The investment policy statement (IPS) has grown in importance in the retail market because of increasing client sophistication and demand for a more formal process. In short, an IPS is a document that specifies how the client's investment portfolio will be funded, how investment decisions will be made and how investments will be monitored. The IPS becomes a financial "blueprint" for the money manager.
"More and more advisors are interested in developing the skill of sitting down with a client and reviewing all the specifics needed for an IPS," says John Nersesian, managing director of Nuveen Investments' Wealth Management Group "We've done at least 35 training sessions for advisors around the country in the last year on how to write an IPS."
Why Use An IPS?
The five reasons advisors should learn how to facilitate investment policy statements are:
Differentiation in the market. They position the advisor as a more compelling choice when clients are seeking advice.
Clear expectations. They establish agreed-upon criteria for selecting investments and measuring performance, which keeps the discussion on a more strategic plane.
Greater discipline. They focus on long-term goals, avoiding much of the short-term over-reaction to market moves.
Continuity. For those advisors working with foundations or endowments, they provide continuity when board turnover may lead to a lack of investment discipline.
Fiduciary responsibilities. They establish clear fiduciary guidelines.
A Thoughtful Approach
It's not enough to create boilerplate policy statements; successful advisors know that developing an IPS is the perfect time to engage in a detailed examination of the client's needs and feelings-which leads to valuable dialogue and understanding. The end result is a deeper relationship and a more satisfied client. The primary elements of a well-crafted IPS are:
Definition of responsibilities. Outlined for all parties involved, including the advisor, the trustee, the money managers and the client.
Plan description. The type of plan, number of individuals (and relationships) covered or referenced and the number of years it is to be in effect.
Return on investment objectives. The returns needed to meet plan objectives, an evaluation of risk and the time horizon.
Asset allocation. A list of approved asset classes, limits per asset class and rebalancing procedures.
Investment restrictions. Lists of restricted securities or industries and how or when those restrictions might change.
Spending policy guidelines.
Monitoring procedures. How each money manager's performance will be evaluated, which benchmarks will be used, specific schedule of meetings and procedures for managing meetings and procedures for amending the plan.
"What the advisor is doing is establishing best-case and worst-case scenarios to fine-tune tolerances," Nersesian says. One last tip: Test the IPS against the real-world performance of various asset classes over the past 10 years to see if the policy is flexible, yet firm enough to withstand actual market moves.