Does your corporation, foundation or not-for-profit organization need help developing an investment policy statement?
An investment policy statement (IPS) is an important document for any organization that has been entrusted with financial assets on behalf of investors, donors, beneficiaries or other stakeholders. Many investment policy statements are only written to meet the legal requirement to have one, but this unfortunately misses the more practical purpose of the document. Often in such cases the IPS is simply a list of restricted investments and an outline of an inefficient approval process that is designed to protect the decision makers from liability.
Though protecting decision makers is certainly an important purpose of the IPS the document should also be viewed as a valuable tool to help to guide investment decisions that support the mission and values of the organization. Our position is that the IPS can and should be useful to improve communication between decision makers and enhance the investment process and the quality of investment decisions.
Delegating investment authority while maintaining responsibility
The IPS is a document owned by the Board of Directors of an organization. The Board of Directors always maintains ultimate authority and responsibility for the stewardship of an organization’s financial resources. However, it is inefficient and unrealistic that a Board of Directors can approve every specific investment action or decision. Therefore, the Board of Directors must delegate this authority first to the management team and further to the investment advisor and the core purpose of the IPS is to outline how this delegation is to be achieved.
The IPS outlines how much authority and autonomy is granted to the management team in making investment decisions, the processes that should be followed and how and when they must report back to the Board of Directors. There can be a temptation for the Board of Directors to write an overly restrictive and cumbersome IPS, but this can inadvertently slow decision making resulting in missed investment opportunities or the excessive consumption of valuable management resources that could be better used to serve the important mission of the organization. Therefore, a useful IPS balances the need to expedite the investment process with clarity without eroding the quality of decisions while still maintaining adequate oversight and guidance by the Board of Directors.
A well written IPS is much more than a restrictive list of prohibited investments with cumbersome approval mechanisms. Though it is important to clearly outline investment restrictions, it is only helpful if the IPS also communicates the range of appropriate investments with enough flexibility to optimize investment performance.
Defining Risk
The IPS should clearly outline the major risks to mitigate through the investment process. These can include but are not limited to credit risk, foreign exchange risk, market risk and interest rate risk. The IPS should describe strategy for mitigating each risk category relative to the risk tolerances of the organization.
Environment, Social and Governance (ESG)
Many organizations have specific social values that are at the core of their purpose. It would make no sense if the organization invested its financial resources counter to its core values or mission. There should be room in the IPS document to outline environmental, social or governance (ESG) objectives and limitations if such exist. However, such ESG guidelines should be written mindfully and be realistic to understand and achieve. Are investment products and tools available to meet the ESG requirements as described while also meeting the broader investment goals outlined by the IPS?
Reporting and Measurement
It can be difficult for the Board of Directors to delegate investment authority because it will always retain responsibility for the consequences of such decisions. However, it is not practical for the Board of Directors to approve each investment action or decision because most boards meet on a limited schedule. Therefore, the IPS should outline the frequency and mechanisms for the management team and investment advisor to report decisions and performance to the Board of Directors.
Stewardship
Sometimes members of the Board of Directors have strong biases around their own investment philosophy or risk tolerance. It is important that the IPS is written from the perspective of the organization’s mission and not through the lens of unique biases of the board members. The organization’s stakeholders are the true owners of the organization’s investment assets and the Board of Directors are the stewards. The IPS helps the Board of Directors keep this perspective of stewardship in focus.
Investment Advisor’s Perspective
The IPS document is an important tool to guide your investment advisor to understand how to best serve your organization. A responsible investment advisor will review your IPS with an abundance of caution to understand it and follow it closely. Therefore, clarity and completeness in the IPS document can greatly enhance the quality of the relationship with your advisor and the quality of advice that your organization will receive.
Writing an Investment Policy Statement can be an overwhelming task for a Board of Directors. If you would like to have further discussion around the best practices or need assistance developing the initial drafts for your IPS please contact Aaron Fennell at 416-313-6397 or aaron.fennell@rbc.com.
