An Investment Policy Statement (IPS) is a living document that defines the client/advisor

relationship and sets clear objectives and constraints on the portfolio in order to develop a
strategic asset allocation that is unique to each investor. The IPS should be reviewed
annually or changed whenever a major change in circumstances could affect risk-return
objectives or portfolio constraints.                      
Basically the IPS helps:

 State the goals of the client and evaluate them in a risk/reward context
 Establish the grounds for a strong working relationship
 Help an advisor better understand the client
 Bring discipline to the investment process

Major Components of an IPS
An IPS has nine major sections in which we:

 Describe the client

 State the purpose of the IPS
 State the responsibilities of the financial managers as well as the client
 Articulate procedures to update the IPS going forward
 Create the investment objectives - risk and return
 Develop the investment constraints – time, taxes, legal, liquidity, unique
 Create the investment guidelines
 Set how performance will be evaluated
 Attach appendices for any other strategic considerations – asset allocation,
permitted deviations etc

Risk & Return on the IPS

This is the RR in RR-TTLLU (which is how we remember the IPS constraints).
Simultaneously defining an investor’s desired return along with their willingness and ability
to take risk and return (R&R) are two of the most critical components of an investor’s IPS. 
The return section is divided into two parts.

 The return objective, which is a statement of the investor’s objectives

 The required return, which is a calculation designed to figure out the return
needed to meet the client’s objectives
Returns can be stated as an absolute return objective, which is a stated percentage return,
or as a relative return objective, which is a desired return relative to a stated benchmark.
Returns can also be expressed on a real or nominal basis and on a pre or post tax basis.
It is the job of a portfolio manager to ensure that the return objective is realistic in light of a
client’s risk tolerance.
Risk tolerance depends on two factors—your willingness to take risk and your ability to
take risk.
Willingness and Ability are different.
1. Willingness is about your attitude & beliefs about asset types (subjective)
2. Ability is financially driven—do you low liquidity needs, longer time horizon, a
secure job, more assets saved? If yes, that indicates higher ability to take risk versus less
wealth, a shorter time horizon,or lower income.
If there is a conflict between the two always go for the most conservative option.
For example, if a client’s ability to take risk is below average but her willingness to take risk
is above average, you would identify that investor’s overall risk tolerance as below average.

The Five Investment Constraints on the IPS

 This is the TTLLU in RR-TTLLU, which is how we remember an investor’s constraints.
There are five constraints that are documented in an investor’s IPS. 

 Taxes – Investors only care about after tax investment returns. So we need to
document and be aware of their tax rate, taxable/retirement accounts, and specific asset
taxes
 Time horizon – The time horizon is the time between saving/investing money and
requiring that money. The longer the time horizon, the more ability to take risk
 Liquidity – Lower liquidity/spending needs, more ability to take risk
 Legal – Any legal issues/constraints, e.g. can’t buy particular type of asset
 Unique constraints – Catch all for preferences. Can include ethical
considerations, religious ones