The investment policy statement (IPS)

Why write an IPS down?

The IPS is the starting point of the portfolio management process: a written plan, agreed before any money moves, for achieving the client’s investment goals in a way the client is comfortable with. Without a full understanding of the client’s situation, successful results are unlikely.

A written investment policy statement (IPS) is worth having because it:

• forces agreement between client and adviser on objectives and limits before money is invested;
• gives a benchmark for judging results in the feedback step of the process;
• keeps the strategy steady when markets are turbulent, and when the adviser or manager changes;
• supports suitability: the manager can check any investment against the IPS;
• may be required: in some countries a written statement (or an equivalent) is a legal or regulatory requirement, for example for pension schemes.

It is usually drafted after a fact-finding discussion, often with a questionnaire. For institutions the fact finding adds reviews of assets against liabilities, liquidity needs, and tax and legal issues.

Exam tip The IPS does not promise returns. It records what the client wants and what limits them, so that everyone judges the portfolio by the same yardstick.

What goes into an IPS?

Memorize

There is no single standard format, but most IPS documents contain the sections below. Learn the table: the exam asks “which section would contain this?”.

Section	What it covers
Introduction	who the client is
Statement of purpose	why the IPS exists
Duties and responsibilities	of the client, the custodian and the managers
Procedures	how the IPS is kept current; what to do in contingencies
Investment objectives	return and risk objectives
Investment constraints	liquidity, time horizon, taxes, legal and regulatory, unique circumstances
Investment guidelines	how policy is executed: leverage, derivatives, excluded assets
Evaluation and review	how results are measured and reported
Appendices	(A) strategic asset allocation (policy portfolio), (B) rebalancing policy

Investment policy statementno single standard format; these nine sections are the common ones

• Sets the scene who, why and how the document is kept alive
  • Introduction Use it who the client is
  • Statement of purpose Use it why the IPS exists
  • Duties and responsibilities Memorize client, custodian and managers
  • Procedures Use it keeping the IPS current; contingencies
• The heart of the IPS Memorize the "objectives and constraints" format
  • Investment objectives Memorize return and risk objectives
  • Investment constraints Memorize liquidity, time horizon, taxes, legal and regulatory, unique circumstances
• How the plan is run execution and follow-up
  • Investment guidelines Memorize leverage, derivatives, excluded assets
  • Evaluation and review Use it how results are measured and reported
  • Appendices Memorize (A) strategic asset allocation, (B) rebalancing policy

The diagram shows the IPS as a one-page document. Notice that the two highlighted bands, objectives and constraints, are the parts that differ for every client. The rest is about how you keep to them.

Which parts matter most?

The sections closest to the client’s distinctive needs, and the most important from a planning perspective, are the investment objectives and the investment constraints . An IPS that concentrates on these two has been called an IPS in the “objectives and constraints” format.

• Objectives are what the client wants: a return objective and a risk objective. They must be consistent with each other, because a high expected return is unlikely without high expected risk.
• Constraints are what limits the client: liquidity, time horizon, taxes, legal and regulatory factors, and unique circumstances. They may be internal (set by the client) or external (set by law or regulation). The next lessons take them in turn.

Constraints or guidelines?

Use it

The two are easy to confuse, and the exam likes the confusion. Constraints describe the client’s situation (for example, “needs EUR 80,000 for a house deposit in two years”). Investment guidelines describe how the policy is to be carried out: whether leverage or derivatives may be used, and which assets are excluded.

If the sentence says…	It belongs to…
“The client needs cash in 18 months.”	constraints (liquidity)
“The portfolio may not use leverage.”	guidelines
“The client wants to beat inflation by 3%.”	objectives (return)
“The custodian reports monthly.”	duties and responsibilities
“Performance is compared with the policy benchmark each quarter.”	evaluation and review

Where do the allocation and rebalancing rules go?

Many investors write down a strategic asset allocation , also called the policy portfolio : the baseline allocation of assets to asset classes, given the client’s objectives. It is normally an appendix, alongside the rebalancing policy that says when and how the weights are brought back to target. The SAA can also state a policy on hedging risks such as currency or interest rate risk. The IPS is therefore the planning document, and the asset allocation is the first step of building the portfolio from it (the lesson on strategic asset allocation picks this up).

How often is it reviewed?

The IPS must stay consistent with the client’s circumstances. Review it on a regular schedule, whenever the manager learns of a material change in the client’s circumstances, and whenever the client asks because the objectives, time horizon or liquidity needs have changed.

Go deeper Mandates that cover only part of a client's wealth

In practice, many managers work with mandates that cover only part of a client’s wealth or financial risk. They are governed by documents such as investment management agreements or partnership agreements. These are similar in content to an IPS for the whole of the client’s wealth, with the same logic: purpose, objectives, limits, execution rules, and review.

Go deeper How an institutional IPS differs from an individual's

For an institution such as a pension plan or an endowment, the IPS often also sets out governance: how the investment committee appoints and reviews managers, what discretion those managers have, and who approves changes. The objectives lean on liabilities or a spending policy rather than on personal goals, and legal and regulatory constraints weigh more heavily.