Investment policy statement IPS

August 22, 2016

IPS mainly focuses on objective & constraints for investment mandate. The IPS must be internally consistent with the return & risk objectives, reasonable given the prevailing capital market conditions and consistent with the client's constraints. 

The contents of IPS: Objective is sub-divided into risk and return. Constrains have five components: 1) Liquidity 2) Tax 3) Time horizon 4) Legal & regulatory 5) Unique circumstances.

The return objective: Ultimately, the return and risk objective have to be consistent with reasonable capital market expectation as well as constrains. Often the return can be divided into a required and a desired component. Required return is what is necessary to meet high priority or critical goals to that client. They might include living expenses, children education, health care, et cetera. Desired return goals will likewise depend but might be things like buying a second home, world travel, et cetera.

The risk objective: This objective should address both the client's ability and willingness to take risk. The client's ability to take risk is determined objectively, while willingness to take risk is far subjective, emotional matter.

Time horizon constraint: It affects ability to bear the risk. In the most basic terms, it is the expected remaining years of life. It is the total number of years the portfolio will be managed to meet the investor's objectives and constrains. 

Tax constraint: Taxation is a global issue and must be taken into account when formulating an investment policy for an individual. Investors have significant consequences on income tax, capital gain tax, wealth transfer tax and personal property tax.

Liquidity constraint: It affects ability to bear the risk and influence return calculation & strategic asset allocation. The liquidity of assets and of a resulting portfolio is a function of the transaction costs to liquidate and price volatility of the assets. High costs and lengthy time to complete the sale make for lower liquidity. Higher price volatility makes the asset less liquid as it increases the probability the asset would be sold in less than market value.

Legal & regulatory constrain: This apply to individuals typically relate to tax relief and wealth transfer. The specific constraints vary greatly according to jurisdictions and typically called for legal advice.

Unique circumstances constraint: This is catch-all category for anything that can affect the management of client's assets and not covered in other constraints. 

The benefit of IPS:

  • The IPS identifies and documents investment objectives and constrains.
  • The IPS is dynamic, allowing changes in objectives and/or constrains in response to changing client circumstances or capital market conditions.
  • The IPS is easily understood, providing the client with the ability to bring in new managers or change managers without disruption of investment process.
  • Developing the IPS should be an educational experience for the client.
  • Clients learn more about themselves and investment decision making.
  • They are better able to understand the manager's investment recommendation.
  • The adviser has greater knowledge of the client.
  • Guidance for investment decision making for investment manager.
  • Guidance for the resolution of disputes. Signed document that can be used to support the manager's investment decisions as well as the manager's denials of client investment requests.                          



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