LOS A and B require us to:
a. describe the reasons for a written investment policy statement (IPS)
b. describe the major components of an IPS
1. Portfolio Planning
a. Portfolio planning can be defined as the program developed before constructing a portfolio that is in line with the investor’s objectives.
b. An investment policy statement or IPS is the starting point of the planning process. It is a plan for investment success, i.e. achieving goals within constraints.
c. There are many factors that influence an investor’s portfolio requirements, such as:
i. Risk Tolerance: Risk tolerance is the amount of risk that an investor can possibly take. It is basically dependent upon two factors, i.e. the willingness of the investor to take a risk and his ability to take the risk. The ability to take risk is very much dependent upon the factors such as wealth, income, and responsibility of the investor.
ii. Objectives. Before constructing the portfolio of an investor, the manager should fair estimate the required rate of return of an investor and the degree of standard deviation.
iii. Constraints: An investor’s investment objectives could have many constraints in the form of liquidity, time, taxes, etc.
d. These plans are written, for the purpose of record in the IPS.
2. Importance of IPS
a. The main importance of IPS is:
i. It helps investors decide on realistic investment goals and manage expectations.
ii. The IPS creates a standard to measure the performance of the portfolio.
iii. The IPS helps guide the actions of a portfolio manager, and assess the suitability of particular investments.
b. This was about the individual’s IPS; but apart from the individual investors, there are institutional investors as well. The institutional investors’ IPS helps in making the governance arrangements as well. They help in appointing and reviewing the portfolio manager, and the number of discretionary powers that should be given to the manager of such portfolios.
c. The IPS should be reviewed and updated regularly since the client’s circumstances change over time.
3. Components of IPS
The IPS mainly contains the following components:
i. An introduction that describes the client.
ii. A statement of purpose.
iii. A statement of duties and responsibilities of the client, custodian, and the investment manager.
iv. A statement of procedures that details the steps required to keep the IPS up to date. Also, the statement should provide the details of the procedures to be followed at the time of contingencies.
v. A statement of investment objectives.
vi. The statement of investment constraints.
vii. The detailed investment guidelines, as to how the policies should be executed, the use of leverage and derivatives, the specific asset types that must be excluded or included, etc.
viii. The execution and review statement, giving feedback on the investment results.
ix. Finally, there should be appendices for strategic asset allocation, rebalancing policies (both dynamic and tactical).