Investment Policy Statement (IPS)

An Investment Policy Statement (IPS) is a strategic document between a portfolio manager and a client, outlining rules and guidelines for managing a portfolio. It covers aspects like financial objectives, risk tolerance, liquidity needs, and asset allocation. While common for institutional clients, portfolio managers often customise IPS for individual clients, ensuring consistent decision-making and effective investment management.

This document can be particularly helpful when considering fixed deposit (FD) as part of a diversified portfolio. Fixed deposit offers a stable and predictable return, making them a suitable option for investors with lower risk tolerance who prioritize capital preservation and consistent income.

Let us consider a hypothetical example highlighting how having an IPS in place can prevent clients from making emotional decisions regarding their portfolio investment.

A client had drafted an investment policy statement with his portfolio manager, where the statement outlined the importance of staying disciplined during market fluctuations and avoiding knee-jerk reactions to short-term market volatility.

At some point, the stock market experienced a sudden downturn due to global economic uncertainty. This naturally created market panic and widespread fear among investors.

Like many other investors, the client was also tempted to sell off his investments to avoid further losses. However, his portfolio manager reminded him that making impulsive decisions could affect his long-term financial goals and that he should maintain a stable course amidst the ongoing market volatility.

Over time, the market recovered, and the client’s disciplined approach paid off as his investments rebounded, eventually helping him progress toward his long-term financial goals.

Every investment policy statement typically seeks to address some of these basic components:

1. Scope of investment

An investment policy statement must clearly specify the scope of the investment portfolio and the goals it aims to achieve. It should outline the expectations, objectives, and risk tolerance of the investor or institution. Some institutions may possess different combinations of long-term assets, operating and short-term reserves, and plant reserves. It is important that each pool has a dedicated Investment Policy Statement (IPS) to define its unique set of objectives and restrictions.

2. Objectives

After defining the purpose, an investment policy statement should further elaborate on the investment objectives to support its reason for existence. This helps set forth the characteristics of eligible instruments, the investment process, and management of a portfolio. The financial advisor may further tailor the scope and objectives to the type of investment to which the policy applies.

3. Performance benchmarks

An investment policy statement should define the performance benchmarks against which the portfolio's performance would be measured. Performance benchmarks provide a means of assessing the effectiveness of the investment strategy and determining whether it is achieving the desired results.

4. Asset allocation

Strategic asset allocation is an essential factor for any investment portfolio. About 90% of the portfolio’s performance depends on asset allocation. As such, an IPS needs to specify the asset allocation strategy, which defines the percentage of the portfolio allocated to various asset classes, such as bonds, stocks and alternative investments.

5. Risk management

Risk is an ambiguous concept that is often ignored in an IPS. You cannot achieve high returns without risk. However, it is important to determine how much risk you are actually willing to withstand. This often requires a deep discussion because the risk parameter definitions are sometimes more qualitative than quantitative.

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What is the purpose of an investment policy statement?

The purpose of an investment policy statement is to outline how the investor’s investment portfolio would be built, handled, and assessed. It specifies the parameters and strategies guiding the decisions within a specified investment scheme. Its objective is to align the investor and the portfolio manager regarding all aspects of the investment process. For high-net worth individuals (HNIs), family offices, and institutions, it is increasingly vital to draft an investment policy statement that reflects their goals and objectives for long-term investing success.

Given the recent phases of remarkable market volatility and lower returns over the market cycle, a well-crafted investment policy statement may prove even more essential today than in previous times.

An Investment Policy Statement (IPS) is intended to guide portfolio managers while protecting client interests. It outlines strategies and principles a portfolio manager should follow when managing client assets. It includes information about the client’s investment prospects and objectives, risk tolerance, and precise requirements and limitations. It helps ensure that all decisions are made independent of biased interpretations of success and failure and supports proper communication regarding the client’s investment objectives.
If you work with an investment management entity, it is most likely that an investment policy statement will be provided to you. If you own or work for an investment management entity, it is good practice to provide your clients with an investment policy statement. This helps ensure that all the parties in the investment process are on the same page and understand the objectives and risks involved.

Also read: What is Capital Investment

Conclusion

An Investment Policy Statement (IPS) essentially functions as a business plan for your investment portfolio. Developing a robust IPS is not an easy process for most investors. It requires a lot of planning and a comprehensive understanding of how the market works. It also requires familiarity with investment principles and practices. It can be a crucial and helpful tool as it lays the foundation for a strong client-portfolio manager relationship and delivers an objective course of action. Thus, an effective IPS can be an excellent guide to your financial future.