Definition
An Investment Policy Statement (IPS) is a document drafted between a portfolio manager and a client that outlines general rules for the manager. It specifies the client’s investment objectives, risk tolerance, and investment restrictions. Essentially, it serves as a strategic guide for making investment decisions.
Key Takeaways
- An Investment Policy Statement (IPS) is a document that outlines an individual’s or a business’s investment philosophy and financial goals. This provides a strategic guide to the types of investments that meet the client’s risk tolerance and objectives.
- The IPS acts as a roadmap for the investment advisor by providing detailed instructions and general investment philosophies for managing the portfolio. It establishes clear criteria for evaluating investment performance, helping to avoid emotional or impulsive reactions to market volatility.
- Regularly updating an IPS is crucial since it must reflect the evolving financial situation, goals, and risk tolerance of the individual or organization. A consistent review ensures that the investment strategy remains aligned with the stated objectives.
Importance
The Investment Policy Statement (IPS) is a crucial document in finance because it clearly defines the investor’s goals and strategies, risk tolerance, and investment parameters.
It serves as a guide for financial planners and portfolio managers in making informed investment decisions and keeping the portfolio aligned with the investor’s objectives.
The IPS acts as a roadmap for investment management, minimizing miscommunication, misunderstandings, and subjective decision-making.
Furthermore, it establishes accountability and sets benchmarks for evaluating portfolio performance, directly linking investment decisions to the investor’s specific objectives and risk profile.
Therefore, it is a pivotal tool in successful investment management and aids in maintaining a consistent investment approach.
Explanation
The primary purpose of an Investment Policy Statement (IPS) is to provide a clear and specific guideline for an investor’s investment approach. It aids in identifying and articulating the investor’s financial objectives, risk tolerance, investment time horizon, and other relevant factors.
By penning down these strategic criteria, an IPS helps investors make consistent and suitable investment decisions, hence providing a long-term investment strategy regardless of fluctuating market conditions. The relevance of an IPS extends far beyond individual investors.
It is also widely used by institutions or fiduciary investors such as pension plans, endowments, or trusts to manage and monitor investments. Additionally, an IPS acts as a communication tool between investors and their financial advisors, ensuring both parties are aligned on expectations, strategy, and assessment criteria.
Thus, an IPS is an indispensable element in prudent and effective investment management.
Examples of Investment Policy Statement
Personal Retirement Planning: An individual who is planning for retirement may create an Investment Policy Statement (IPS) to guide their investment strategy. In this IPS, they would outline their retirement goals and objectives, their risk tolerance, their desired asset allocation, and the specific types of investments they wish to include in their retirement portfolio. This IPS would then be used to guide the individual’s investment decisions and would serve as a benchmark for evaluating their portfolio’s performance.
Corporate Pension Fund: A corporation that manages a pension fund for its employees would have an IPS to explain their strategy for investing the fund’s assets. This could include details such as the fund’s objectives, the risk levels it is willing to accept, the types of investments it will make, and how it will measure and review its performance. This IPS would be used to guide the corporation’s decisions and actions regarding the pension fund.
Endowment Funds: Say a large university has an endowment fund that it uses to generate income for scholarships and operational costs. The university would have an IPS that outlines their objectives (such as maintaining a certain level of income, preserving the principal, etc.), their risk tolerance (either conservative, moderate, or aggressive), their target asset allocation (how much to stocks, bonds or alternatives), any restrictions (like no tobacco stocks) and the review/rebalancing process. This allows them to consistently handle the investments, despite changes in the economy or personnel.
Investment Policy Statement FAQ
What is an Investment Policy Statement (IPS)?
An Investment Policy Statement (IPS) is a document drafted between a portfolio manager and a client that outlines general rules for the manager. This statement provides the general investment goals and objectives of a client and describes the strategies that the portfolio manager should employ to meet these objectives.
Why is an Investment Policy Statement important?
An IPS is important as it serves as a strategic guide for the portfolio manager to follow and helps to avoid misunderstandings in the future. It provides a clear understanding of the client’s investment goals and risk tolerance, ensuring that both parties have aligned expectations.
What typically gets included in an Investment Policy Statement?
An IPS typically includes general investment goals, acceptable risks, strategies to be employed, communication and reporting guidelines, and rebalancing and review provisions. The specific contents can vary, but these components are commonly seen in an IPS.
Who needs an Investment Policy Statement?
Any individual or entity that uses a professional portfolio manager can benefit from an IPS. It serves as a mutually agreed-upon document that safeguards both parties – ensuring that the portfolio manager knows exactly what is expected of them and that the client has clarity about the investment process.
How often should an Investment Policy Statement be reviewed?
An IPS should be reviewed at least annually to ensure that it still aligns with the client’s circumstances and the current economic environment. It can, however, be reviewed more often if significant changes occur in the client’s financial situation or if the client requests a review.
Related Entrepreneurship Terms
- Asset Allocation
- Risk Tolerance
- Investment Objectives
- Time Horizon
- Review Procedures
Sources for More Information
- Investopedia : A comprehensive online resource for finance terms and concepts, including Investment Policy Statement.
- Morningstar : A renowned investment research firm that provides data and analysis on a wide range of investment offerings.
- Charles Schwab : A leading provider of investment services, offering information and resources on a variety of financial topics.
- Fidelity : A multinational financial services corporation known for its research and guidance on investment and financial planning.
