It provides a strategic guide for implementing and planning investment activities or programs.
Currently an Investment Banking Analyst at Alkes Research (Tashkent, Uzbekistan based Investment Banking Boutique). Bakhtiyorjon (Ben) previously worked in private equity at Uzbekistan Direct Investment Fund and telecommunications at Uztelecom prior to joining Investment Banking team at Alkes Research. Ben is currently senior undergraduate, concentrating in Corporate Finance and Security Analysis at British Management University in Tashkent.
Reviewed By: Christopher Haynes
Chris currently works as an investment associate with Ascension Ventures, a strategic healthcare venture fund that invests on behalf of thirteen of the nation's leading health systems with $88 billion in combined operating revenue. Previously, Chris served as an investment analyst with New Holland Capital, a hedge fund-of-funds asset management firm with $20 billion under management, and as an investment banking analyst in SunTrust Robinson Humphrey's Financial Sponsor Group.
Chris graduated Magna Cum Laude from the University of Florida with a Bachelor of Arts in Economics and earned a Master of Finance (MSF) from the Olin School of Business at Washington University in St. Louis.
Last Updated: October 4, 2023 In This ArticleThe investment policy statement provides a strategic guide for implementing and planning investment activities or programs. By successful implementation, the policy forecasts constraints regarding investment governance and proper planning for asset allocation.
Through implementation, an investment program with external or internal management, the monitoring of results, risk management, and proper reporting are the features of the successful structure of the IPS.
The statement considers different enterprises operating on an investor’s behalf. Even the most important thing it does is serve as a policy guide capable of offering an objection to be followed during market disruptions.
The IPS is considered a document with high customization features that can be tailored for each investor’s attitude, situation, and preferences. That is why investment professionals should thoroughly understand investors’ characteristics.
This includes but is not limited to:
Investors should be mindful and specify who will take responsibility for structuring investment policy, execution of that investment policy, and last but not least, who will monitor the policy implementation results.
The statement provides a document that takes all the periods of investment policy development and its implementations.
It can increase the quality and reinforcement of the responsibilities of investment advisors to present counsel and the responsibilities of principals to provide an ultimate approval or disapproval for the statement of investment policy.
Regarding the updating features of the IPS, as an investor’s circumstances and characteristics change over time, investment professionals should be attentive to those changes and update that investor’s investment policy.
In terms of the presence of investment advisors for the management of investors’ assets, the IPS must have defined written responsibilities of managers for the engagement and disengagement of external advisors.
The policy also defines the assignment of responsibilities for determining the asset allocation , which includes the inputs used and the required criteria for updating or developing the input assumptions.
The asset allocation framework presents strategic circumstances for many tactical investment decision processes. Since the characteristics of an investor and market circumstances change, the policies related to asset allocation are likely to change over time.
The appendix of the investment policy statement includes the policies related to asset allocation, which can be reviewed and considered instead of structuring new IPS.
However, investment professionals should be mindful of the assumptions related to the development and the inputs required for the asset allocation decision-making process.
Documenting the assignment of risk management responsibilities, reporting, and monitoring to a particular investment professional is crucial for successfully implementing the investment policy statement.
The statement describes the overall investment objectives of an investor, and the policy should present the purpose of the invested asset to one or several broad investment objectives.
A) Investment Objective
Since the policy describes the distribution and risk requirements and an investor’s return, the carefully specified overall investment objectives are likely related to general funding needs descriptions and their connection with key factors, which may be spending rate or inflation.
The statement elaborates on all the asset classes that have permission to invest in the portfolio. Some investors profit from utilizing the techniques to risk-adjust the benchmark return of asset class and portfolio return to make a comparison.
Interestingly, however, some asset classes can not be utilized almost all the time. Therefore, those asset classes should be described in the policy.
It means that for each class of an asset, a brief description and identification should be presented, and the benchmark for performance attribution analysis should be provided.
Regarding the policies of spending and distribution from the portfolio, relevant information should be presented.
A ‘spending calculus’ that often provides a reconciliation of taxes, fees, inflation, return objectives, and forecasted spending is beneficial, which leads to realistic assumptions. The distribution is a percentage of the portfolio’s market or cash value.
A designation of an asset allocation policy presents a target allocation for each class of an asset while allowing a certain range around the targets. In addition, the same ranges are provided for the subclasses of an asset.
All in all, fund returns are weighted according to strategic asset allocations and can be constructed and presented in comparison with portfolio attribution analysis.
B) Investment Risk
Regarding an investor’s risk tolerance , the investment policy statement should provide information related to the general philosophy of an investor. The policy also should acknowledge the assumption of risk and the potential returns with the risk to be both positive and negative.
The above-mentioned relevant risks are but are not limited to:
Additionally, the specification of relevant risks and the definition of acceptable risk paths may be crucial factors.
Assessing the risk tolerance of an individual investor is quite complicated and can easily get subjective. Therefore, if possible, the policy should take the known liabilities for the quantitative lending basis for assessing risk tolerance.
Moreover, an individual investor can assess their emotional and intellectual tolerance due to potential losses with those mentioned risks. The assessment includes an interview and questionnaire with the client or investor.
There are also relevant constraints available that investors address and which, in turn, affect their investment programs. Those constraints include but are not limited to regulatory and legal or internal policies.
Apart from the relevant constraints, investment professionals prepare the valuation of the investment horizon for achieving performance objectives.
Relatively, a short period is utilized for analyzing the performance, and establishing a minimum time horizon for fulfilling the performance objectives determines the time the action may be necessary to solve issues related to underperformance.
In terms of liquidity, finance professionals clearly define investors’ liquidity needs and characteristics in the investment policy statement. An investor may have short-or medium-term liquidity needs for cash.
Any tax consideration or tax constraints of an investor is defined in the policy. In particular instances, the tax consequences of an investment decision may hugely alter the desirable transactions, and those abovementioned considerations are taken into account for the IPS.
Coming to the policies related to leverage, the capability of leveraging the portfolio may become constrained by policies or related legal statements. Again, those kinds of constraints are described in the IPS.
Identify certain restrictions on foreign investment securities or any other securities that investors are unwilling to have in their portfolio.
Since those investors desire to limit their exposure to those securities outside of their country for economic, political, or other relevant investment-related reasons.
C) Risk management in the IPS
Investment professionals determine appropriate metrics for evaluating and measuring the risk in the policy. Consistency of metrics for the assessment and evaluation of the risk profile of an investment portfolio is vital for reasonable and meaningful comparison over time.
The rebalancing of portfolios for target allocations is also present since it is documented in the policy.
The rebalancing feature is often integrated with the risk management system. Eventually, there will be a separate appendix for the rebalancing policy, while providing the reference to the risk management is considered appropriate.
The IPS includes several characteristics of investors, obligations, and responsibilities of both parties, investor and finance professional operating as a portfolio manager .
The content of IPS includes but is not limited to:
1. Introduction
The introduction part of the IPS provides the purpose of establishing the investment policy statement between investor and investment manager and gives a brief overview of the IPS content.
2. Investment Policy Overview
The overview part defines the IPS, possible approaches to building the policy, and the steps taken to establish an investment policy.
3. Investment Philosophy
Presentation of the fundamental principles for the portfolio under the management. Those principles include, but are not limited to:
Overall, investment philosophy demonstrates the principles that optimize the risk and return relationship for the given portfolio.
4. Investment Objectives in the investment policy statement
Investment objectives define an investor’s primary goal and priority by an investment in the portfolio. The manager establishes an optimal portfolio strategy by determining an investor’s investment objectives.
5. Time Horizon
According to an investor’s specific goal and objectives, the portfolio manager defines an investor’s investment horizon, which should be consistent with an investor’s goal.
6. Tax policy
Based on the investor’s desired tax account, certain types of tax-efficient securities are utilized, such as passive investment strategy , tax-free bonds , funds, and other income-generating securities.
7. Risk Tolerance
According to the desired return and investment horizon level, the investor gets exposed to a certain level of risk. Even the possibility of losing in extreme market conditions is described in the IPS.
8. Asset allocation
Specific asset classes are described to choose and increase diversification benefits in the portfolio. Those asset allocations are made with the portfolio’s weightings of different investment securities.
9. Frequency of policy review
As time passes, the characteristics of investor and asset classes, certain securities change, and market conditions in the financial industry evolve, and because of that frequency of the investment policy statement review is discussed between manager and investor.
10. Liquidity
The liquidity needs of an investor are one of the major parts of the IPS. Certain investors require the most liquid marketable securities, while some have low liquidity needs and long investment horizons.
11. Diversification
This part provides information about which types of investment securities, asset classes, and index selections. For example, there may be a band of permitted security types or recommended index selections.
12. Selection/ retention criteria for investments
Criteria for choosing certain investment securities under certain asset classes based on their different characteristics.
13. Duties and responsibilities
A description of the responsibilities and obligations of the manager and investor will be presented, and certain exceptions and discretions are identified.
Since portfolio managers operate in the interest of investors, they consider the most optimal construction of the investment policy statement.
By doing that, managers provide a thorough analysis of all the aspects of the investor, which can eventually increase the quality and the overall benefit of that investment policy statement for the investor as a whole that managers consider the interest of the investors.
Considering the application of the investment policy statement, clients or an investor will know about the manager’s service, duties, and responsibilities, increasing the communication quality during the management investor’s portfolio.
For investors, in the case of the constitution or rebalancing of the assets or asset classes in the portfolio, the investment policy statement facilitates updating the investor’s characteristics, if necessary, and the portfolio management strategy.
Establishing the investment policy statement can significantly reduce an investor’s mental load and increase the confidence of an investor toward the portfolio and manager, who is the advisor and responsible for portfolio management.
Since an investor has his IPS, the investor always tracks its performance and the most valued securities, top performance in the portfolio.
During periods of market turmoil and economic recessions, the presence of the IPS mitigates the risk of behavioral biases and actions by investors and portfolio managers.
Since the characteristics, obligations, responsibilities, and objectives of both parties are defined for certain actions and situations.
