Topic 5: Investment Policy PAK Study Manual QFIP-136-19

QFIP-136-19:
Elements of an Investment Policy Statement (IPS) for
institutional investors
Introduction: Definition and function of an IPS

It serves as a strategic guide in the planning and implementation of an investment program.

It anticipates issues related to governance of the investment program, planning for appropriate asset
allocation, monitoring the results, risk management and reporting.
It establishes accountability for the various entities that may work on behalf of an investor.
It is a highly customized document tailored to the preferences, attitudes, and situation of each
investor.

The current paper:

Suggests desirable components of an IPS,

For each component, additional details are presented (for instance, an example of the IPS language is
presented that may be relevant to an institutional investor).
Note however, that the final appropriate language shall be developed by the investment professional
in consultation with the investor and, often, with legal counsel.

The four main components of an IPS

1) The Scope and Purpose,

2) The Governance,
3) The Investment, Return and Risk objectives,
4) The Risk Management,

We briefly discuss each of these components:

The Scope and the Purpose

The IPS shall address the following items:

1a- Define the investor

1b- Define the structure

Furthermore, for item 1b, the IPS shall:

Set forth key responsibilities and actors,

Identify an organizational structure for investing,
Identify a risk management structure applicable to investing,
Assign responsibility for monitoring and reporting,
Document acceptance of the IPS.

Next:

The Governance

The IPS shall also specify the following items:

2a- Specify who is responsible for determining investment policy, executing investment
policy, and monitoring the results of implementation of the policy.

The PAK Manual for PM Exam Page 1

Topic 5: Investment Policy PAK Study Manual QFIP-136-19

2b- Describe the process for reviewing and updating the IPS as the investor circumstances
change.
2c- Describe the responsibility for engaging and discharging external advisers (money
managers and consultants).
2d- Describe the roles and responsibilities of boards and staff 1.
2e- Assign responsibility for determination of asset allocation, including inputs used and
criteria for development of input assumptions 2.
2f- Assign responsibility for risk management, monitoring and reporting

The Investment, Return and Risk Objectives

The IPS shall address the following items:

3a- Describe the overall investment objective 3,

3b- State the return and risk requirements 4,
3c- Define the risk tolerance of the investor 5,
3d- Describe relevant constraints 6,
3e- Describe other considerations relevant to investment strategy.

The Risk Management

The IPS shall address the following items:

4a- Establish performance measurement and reporting accountabilities,

4b- Specify appropriate metrics for risk measurement and evaluation.
4c- Define a process for rebalancing portfolio to target allocations.

1 Institutional investors often have boards of trustees (Or similar structures) with oversight
responsibility for asset management as well as having professional staff responsible for day-to-day
management.
2 An IPS may include an asset allocation policy as an appendix, which can be revised without

requiring approval of an entirely new IPS.

3 For instance, the IPS may state the following: ‘The assets of the ABC Endowment Fund are intended

to fund the ABC mission value preserving the principal value of donated funds’.
4 Under item 3b, the IPS shall also:

State the overall investment performance objective,

Identify performance objectives for each asset class eligible for investment,
Define a policy portfolio to serve as a basis for performance and risk assessments.
5 In addition to identifying relevant risks (liquidity, legal, political, regulatory, longevity, mortality,

business risks,…), the IPS shall define acceptable paths of risk.

6
Under item 3d, the IPS shall also:

Define an evaluation horizon for achievement of performance objectives,

Identify any requirements for maintaining liquidity,
Identify to what extent, if any, tax considerations will affect investment decision making.
Specify any policies related to leverage.
If relevant, specify a policy on foreign currency management.

The PAK Manual for PM Exam Page 2