Creating Your Investment Policy Statement I

Part I – Theoretical approach

The Investment Policy Statement (IPS) is your investment strategy in writing and helps you commit to a disciplined investment plan. It is an instrument to face your future financial goals today.

A well-constructed IPS is thought to address at least the following areas:

>your financial goals and desired/required return
>your willingness and ability to take risk
>your relevant investment constraints

It should usually set guidelines for constructing and monitoring a portfolio that can be expected to best meet your goals while remaining in compliance with any relevant constraints.

Stating your financial goal is not an easy task, but it a building block for your IPS. After all why bother to write a statement if this is not included. Each goal/goals should be detailed and accompanied by a possible way to meet it. Return objectives, which focus on rates that increase your current wealth or future savings, should always be addressed with the risk-return trade-off in mind. Increasing return increases risk or vice versa. The stated return objective will be useless if it does not take into account all relevant portfolio constraints.

Overall risk tolerance is a function of both your ability to take risk and willingness to take risk. Your ability can be expressed in numbers. Your willingness, however, involves a more subjective assessment. Reconciling both is a right step toward the proper portfolio.

The following matrix illustrates the reconciliation process:

In case you fall into the problem area, you should reconsider your options and address the mismatch early. Otherwise improper positioning will mean only future trouble.

Few portfolios have no investment constraints. Usually your portfolio constraints generally will fall into one of the following categories:

-Liquidity
-Time horizon
-Taxes
-Legal / regulatory environment
-Unique circumstances

Liquidity may range from very important to not applicable. You would not want to liquidate your portfolio in a depressed market in order to meet liquidity needs. Therefore good planning of portfolio liquidity may prove paramount for returns.

As for the time horizon, each portfolio could have several time horizons and this should be addressed in the IPS.