By Thomas Kostigen
An investment policy statement is de rigueur in the world of institutional finance, and should be equally as requisite for individuals investors, too. But it often is not.
An investment policy statement can establish goals, keep portfolios on track, and mitigate the risk of improper trading. It’s a terrific record to ensure investment objectives and can be a solid reference if ever arbitration arises with investment managers.
Definitionally, an investment policy statement “serves as a strategic guide to the planning and implementation of an investment program. When implemented successfully, the IPS anticipates issues related to governance of the investment program, planning for appropriate asset allocation, implementing an investment program with internal and/or external managers, monitoring the results, risk management, and appropriate reporting. The IPS also establishes accountability for the various entities that may work on behalf of an investor. Perhaps most importantly, the IPS serves as a policy guide that can offer an objective course of action to be followed during periods of market disruption when emotional or instinctive responses might otherwise motivate less prudent actions,” according to the Chartered Financial Analyst (CFA) Institute.
Investment policy statements are so important in the world or professional finance that software programs, questionnaires, workshops, and online tutorials are dedicated to the art of crafting them. Many registered investment advisers utilize investment policy statements when working with clients to devise a long-term roadmap against which investment strategies can be tailored.
Beyond scope, the investment policy statement should lay out who is responsible for overseeing and executing the specific policies covered by it. The statement should also cover return expectations, risk tolerance, and preferences. For example, there may be a desire to hold only dividend-paying companies, or to screen out, say, guns & ammo stocks. Since preferences may change over time, it’s wise to keep parameters on file.
Perhaps most significant is the area of reviewing external managers (mutual funds, or otherwise). If you are a do-it-yourself investor, do you have the skillset to exact proper due diligence and monitoring to ensure your portfolio is being vigilant to your wants? If you have a financial adviser, does he or she have those skills and what is the process for reporting to you? Most financial advisers study and train hard to create value for investors by overseeing outside portfolio managers.
Lastly, the investment policy statement should envelope risk management protocols, including performance measurement, and outlining the process for rebalancing portfolios.
Still, an investment policy statement is only as good as the person who creates it. And often, individual investors are not as honest with themselves as they should be. A recent survey by Natixis Investment Managers found that even though investors recognize volatility is a given in the financial markets, six in ten feel that volatility undermines their ability to achieve savings and investment goals. “As a result, many are looking for investments that can help mitigate the risks – along with their anxieties. Nine out of ten investors say it is important to protect their assets in volatile times. That feeling is so strong that, in an era in which fees on some passive investments have dropped to nearly zero, 56% of investors are willing to pay a premium price for an investment that could help protect them from volatility,” Natixis says.
Extend that rationale to the investment policy statement. Would an investor stretch outside their written investment policy to grab at an inappropriate investment to satisfy short-term goal over long-term investment objectives?
“One of the hardest-learned lessons for investors may simply be that their risk tolerance is much lower than they thought,” Natixis explains.
An investment policy statement can keep investors honest, but only if they are honest with themselves. Otherwise, a professional adviser should be sought to strengthen that resolve.
Thomas Kostigen is a contributing writer to www.myperfectfinancialadvisor.com, the premier matchmaker between investors and advisors. Thomas is a best-selling author and longtime journalist who writes about environmental, social, and governance issues.