What it means
An Investment Policy Statement is agreed before money is invested and reviewed regularly. It is used by individuals with advisers, by pension funds, by charities and by company treasury teams.
The purpose is to make investing decisions deliberate, consistent and easy to explain. A typical IPS covers several items.
It states the objective, such as growing a pension fund to meet obligations or preserving the value of a reserve. It sets the time horizon, the acceptable level of risk, the liquidity needs and any restrictions, such as banning certain industries or limiting any single holding.
The heart of the document is the strategic asset allocation (the long-term split between assets such as shares, bonds and cash). It often includes permitted ranges around each target, such as 60% shares plus or minus 5 percentage points.
When market moves push the portfolio outside a range, the IPS tells the manager to rebalance back to target. The IPS also defines who is responsible for what.
It names the decision-makers, the advisers and managers, the benchmarks used to judge performance and how often reports are produced. This clarity protects both the owner and the adviser, because it can be checked afterward whether the manager followed the plan.
In a business, an IPS for corporate cash prevents the treasurer from taking more risk than the board approved. It can set limits on credit quality, maturity and counterparty exposure.
In a pension scheme, trustees use it to show that they have met their duty to manage assets prudently.
In practice
Real-world examples.
Example
A couple saving for retirement agree an IPS with their adviser that sets a 70% share and 30% bond mix, a maximum of 5% in any one company and an annual review. When markets crash, the document reminds them not to sell in panic. They also agree to rebalance each January, so the review becomes a routine event.
Example
A university endowment board writes an IPS that sets a spending rate, an allowable range for each asset class and a ban on investments in tobacco. The investment committee uses it to judge each manager.
Example
A manufacturing company drafts an IPS for its $10,000,000 cash reserve, requiring that all bonds carry a high credit rating, that no more than 20% be invested for longer than two years and that cash be available within three days. The treasurer reports against these limits every quarter.
Formula
Calculation
Rebalancing trade = current value of an asset class - (target weight x total portfolio value)
A fund has a target of 60% shares and 40% bonds, with a rebalancing trigger at 5 percentage points either side. It starts with $600,000 in shares and $400,000 in bonds, a total of $1,000,000. After a rally, shares are worth 600,000 x 1.25 = $750,000 and bonds are still $400,000, so the total is $1,150,000. Shares now make up 750,000 / 1,150,000 = 65.2%, which is beyond the 65% limit. The target value of shares is 0.60 x 1,150,000 = $690,000, so the fund sells 750,000 - 690,000 = $60,000 of shares and buys $60,000 of bonds.Case study
Seen in the real world.
Lindenfield Foundation is an illustrative, fictional charity with a $20,000,000 endowment. Before adopting an IPS, its trustees changed the investment mix several times in response to news, and results lagged the benchmark.
They then wrote an IPS with a target of 55% shares, 35% bonds and 10% cash, with a rule to rebalance when any class drifted more than five points from target. In a strong year for shares, the equity portion rose to 61% and the rule required the trustees to sell about $1,200,000 of shares to return to 55%, which locked in some of the gain.
The illustrative lesson is that the document did not predict markets, but it forced the trustees to act in a disciplined way and made their decisions easy to justify to donors and auditors.
Watch out
Common mistakes.
- Writing the IPS once and never updating it, when changes in goals, laws or the investor's situation should trigger a review.
- Setting a risk limit that sounds sensible in calm markets but that the owner cannot tolerate in a fall, so it is abandoned when it matters.
- Leaving out who is responsible for decisions, so that nobody is accountable when the plan is not followed.
Questions
People also ask.
Is an IPS legally required?
For some pension and charity funds the law or regulator expects one, but for private individuals it is good practice and not a legal requirement, and many advisers insist on one anyway.
How often should an IPS be reviewed?
At least once a year and whenever there is a major change in goals, liquidity needs or market conditions.
Does an IPS guarantee better returns?
No, it gives structure and discipline but cannot control markets.
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