Resource Toolkit: Investment Policy Statemen Checklist

Deconstructing the Comprehensive IPS: Essential Elements

While the specific format and level of detail may vary depending on the institution’s complexity and needs, a comprehensive and effective IPS typically addresses a core set of essential elements. These elements provide the structure and substance necessary to guide the investment programme effectively. The downloadable IPS template included in this Acclimetry investment policy toolkit is structured around these fundamental components, offering a practical policy drafting resource.

A. Defining Scope, Purpose, and Mission Alignment

This foundational section sets the stage for the entire document.

• Scope: It must clearly define the specific entity (e.g., The XYZ Foundation Endowment Fund, ABC Corporation Pension Trust, Smith Family Office Investment Pool) and precisely identify the assets or accounts governed by this particular IPS. If an institution manages multiple pools of assets with distinct objectives or constraints (e.g., long-term endowment vs. short-term operating reserves), it is often best practice to have separate IPS documents or clearly delineated sections within a master IPS for each pool.
• Purpose of the IPS: The statement should explicitly articulate its own purpose, such as establishing investment guidelines, defining roles and responsibilities, clarifying objectives, providing guidance for investment managers, establishing the basis for performance evaluation, and defining the relevant investment time horizon.
• Purpose of the Funds/Mission Alignment: This critical element connects the investment activities to the institution’s reason for being. It should articulate the fundamental purpose of the specific assets being managed (e.g., to generate income for annual grants, preserve the purchasing power of the corpus in perpetuity, fund specific capital projects, meet pension obligations) and explicitly link the investment strategy to the overall mission of the organisation.

B. Establishing Clear Governance: Roles, Responsibilities, and Authority

A robust governance section is vital for operational clarity and accountability.

• Identify Key Parties: The IPS must clearly identify all parties involved in the investment process. This typically includes the ultimate governing body (e.g., Board of Directors, Trustees), any delegated committees (e.g., Investment Committee, Finance Committee), internal staff (e.g., Chief Investment Officer, finance staff), external advisors or consultants, investment managers responsible for security selection, and the custodian responsible for safeguarding assets.
• Define Specific Duties: Ambiguity regarding responsibilities is a significant weakness. The IPS must clearly delineate the specific duties of each party concerning critical functions such as: setting and approving investment policy, executing the investment strategy, monitoring performance and ensuring compliance with the IPS, selecting, evaluating, and terminating external managers or consultants, and fulfilling reporting requirements.
• Delegation of Authority: If responsibilities are delegated (e.g., from the Board to an Investment Committee, or from the Committee to staff or an Outsourced CIO), the IPS must clearly state the scope and limits of this delegated authority.
• Decision-Making Process: For committees, outlining procedures for meetings (frequency, quorum rules), voting, and record-keeping can enhance procedural prudence.
• Fiduciary Acknowledgement: Including a statement where relevant parties acknowledge their fiduciary status can reinforce understanding of their obligations.

C. Setting Measurable Investment Objectives: Balancing Risk and Return

This section translates the broad purpose of the funds into specific, actionable investment goals.

• Overall Objective: Begin with a clear statement of the overarching investment goal, such as preserving the real (inflation-adjusted) value of assets while supporting a specific spending level, achieving a target funding ratio for a pension plan, or maximising long-term growth subject to risk constraints.
• Return Requirements: Define the target return in specific, measurable terms. Vague goals are difficult to manage and evaluate. Examples include:

• • An absolute return target (e.g., achieve an average annual nominal return of 7% or a real return of 4% over rolling five-year periods).
  • A relative return target linked to spending needs (e.g., earn a return sufficient to cover the annual spending rate, plus inflation, plus investment management fees).
  • A target relative to a specific market benchmark or a custom policy benchmark.
  • A target relative to a peer group of similar institutions.
  • For defined benefit plans, a target is related to the plan’s funded status.

• Risk Objectives: Complementing return targets, the IPS must define risk objectives and constraints in measurable ways where possible. Examples include:

• • Limits on portfolio volatility (e.g., standard deviation not to exceed X% annually, or tracking error relative to a benchmark).
  • Maximum drawdown limits (e.g., portfolio value should not decline by more than Y% from its peak over any 12-month period).
  • Probabilistic statements (e.g., the probability of a negative return in any given year should be less than Z%).
  • For pension plans, limits on surplus volatility (the volatility of assets relative to liabilities).
  • Qualitative descriptions of risk tolerance (e.g., “moderate,” “conservative”) should ideally be supported by quantitative measures.

• Consistency: Objectives must be realistic and internally consistent. The return target must be achievable given the defined risk tolerance, constraints, and reasonable expectations for capital market returns.

D. Articulating Risk Tolerance: Defining the Boundaries

Risk tolerance is a critical input that shapes the entire investment strategy.

• Willingness and Ability: The IPS should consider both the fiduciaries’ and stakeholders’ psychological willingness to accept risk (their comfort level with potential fluctuations and losses) and the institution’s financial ability or capacity to withstand adverse outcomes without jeopardising its mission, spending commitments, or long-term viability.
• Quantification: As noted under Objectives, risk tolerance should be translated into quantifiable metrics and constraints within the IPS wherever possible (e.g., volatility limits, drawdown constraints) to provide clear guidance.
• Influencing Factors: The appropriate level of risk tolerance is influenced by several factors that should be considered, including the length of the investment time horizon (longer horizons generally allow for more risk), liquidity needs (higher needs constrain risk-taking), the degree of reliance on investment returns to fund operations or distributions, and the nature and predictability of any liabilities (e.g., pension obligations).

E. Identifying Constraints: Liquidity, Time Horizon, Legal, Regulatory, Tax, and Unique Needs

Constraints define the boundaries within which the investment strategy must operate.

• Liquidity: The IPS must address the institution’s liquidity requirements. This involves estimating anticipated cash outflows (e.g., grants, operating expenses, benefit payments, capital calls for private investments) and specifying the need to hold a certain portion of the portfolio in highly liquid assets to meet these needs without forced selling of illiquid investments at inopportune times. Policies regarding the management and maximum allocation to illiquid asset classes should also be stated.
• Time Horizon: The expected duration over which the assets will be invested is a primary constraint influencing risk tolerance and asset allocation. The IPS should clearly state the time horizon, whether it is perpetual (common for endowments and foundations), long-term (e.g., 10+ years), medium-term, or tied to a specific future liability or goal.
• Legal/Regulatory: All applicable legal and regulatory requirements must be documented and adhered to. This includes relevant federal laws (like ERISA for pension plans), state laws (like UPMIFA for endowments), specific regulations governing foundation payout requirements (e.g., the IRS 5% minimum distribution for private foundations), and any restrictions on specific types of transactions. Prohibited transactions should be explicitly listed.
• Tax Status: The tax status of the institution (e.g., tax-exempt foundation, taxable family office) is a crucial constraint that impacts investment strategy, particularly regarding asset location (holding tax-inefficient assets in tax-advantaged accounts) and the suitability of certain investments (e.g., tax-exempt bonds).
• Unique Circumstances: This category captures any other specific policies, restrictions, values, or preferences unique to the institution. Examples include: mandates related to socially responsible investing (SRI) or ESG factors; restrictions on investments in specific industries (e.g., tobacco, armaments); policies regarding proxy voting; guidelines for securities lending programmes; or specific instructions related to gifts or donor-advised funds.

F. Strategic Asset Allocation: The Policy Portfolio Blueprint (Targets, Ranges, Benchmarks)

The Strategic Asset Allocation (SAA) is often considered the most important decision in determining long-term investment outcomes, as it is the primary driver of portfolio risk and return. This section outlines the long-term blueprint for the portfolio’s construction.

• Policy Portfolio: The IPS should define the SAA, also known as the “policy portfolio.” This is the baseline or target mix of assets across different classes, carefully designed to achieve the stated investment objectives while respecting the defined risk tolerance and constraints.
• Asset Classes: The policy must clearly list the permissible asset classes included in the portfolio and provide definitions for how they are categorised (e.g., Global Equity (further broken down into US Large Cap, US Small Cap, Developed International, Emerging Markets), Global Fixed Income (Core, High Yield, Inflation-Linked), Real Assets (Real Estate, Infrastructure, Commodities), Alternative Investments (Hedge Funds, Private Equity, Private Credit), Cash and Cash Equivalents).
• Targets and Ranges: For each defined asset class, the IPS must specify a long-term target allocation percentage. It should also define a permissible range (e.g., +/- 5% or +/- 10%) around each target. These ranges serve two purposes: they trigger rebalancing actions when breached, and they define the boundaries for any permitted tactical deviations from the long-term strategy.
• Benchmarks: Appropriate benchmarks must be assigned to each asset class and to the total portfolio. These benchmarks are crucial for evaluating performance objectively. The IPS may also specify criteria for selecting benchmarks, ensuring they are relevant, investable, measurable, unambiguous, and specified in advance.
• SAA Determination Process: While the detailed analysis may reside elsewhere, the IPS should reference the process used to determine the SAA, which often involves sophisticated techniques like asset-liability modelling (ALM) for pensions or endowments, analysis of long-term capital market assumptions (expected returns, risks, correlations), and potentially risk budgeting approaches. Because capital market assumptions and optimal allocations can change over time, the specific SAA targets and ranges are often included in an appendix to the IPS, allowing for updates without requiring a full revision of the core policy document.

G. Guidelines for Allowable Investments and Implementation

This section provides more granular detail on how the asset allocation strategy will be implemented.

• Permitted Instruments: Specify the types of investment vehicles and securities that are permissible within the portfolio. This could include individual stocks and bonds, mutual funds (active and passive), exchange-traded funds (ETFs), separately managed accounts (SMAs), commingled funds, limited partnerships (for private equity, venture capital, hedge funds), and potentially derivatives for specific purposes like hedging or efficient portfolio management.
• Prohibited Investments/Strategies: It is equally important to clearly list any investments, asset classes, or strategies that are explicitly forbidden. This might include specific types of complex derivatives, short selling, the use of leverage beyond certain limits, investments in industries excluded due to SRI/ESG criteria, or securities not meeting specific quality criteria.
• Manager Styles: The IPS may articulate the institution’s philosophy regarding active versus passive management, potentially specifying preferences or criteria for using each approach within different asset classes.
• Concentration Limits: To manage risk, the IPS might set limits on the maximum exposure allowed to any single security, issuer, industry sector, or geographic region.
• Due Diligence and Manager Selection: The policy should outline the criteria and process for selecting, monitoring, and potentially terminating investment managers. Criteria often include evaluating the manager’s performance record (absolute, relative to benchmark, risk-adjusted), investment process and philosophy, organisational stability and personnel, fee structure, adherence to stated style, and reporting capabilities.

H. Rebalancing Policy: Maintaining Strategic Discipline

Rebalancing is the mechanism for ensuring the portfolio does not drift too far from its intended strategic asset allocation due to market movements.

• Purpose: The IPS should state the purpose of rebalancing, which is primarily to control risk by bringing portfolio allocations back in line with the long-term targets defined in the SAA.
• Methodology: The specific rebalancing methodology should be described. Common approaches include:
  • Calendar-based: Rebalancing occurs at predetermined intervals (e.g., quarterly, semi-annually, or annually) regardless of allocation drift.
  • Percentage-range based (Corridor Rebalancing): Rebalancing is triggered only when an asset class allocation moves outside its predefined permissible range (corridor) around the target allocation. This is often preferred as it avoids unnecessary trading while still controlling significant deviations.
  • Combination: Some policies may use a combination, such as reviewing allocations quarterly but only trading if corridors are breached. The policy should also state whether any tactical deviations within the allowed ranges are permitted.
• Responsibility: Clearly assign responsibility for monitoring asset allocation drift and executing the necessary rebalancing transactions (e.g., internal staff, investment consultant, OCIO, or lead investment manager).
• Allowable Ranges: The policy should reference or reiterate the allowable allocation ranges established in the SAA section, as these define the triggers or boundaries for rebalancing.

I. Monitoring, Evaluation, and Review Procedures (Performance & Policy)

This section closes the loop, defining how the effectiveness of the investment programme and the policy itself will be assessed over time.

• Performance Monitoring: Detail the requirements for performance reporting, including frequency (typically quarterly) and content. Specify the required performance metrics (e.g., total returns, time-weighted returns compliant with GIPS standards where applicable, returns net of fees, comparison to assigned benchmarks and potentially peer groups, risk metrics like standard deviation or Sharpe ratio).
• Manager Evaluation: Describe the ongoing process for evaluating investment managers based on the selection criteria outlined earlier. This includes assessing performance relative to objectives and benchmarks, consistency of investment style, personnel changes, fee reasonableness, and overall compliance with the IPS and its mandate. Define criteria or conditions that might lead to a manager’s probation or termination.
• IPS Review: Crucially, the IPS must mandate a process for its own periodic review. Specify the frequency (e.g., reviewed annually for continued relevance, with a more in-depth review every 2-3 years or 3-5 years). Define who is responsible for conducting the review and the process for proposing and approving amendments. The review should ensure the IPS remains aligned with the institution’s objectives, constraints, risk tolerance, and the prevailing market environment.
• Reporting Lines: Clarify the flow of information and reporting responsibilities among the various parties (e.g., Investment Managers report to Staff/Consultant, Staff/Consultant reports to the Investment Committee, Investment Committee reports to the Board).

Table 1: Key Components of a Comprehensive IPS