Your Investment Policy Statement should address the following:
The strategy section of the IPS should outline how your portfolio will be managed and summarize your objectives for the account. The account could, for example, be managed on a discretionary basis, like with our Portfolio Management Service, or it could be managed on an advisory basis, like with our Portfolio Advisory Service. Objectives might be income, growth, or capital preservation.
A time horizon should be indicated that reflects your financial planning goals. This doesn't mean that there cannot be withdrawals or additions to the account before the time is up, but certain investments are time-sensitive. For example, if a U.S. government note that pays a coupon of 5% is purchased at par, it is reasonably certain (barring a default of the U.S. government and assuming a 5% reinvestment rate) that a yield of 5% will be realized if the note is held to maturity. However, if interest rates go up, the market price of the note will likely go down, and if it is sold before maturity, a smaller yield may be realized.
Risk and return go hand-in-hand. We would all like to have a low-risk portfolio that yields a high rate of return, but the reality is that there is always a trade-off. An important choice needs to be made: guidelines can be set for risk and return, or definite limits. It is possible to put together a portfolio that has definite risk/return characteristics, however there is always a penalty to be paid for this assurance and that is usually that the portfolio will be limited as to its upside potential. Principal protected investments work in this manner.
We suggest that risk guidelines be set which, when breached, will require the portfolio manager to go to a more conservative allocation. Return guidelines should be set to reflect your financial planning goals.
It is important that portfolio holdings match the risk/return profile and time horizon. For example, a growth-oriented portfolio should contain a higher weighting to investments such as equities, whereas a conservative income-producing portfolio may be more oriented towards bonds or other fixed income investments.
Constraints may be placed on the portfolio regarding, for example, the maximum loss that will be allowed prior to switching to a more conservative strategy, or the minimum amount of income required. Constraints can also be applied to the investment products used or to which company shares may be purchased for investment. For example, companies that are considered to be environmentally unfriendly or unethical may be specifically excluded, or more volatile small-cap or emerging market investments might be excluded as a group in a conservative portfolio.
This is a vitally important part of the IPS and the section that is most often neglected by financial advisors. It is necessary to keep track of how well your investments are doing with respect to your goals and also with respect to a benchmark. If performance is not measured and reported, then how will you know where improvement is necessary or whether your financial advisor is in fact adding value?
IAM provides quarterly updates and a comprehensive yearly review to Portfolio Management and Portfolio Advisory clients and the IAM IPS always includes an appropriate benchmark that is decided in advance and against which portfolio performance will be compared in the yearly review.