An investment policy statement, or IPS, is the written agreement between an organisation and whoever manages its money. It sets out what the money is for, how much risk is acceptable, what the manager may and may not do, and how success will be judged. Many organisations have one. Fewer have one that anyone reads after it is signed.

A good IPS is short enough to use and specific enough to settle disagreements. Here is what it should cover.

Purpose and scope

Say which pool of money the policy covers, such as an operating reserve, an endowment, a staff gratuity fund or surplus treasury cash, and what that money is ultimately for. Different pools need different policies.

Return objective

State the return you need in plain terms. In Nigeria, a return objective that ignores inflation is incomplete, so express it in real terms where you can, for example inflation plus 2% a year over rolling three-year periods.

Risk tolerance

Describe how much loss the organisation can bear and still meet its obligations, and how much the board is willing to bear. These are not always the same. A fund that can afford a 15% fall may still have trustees who would panic at 10%. Write down the lower number.

Constraints

  • Liquidity. How much cash must be available, and how quickly?
  • Time horizon. When will the money be needed?
  • Legal and regulatory. Any rules that apply, such as pension or insurance regulations.
  • Tax. Anything that changes which instruments make sense.
  • Ethical or religious requirements. For example, a requirement that all holdings be Sharia-compliant.

Asset allocation

Set a target mix across asset classes, with a range around each target, for example fixed income at 60% within a range of 50 to 70%. Ranges give the manager room to act without asking permission for every move, while keeping the overall shape of the portfolio under the board's control.

Currency policy

Decide how much may be held in foreign currency and why. Tie it to future foreign-currency obligations rather than to views on where the naira is heading.

Benchmarks and reporting

Name the benchmark each part of the portfolio is measured against, how often reports arrive, and what they must contain. A benchmark agreed in advance prevents the familiar argument about whether a result was good.

Rebalancing and review

Say what happens when the portfolio drifts outside its ranges, and commit to reviewing the IPS itself at least once a year, or whenever the organisation's needs change.

Roles and responsibilities

Spell out who decides what: the board, the investment committee, management and the external manager. Most failures in institutional investing are failures of governance, not of markets.

Keeping it alive

The test of an IPS is whether it gets opened when markets turn. Put it on the agenda whenever performance is reviewed, and measure the manager against it, not against whatever happened to do well that quarter. If you would like help drafting or reviewing one, our team can work through it with you.

This article is for general information only and is not investment advice. Investments can go down as well as up. Speak to a qualified adviser about your own circumstances.