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Creating An Investment Policy Statement


What is an investment policy statement, or commonly termed in short as ‘IPS”?


An IPS is a written investment plan that serves as investment guidelines for all investment decision making for the investor and his investment advisor. It is a standard practice for institutional investors to establish investment policy statements, which enable them to outline their investment processes and expectations, so that all these critical information can be communicated effectively to their investment managers. It also provides a means for measuring results. For the same reason, individual investors should use the IPS to establish their own investment blueprints, especially if they are working with a financial advisor. 


With a written policy statement in place, it helps an investor to maintain a disciplined investment approach so that he is not easily driven by his own emotions, or swayed by the market conditions, even when he is faced with extreme market ups and downs. It also serves as the most important communication documents with the financial advisors. An investment policy statement also creates a framework for reviewing changes in important circumstances as time goes by.


A typical IPS consists of the following elements:


  • 1) Investment goals and objectives — for any investments, the first and foremost thing to do is to set the investment objectives, which could include the need for future retirement planning, children’s educational funding, new house purchase or other long-term financial needs. Any planning for future expenditure should include inflation expectations as we all know that the value of one dollar in the future worth less than a dollar now.


2) Define investment time horizon — the investors may be having more than one investment objective, each with different investment time horizons. For example, planning for a family vacation may be short-term while retirement planning is a long-term goal. Usually if the time horizon is short, i.e. one to three years’ time, then, the investment should be of low risk while an investment with more than ten years horizon is able to tolerate higher risk as the chances of recovering from any losses is higher. The length of an investor’s time horizon is very critical in setting the risk tolerance limit of a portfolio.


3)Define liquidity need – An investor who is having a near-term liquidity need will want to have a cash reserve or investment in cash equivalent to ensure enough cash is available to fulfill the need. If the investor does not pay attention to this and all his money is being tied up in low liquidity investments, when the money is needed, he will be forced to liquidate parts of his investments, even at an undesirable price.


4) Determine risk profile — depending on each individual investor’s age, financial background and constraints, not forgetting the volatility of the investment markets and the time horizon of each investment goal in the above sections, the investor will establish an acceptable and appropriate risk tolerance limit. There are various ways to evaluate risk, all with the same objective, which is mainly to quantify the possibility of the expected returns or asset growth not meeting the investor’s expectations. A skilled investment advisor can be of great help in this area. 


5) Establish an expected rate of return — after putting all the above in place, an investor is ready to determine the expected rate of return required to reach his financial objectives. One important thing to note is that risk and return always come hand in hand. If the risk tolerance limit is low, the investor should not expect the expected return to be high and vice versa. Therefore, the investor should try to strike a balance in setting a realistic investment risk tolerance limit and achievable expected return of the investment portfolio.


6) Develop asset allocation guidelines — with a written asset allocation policy, it will help to guide portfolio management decisions and assist the investment advisor in the ongoing management of the investment portfolio. A sound portfolio should consist of asset classes with low correlations in order to achieve maximum diversification benefits, taking into consideration the appropriateness of the expected return and risk profile of each asset category as it relates to the portfolio as a whole. Other considerations may include liquidity and tax efficiency 


7) Develop rebalancing guidelines — Once the investment portfolio is drawn up, the next thing that should be considered is how the portfolio is going to be maintained. As the market is ever changing, the investor needs to have guidelines in place for portfolio maintenance. Should a passive approach of buy-and-hold strategy be taken or active approach of constant rebalancing of portfolio when the values of the investments have grown out of the target? These are the questions that need to be answered in planning this section, taking into considerations the cost of rebalancing: cost of monitoring and cost of trading.


    With a well written IPS, an investor will be able to make his investment journey a more disciplined and systematic one. Always remember that an IPS is not a static document, as the market is ever changing, the IPS serves as an investment blueprint to help steer the investor in the correct course.


Ooi Kok Hwa
CFA, CM & AA, MA (Finance), B.Sc (Actuarial Science)
Managing Partner of MRR Consulting