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Lesson 1 of 8 · 12 min

The investment policy statement: why and what

The investment policy statement (IPS) is the written plan, built from a fact-finding with the client, that records the client's objectives and constraints and governs every later portfolio decision.

In short

Portfolio planning is the work done before any portfolio is built; its written output is the investment policy statement (IPS), the starting point of the portfolio management process.
Reasons for a written IPS: it communicates the plan for investment success, is best practice, is the yardstick for judging whether an investment is suitable, and is sometimes required by law or regulation. It does not guarantee the objectives will be met.
Typical sections: introduction, statement of purpose, duties and responsibilities, procedures, investment objectives, investment constraints, investment guidelines, evaluation and review, and appendices on the strategic asset allocation and rebalancing policy.
The objectives (risk and return) and constraints (liquidity, time horizon, tax, legal/regulatory, unique circumstances) are the parts most tied to the client's distinctive needs: the 'objectives and constraints' format.
The IPS is built after fact-finding (know your client) and must be reviewed regularly and whenever the client's circumstances change materially.

What the IPS is and why it is written down

Before anyone buys a security, the adviser must understand what the client wants to achieve, what resources they have and what limits apply. Portfolio planning is that preparatory work, and the investment policy statement (IPS) is the document that records it. Investment 'success' means the client reaches their important goals using means they are comfortable with, so the IPS is essentially a plan for success.

A written IPS has several uses. It makes the plan explicit so client and manager agree on it; it is standard best practice for a manager; and it gives the manager a reference point to test whether any particular investment is suitable for the client. In some jurisdictions an IPS or an equivalent document is a legal or regulatory requirement, for example a pension scheme's statement of investment principles.

Be careful about what an IPS cannot do: having one does not ensure the risk and return objectives will actually be achieved. It is a communication and governance tool, best created collaboratively with the client, not a promise of results and not a manager's sales script.

For institutions such as pension plans or endowments, the IPS can also set out governance: how the investment committee appoints and reviews managers and how much discretion those managers have. Responsible investing (ESG) policies may sit in a separate document or, as assumed in this module, inside the IPS itself.

Think of the IPS as the brief an architect gets before drawing a house. It does not guarantee the house will be built well, but without it the builder cannot even check whether a proposed design fits the owner's needs.

The major components

There is no single standard format, but most IPS documents contain the sections below. Two families matter most on the exam: the sections that describe the client's needs (objectives and constraints) and the sections that describe how the policy is run (duties, procedures, guidelines, review).

The strategic asset allocation (SAA), also called the policy portfolio, is the baseline mix of asset classes chosen to meet the client's objectives. It and the rebalancing policy are often placed in appendices, and the SAA may include a policy on hedging risks such as currency or interest rate risk.

Typical sections of an IPS
Section	What it covers
Introduction	Describes the client
Statement of purpose	States what the IPS is for
Statement of duties and responsibilities	Duties of the client, the custodian of the assets and the investment managers
Procedures	How the IPS is kept up to date and how to respond to contingencies
Investment objectives	The client's risk and return objectives
Investment constraints	Liquidity, time horizon, tax, legal/regulatory, unique circumstances
Investment guidelines	How the policy is executed: e.g. whether leverage and derivatives are allowed, which assets are excluded
Evaluation and review	How investment results are reported and assessed
Appendices	(A) strategic asset allocation (policy portfolio); (B) rebalancing policy

Fact-finding: gathering client information

The IPS follows a fact-finding discussion at the start of the relationship. For an individual this may include a risk tolerance questionnaire; for an institution it may involve asset-liability reviews and analysis of liquidity, tax and legal needs. Regulation increasingly demands it: in the EU, MiFID II requires substantial fact-finding not only for full wealth management but also for advisory and even execution-only relationships.

Useful information covers the client's family and employment situation and financial position, the needs of a spouse or other dependants, and the health of the client and dependants. For an institution, the adviser needs to know the key stakeholders and what each of them wants. Information can be collected informally, by structured interview or questionnaire, or by analysing data.

Good recordkeeping matters: if any part of the relationship is later disputed, documented facts and decisions protect both sides.

Constraints can be internal (set by the client, such as a wish to exclude certain industries) or external (imposed by law or regulation, such as limits on a pension fund's foreign holdings).

How an IPS comes about: the facts gathered at the start become the objectives and constraints, the IPS is agreed with the client, the policy portfolio sits in an appendix, and the whole document is reviewed regularly.

Keeping the IPS current

An IPS is a living document. It should be reviewed regularly (one pension regulator, for example, suggests at least every three years) and also whenever the manager learns of a material change in the client's circumstances, or when the client's objectives, time horizon or liquidity needs change.

The asset allocation itself is usually reviewed on a different cycle from the client's objectives, because capital market views change for different reasons than the client's life does. That is one reason the SAA is often kept in an appendix or a separate document.

Worked examples

Example 1 Placing items in the IPS

The trustees of Halvorsen Foundation, a Norwegian charity, are drafting an IPS. Where does each item most likely belong? (1) External managers may not use leverage or buy tobacco shares. (2) The custodian bank must report holdings monthly. (3) The policy weights are 45% equities, 40% bonds, 15% real estate. (4) The foundation must pay out NOK 20 million a year in grants.

Example 2 What an IPS does and does not do

Elena Moretti tells her new adviser: 'Once we sign the IPS I am guaranteed to reach my 6% target, right? And you can write it yourself, you know best.' How should the adviser respond?

On the exam

Questions ask for the main reason for a written IPS (it communicates a plan for success), which item is least likely to be a reason, or which section holds a given item (guidelines vs objectives vs duties vs appendices).

Saying an IPS ensures the objectives will be achieved; it does not.
Putting excluded assets or the leverage policy under 'objectives'; they belong in investment guidelines.
Placing the statement of duties and responsibilities in an appendix; the appendices hold the SAA and rebalancing policy.
Forgetting that the IPS must be reviewed when the client's circumstances change, not only on a fixed schedule.

Check yourself

Q1Which of the following is least likely to be a reason for preparing a written investment policy statement?
Q2The section of an IPS that states whether derivatives may be used and which types of assets are excluded is best described as:
Q3Which item is most likely to appear as an appendix to an IPS?
Q4A written IPS is most likely to succeed if it is:
Q5A client tells her adviser that she has just inherited a large sum and plans to retire five years earlier than stated in her IPS. The adviser should most appropriately:

0/5Check yourself

Answer the 5 questions: +10 XP for each one you get right first time.

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