement will be implemented. It will state the terms via which the client and the advisor will evaluate the plan’s success. Specifically, it should state that the IPS will not require a change due to short-term changes in the market. This will help manage clients who may want to completely restructure their portfolio based on increased volatility.
Signatures and Date
This is the last part of the IPS and is what makes binding for both the advisor and the client. By signing the investment policy statement, both the client and advisor agree to all the terms in the IPS.
Investment Policy Statement Software with StratiFi Technologies
Creating an investment Policy Statement can be challenging, especially if you use a conventual word processor. With our investment policy statement software, you can capture all the essential information that the financial advisor and client need to know. StratiFi Technologies has a built-in software that sends a 17-part questionnaire to the client and advisor to fill out, which financial advisors can use to create and export Investment Policy Statements. An example of StratiFi Technologies software is below.
The software utilizes the client portfolios and a benchmark portfolio to create a full multi-page IPS that starts similarly to the below:
It then goes through your full accounts and risk tolerance after the executive summary:
It provides a statement of objectives and a suggested model portfolio, if required:
It then goes through your risk tolerance and asset class preferences:
And finally, the IPS generated also covers the governance and review, as well as final signatures.
Of course, the report is fully customizable with the ability to hide or edit any sections.
Contact us to see how a full report would be generated for you and your clients today.
In conclusion, investment policy statements are crucial to help both clients and advisors understand how their portfolios will be managed, as well as what results to expect. The client and advisor must strive to be on the same page and understand everything that is written in the investment policy statement.