Investment Policy Statements For Families

By Mark Barnicutt on April 24, 2010

A good friend of mine recently told me that he was changing his Investment Advisor.  When I asked about the reason(s) why, he simply stated “performance“.  When I then asked if his Investment Advisor had not measured-up against my friend’s Investment Policy Statement, he just looked at me with this blank stare and asked: “Investment Policy Statement…..what’s that????”  I replied that an Investment Policy Statement was the key document that enables a client to measure the success of his/her Investment Advisor.  My friend, again looking at me with a blank stare said, “Nope….never heard of it!”  Given the growing investable wealth of many families, I’m always shocked at how few investors have an Investment Policy Statement (IPS) developed for them by their Investment Advisors.  The purpose of this article is to highlight the importance of an IPS and the key elements that should be included in such a document.

An IPS is frequently used document in the world of institutional asset management for clients such as pension plans, foundations and endowments. Unfortunately, its use in the management of family (also known as private) wealth remains sporadic at best. Having been in the wealth management industry for 20 years, I believe this IPS gap exists as the private wealth industry is still in the early days of a long-term conversion from Transaction advice to Consulting advice.  Specifically, most Investment Advisors today continue to sell their clients ‘investment ideas’ with the hope of top-tier performance ie: buy this fund, or this stock, or this bond. There is no/limited reference to client’s goals, objectives or risk tolerance….it’s all about trying to ‘Hit The Ball Out Of The Park’ with superior, and many times, unrealistic investment returns… this is a transaction service in which the Advisor is focused exclusively on Returns!

In contrast, though,  a growing number of Advisors have begun in recent years to shift their practice from the Transaction advice model to one of providing Consultative advice. In this model, Advisors are focused on identifying the purpose of a client’s money and the various financial goals associated with that money, and then structuring a portfolio of prudently selected investments to help meet those goals — all the while being sensitive to each client’s tolerance for risk and adjusting their portfolio appropriately. In the Consultative approach, an Advisor is primarily a Manager of Risk.

For Advisors who have adopted a Consultative Approach to managing client wealth, the Investment Policy Statement is the key document in their business relationship with their clients.  The reason for this is that the IPS, constructed properly, is the link between a client’s investment objectives and how an Advisor will manage his/her client’s portfolio on a day-to-day basis.  In other words, it’s the equivalent of a blueprint that an architect would use to build a house.  Without such a blueprint, the architect doesn’t have a detailed plan to follow when constructing the house and the homeowner doesn’t have a document to hold the architect accountable for the construction of the house as agreed upon.  In the private wealth management industry today, I strongly believe that there is such broad-based dissatisfaction by investors as they do not have any blueprint, or IPS, for the management of their wealth.  As a result, their hard earned wealth is being managed without any concrete guidelines that are clearly understood by both client and Advisor.

In the private wealth world, an IPS does not need to be a lengthy document.  Most IPS that we’ve used with family clients ranges from 4 – 8 pages, depending upon the complexity of each client’s situation.  As a result, a sound framework that we’ve used for years successfully with clients contains the following key five sections:

1. Statement Of Objectives & Risk Tolerances:

– What is the purpose of the money as well as the quantified goal and timeline? (ie: We need to have $1 Million saved for retirement purposes in 20 years)

– Will any income be required now (later)? If so, how much?

– What is the investor’s tolerance for risk of both capital and income?

– What are the investment constraints to be considered when managing the money? (ie: taxes, requirement for short-term liquid funds, unique preferences such as Socially Responsible Investment requirements such as no defence/military investments)

2. Portfolio Construction Guidelines:

– What asset classes (ie: Stocks, Bonds) and geographies (ie: Canada, US, Internationally, etc.) will the portfolio be invested in, and how much will the portfolio be allocated to each of these categories?

– How will the portfolio asset classes be rebalanced when market prices shift?

3. Duties & Responsibilities:

– What are the client’s responsibilities in the relationship (ie: providing personal financial updates to Advisor)?

– What are the responsibilities of the Advisor?

– Who will custody/hold the client’s assets to keep them safe?

4. Portfolio Control Procedures:

– What are the performance objectives and how will they be measured?

– How will the portfolio be monitored to ensure that it continues to meet the standards of the IPS?

– How will the costs associated with managing the portfolio be monitored (ie: trading, custody, investment management, etc.)?

5. Investment Policy Review:

– How frequently will the investor and Advisor mutually agree to review the IPS?

In his book, “Investment Policy”, Charles Ellis provides five simple tests of Investment Policy Statements:

1. Is the Policy carefully designed to meet the real needs and objectives of the client?

2. Is the Policy written so clearly and explicitly that a competent stranger could manage the portfolio and conform to the client’s intentions?

3. Would the client have been able to sustain commitment of the policies during the capital markets that have actually been experienced over the past 50  – 60 years – particularly over the past 10 years – when conventioanl wisdom was most opposed?

4. Would the Investment Advisor have been able to maintain fidelity to the policy over the same periods — despite intense daily pressure?

5. Would the policy, if implemented, have achieved the client’s objectives?

“Sound investment policies will meet ALL of these tests.  Do yours?”

Mark Barnicutt
See Beyond

Receive Market Commentary + Stewardship Insights.