The Investment Policy Statement (IPS) for Asset Management

The investment mandate is formalized in a written document called the Investment Policy Statement (IPS). This is the constitution for the portfolio. It is created with the client, not for the client. It is a collaborative process to translate the client's situation and goals into a workable investment plan.

The IPS is not a "set it and forget it" document. It should be reviewed regularly (at least annually) and updated if the client's circumstances change significantly (e.g., they inherit a large sum of money, their retirement date changes, or the institution's spending needs change).

Deconstructing the IPS Components

An IPS has two primary sections: Objectives (what the portfolio needs to achieve) and Constraints (the limitations and rules you must follow to achieve the objectives).

A. Objectives:

This section defines the portfolio's purpose. It has two parts:

• Return Objective: This is the specific rate of return the portfolio needs to earn. It should be a realistic number based on the client's goals. For an individual, the calculation might be:

  • Required Spending Rate (e.g., 4%) + Inflation (e.g., 2.5%) + Management Fees (e.g., 1%) = Required Return (7.5%)

• Risk Objective: This defines how much risk is acceptable in pursuit of the return objective.

  • Willingness to Take Risk: This is the client's psychological tolerance for volatility. Are they going to panic and sell when the market drops 20%?

  • Ability to Take Risk: This is the client's financial capacity to withstand losses. A 30-year-old has a high ability to take risk; a 70-year-old relying on the portfolio for income has a very low ability. Ability to take risk always trumps willingness.

B. Constraints

These are the five specific limitations that shape the strategy. A common acronym to remember them is LLTTU.

• Liquidity: What are the expected cash needs from the portfolio? This could be for regular expenses (like a retiree's living costs) or a one-off payment (like a down payment on a house in two years). Any asset in the portfolio must be saleable to meet these cash needs without significant loss of value.

• Legal & Regulatory: What rules apply? For an individual, this section might be minimal. For an institution like a pension fund, this is huge and involves complex regulations (like ERISA in the US) that govern what they can and cannot invest in.

• Time Horizon: What is the lifespan of the portfolio? It is rarely a single number. It's often multi-stage. For example, a 45-year-old has a 20-year "accumulation" stage until retirement, followed by a 30-year "distribution" stage during retirement. These different stages require different strategies.

• Taxes: How are different types of investment returns (dividends, interest, capital gains) taxed? The tax situation is critical. A high-income individual in London will have a strategy that favors long-term capital gains and tax-advantaged accounts (like ISAs), which is very different from a tax-exempt institution like a pension fund.

• Unique Circumstances: This is the catch-all for everything else. Does the client have a highly concentrated position in a single stock (e.g., a tech executive with millions in company shares)? Are there ethical considerations (e.g., no investments in fossil fuels)? Does the portfolio need to support a specific philanthropic goal?