Most Important Things to Have In Your IPS

14 Pages·2014·2.28 MB·English

The Financial Advisor’s
Most Important 

10
Things to Have 

In Your IPS 

Investment Policy
Statement

In partnership with:
Roger L. Levy, LLM, AIFA®, of Cambridge Fiduciary Services, LLC
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IPS... It’s Pretty Simple
It’s pretty simple when you think about it. You wouldn’t start
“Hell, there are no
a business today without first having a written business plan.
The same is true for managing an investment portfolio.
rules here. We're
Whether the portfolio is owned by an individual, a trust, trying to accomplish
foundation, retirement plan, or other institution, a disciplined
something.”
investment approach is required to achieve successful

outcomes and a plan must be established to guide the
investment process.
-Thomas Edison
This plan, the Investment Policy Statement (IPS), must be
carefully crafted to ensure that it reflects the client’s intent and
Edison wasn’t an investment advisor, but
because the actions taken by those responsible for the
these words come to mind when
investment process will be judged to some extent by the
reviewing how some investment portfolios
requirements stated in the IPS.
are managed.
iii
Take it from a pro.
“The IPS is particularly important to the investment advisor because it will set
Roger Levy, LLM, AIFA® 

expectations governing investment performance and set the boundaries for permitted
CEO of Cambridge Fiduciary 

investments and strategies. This can be very helpful for resolving differences of
Services, LLC opinion, for example, when an investment committee member is urging action outside

 the IPS guidelines. The IPS is also an opportunity to document that the investment

 process will be managed in accordance with the applicable fiduciary standard.
Roger is a friend of the Blueleaf.com team.
“Although the IPS must reflect the client’s intent, you, as the advisor, should take the
He has 25+ years experience guiding lead in preparing the IPS and in suggesting the topics to be included. The client’s legal
fiduciaries, including investment advisors, advisor should also be consulted. While there are no specific legal requirements for
with their fiduciary obligations and building
what an IPS should contain, it must be consistent with applicable laws, such as ERISA,
due diligence records of their investment
UPIA, UPMIFA and UMPERSA1, and with controlling documents, such as a trust
process. As a CEFEX Analyst, he offers
agreement, foundation charter, or retirement plan. For a mature portfolio, also look at
fiduciary consulting and assessment
prior investment committee minutes (if applicable), service agreements, investment
services. 

reports and other documents that reflect past decisions and how they were made and

implemented.

» Questions are welcomed at 

“With those considerations in mind, the following2 are the 10 most important things to
rll@cambridgefiduciaryservices.com 
include...
1The Employee Retirement Income Security Act of 1974 governing retirement plans; the Uniform Prudent Investor Act, a state law governing
private trusts; the Uniform Prudent Management of Institutional Funds Act, a state law governing foundations, endowments and government
sponsored charitable organizations; and the Uniform Management of Public Employee Retirement Systems Act, a state law applicable to state,
county and municipal retirement systems, adopted in Maryland and Wyoming only.
2This Checklist has been partially derived from the handbook, Prudent Practices for Investment Advisors, published by fi360.
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ministerial. Custodians are not generally This raises the topic of “outsourcing” by
fiduciaries either, unless they exercise some which a client delegates to an investment
discretion or management over the assets advisor discretionary authority for all or part
Most Important entrusted to them, such as occurs when of the investment process. This has gained
securities lending is permitted. Note that, popularity today among some retirement
Things to Have
 where a party has a fiduciary role, it is good plans, foundations and endowments as a
practice to obtain acknowledgment of that means of making the investment process
In Your IPS party’s fiduciary status in writing. For more nimble by removing the investment
service providers, this can be addressed in committee from the decision process.
their contract. Accordingly, if your firm is to be granted
discretionary authority over some aspect of
Where an investment committee is

 the plan’s investment process, such as
authorized to make investment decisions,
1. Identify Those asset allocation, and investment manager
confirm the committee’s authority by
selection and replacement, the scope of
Involved In The reference to the plan document or board
that authority should be described in the
resolution. The IPS should then identify the
IPS as well as in your service provider
Investment Process and
committee’s composition and functions.
agreement.
Its meeting requirements and other
Describe Their Roles
operational guidelines should be included
but a better practice would be for the
Start with a list all those who will play a role
committee to adopt bylaws governing the
in the investment process and identify their
committee’s operation.
responsibilities. In so doing, distinguish
between parties who are fiduciaries and With large portfolios there may be a need
those who are non-fiduciaries. For to engage separate account managers. If
example, you, as the investment advisor, so, investment guidelines will be required
are always a fiduciary. Your client, unless for each manager upon engagement and
an individual, will likely be a fiduciary too, care must be taken to ensure that such
as in the case of the investment committee guidelines are consistent with the IPS.
of a retirement plan, endowment of Further, contracts with separate account
foundation. Record-keepers and third managers should require the managers to
party administrators are generally not adhere to the IPS.
fiduciaries as their functions tend to be
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2. Describe The and salary rate assumptions may be 3. Identify Acceptable
referenced. Foundations and endowments
Investment Objective Asset Classes
will take into account their particular
spending rate.
At the core of an investment objective lies From a fiduciary perspective, asset
In the case of defined contribution plans
an understanding of the client’s time allocation should conform to generally
which are participant directed (an ERISA
horizon and risk tolerance. accepted investment theories. Modern
401(k) plan for example), a plan level
Portfolio Theory, despite recent criticism,
• The time horizon will vary based on the investment objective is inappropriate, since
has been validated by regulation and court
type of client and cash flow needs. For it is up to the plan participants to decide for
decisions on the basis that it recognizes the
example, a client who is an individual will themselves the levels of risk and return
relationship between risk and return, the
have a different time horizon and different which they need to achieve retirement
historic return of different asset classes and
cash flow requirements compared to a income security. Accordingly, the objective
the importance of diversification. Because
pension plan, which has long term needs stated in the IPS should be to offer an array
of the complexity of asset allocation, it is
and cash flow requirements based on of investment choices that allow
important for you, as the investment
actuarial assumptions. The IPS should participants to construct portfolios meeting
advisor, to explain to the client the asset
describe the relevant considerations. different risk and return objectives, while
allocation strategy which you recommend.
providing methodologies to minimize large
This will allow the client to gather
• Investment risk takes many forms but is
losses.
appropriate information to evaluate and
typically measured in terms of volatility of
subsequently monitor your
returns or standard deviation. For many Where custom portfolios are offered as
recommendation.
clients, identifying their tolerance for investment choices, perhaps constructed
negative returns over a market cycle may of other core investment options, an
In terms of the IPS, permitted asset classes
be the best measure. investment objective should be stated for
to be included in portfolio construction
each such portfolio so that it can be clearly
should be described. Traditional asset
The investment objective articulated in the
communicated to the participants.
classes have consisted of cash equivalents,
IPS will provide guidelines for portfolio
Investment objective guidelines should also
fixed income and equity securities. These
construction and the benchmark for
be stated for target date funds (TDFs).
are often sub-characterized: between
monitoring investment performance. The
large-cap, mid-cap and small-cap for
investment objective can be described in
equities, and government and corporate
terms of maintaining purchasing power as
bonds, say, for fixed income. The use of
measured by the Consumer Price Index.
non-US investment markets should also be
For pension plans, the actuarial investment
described.
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Today, it is common to add “alternative” 4. Describe Permitted these strategies are inherent in some
assets to portfolio construction, such as mutual funds and ETFs.
Investment Vehicles
real estate, hedge funds, private equity and
Note that for retirement plans, ERISA
commodities to increase diversification.
provides relief from fiduciary responsibility
However, not all asset classes are suitable The IPS should describe what vehicles may
for investment decisions (not from
for every client - alternative assets tend to be used for portfolio investments. The
oversight responsibility) made by an
be illiquid and to involve higher fees - and most popular investment vehicles today
“investment manager” engaged by a plan
it is important for the client to understand consist of separate accounts, mutual funds,
under ERISA § 3(38). Such a manager must
why a particular asset class is to be collective trusts, limited partnerships and
be appointed by the plan’s “named
included. exchange traded funds (ETFs). In
fiduciary”, typically the board of directors or
describing permitted funds, mention
Asset class selection will also be impacted investment committee. Additionally, the
should be made of the use of passive and/
by the size of the portfolio, the manager must be a bank, insurance
or active management.
sophistication of the client, investment company or registered investment advisor
costs, the desire for socially responsible For large portfolios, investment in individual and acknowledge fiduciary responsibility in
investments, and the ability of the client to equity and fixed income securities can be writing to the plan. There is a large
intelligently monitor performance. permitted, with management entrusted to universe of separate account managers
an independent asset manager. The IPS who conform to these requirements but
Having identified permitted asset classes,
should impose restrictions on the amount many have minimum investment
the IPS should identify the percentage
that may be invested in a single issuer and requirements which put them beyond the
guidelines that may be allocated to each
security, the minimum required market reach of small plans.
class. In order that the IPS does not
capitalization, and the minimum quality
require amendment when changes to asset Note also that ERISA places restrictions on
rating that would apply to bond purchases.
allocation are made, a target allocation the use of employer securities and
should be identified within a permitted If the client contemplates the use of hedge employer real estate as plan investment
range for each class. funds or private equity funds, the IPS options.
should describe the fund category to be
Further, the IPS should address rebalancing
considered. If consistent with the client’s
procedures for when the investment
philosophy, the IPS should also impose
environment causes an approved allocation
guidelines and/or restrictions on the use of
to change.
options, futures, leverage, contra parties
and other derivatives and on the use of
securities lending, noting that some of
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5. Identify Investment • Absence of regulatory issues or litigation • Investment strategy –strategic/tactical
affecting peer performance or asset allocation and asset class selection
Selection and management
• Use of passive/active management
• Timeliness and accuracy of investment
Monitoring Criteria
reporting according to Global Investment • Underlying funds structure – mutual
Performance Standards funds/collective trusts
Selection Criteria
• Back office function substantiated by • Fees and expenses of TDF and underlying
SSAE 16 or similar report funds
It is a fiduciary responsibility to perform due
diligence when selecting an asset manager, • Fair and reasonable investment costs • Proprietary versus nonproprietary funds
whether a separate account manager,
• Evidence of conformity with fiduciary • Availability of custom portfolio
mutual fund, commingled trust or other
best practices
investment vehicle. In order that ultimate • Participant Communications strategy and
selection fulfills the client’s investment For participant directed plans, special available material

objective within the bounds of prudence, attentions should be paid to the selection
criteria must be established to guide the of TDFs because of differences in their
Monitoring Criteria
selection process. For the purposes of this style, construction, performance, glidepath
Checklist, the term “manager” is broadly and cost. The US Department of Labor Equally important to a prudent investment
used to describe a separate account (DOL) has issued some guidance on this process and meeting one’s fiduciary duty is
manager, mutual fund, collective trust or topic (Target Date Funds –Tips for ERISA the periodic monitoring and documenting
other vehicle. Plan Fiduciaries – February 2013) and their of investment performance. As with the
comments should inform the selection selection process, establishing expectations
Typically, selection criteria will focus on the
criteria in the IPS. The following would be in advance will aid you and the client in
following:
among the criteria on which to focus: evaluating investment performance.
• Investment performance relatives to
• TDFs’ objective – long term growth/ In the case of separate account managers,
peers and benchmarks
capital appreciation it is also good practice to explain to them
• Consistency of style in advance of engagement the monitoring
• Glidepath suitability – the role of equities
criteria to which they will be subject. This
and the pace of change in allocation
• Investment Manager team tenure
will establish for the benefit of all involved
• Suitability of TDF series based on current
• Minimum assets under management for confidence in the manager’s ability to
and historic participant demographics
liquidity comply.
and/or average risk tolerance assessment
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Monitoring criteria will include: 6. Define Investment
• Applicable benchmark indices Watch List and
Monitor every client account
• Applicable peer groups
automatically. Replacement Criteria
• Performance expectations compared to
peers, benchmark and indices (on a risk
The IPS should define what action is to be

adjusted basis, if desired)
taken if investment performance does not
Whether there’s
• Investment performance comparison money on the move meet expectations. Clients need to know
periods, e.g. one, three, five and ten year or allocations adrift, when it is time to replace a manager. This
you need to know
is not a simple matter but establishing
• Absence of adverse changes in the what is happening
“watch list” procedures will facilitate the
manager’s organization, staff or with your clients.
investment process, including process. Such procedures should reflect
acquisitions and divestitures what level of negative performance will
trigger watch list treatment and what
• Continued absence of regulatory and Blueleaf.com gives financial advisors
period of time should elapse before
legal issues of all sizes (and at all stages of
negative performance triggers
business) the tools needed to
If target date funds have been selected as
replacement.
automatically monitor ALL client
investment options, additional monitoring
accounts, automatically.
Some advisors have created proprietary
criteria may be required in accordance with
methodologies to perform this evaluation.
the DOL guidance previously mentioned. Blueleaf account aggregation,
While the foregoing criteria cover most of performance reporting, and If so, as a practice note, it is important for
the important TDF issues, particular automated alerting helps you keep the client to understand how the
attention should be paid to whether any on top of the things you need to methodology functions so that the client
significant changes have occurred in the know, allowing you to manage may make an informed and reasoned
money that is held away almost as
decision when you make a replacement
TDFs’ characteristics compared to when
well as custodial assets.
they were first selected. recommendation. The IPS may also
provide for automatic replacement

Learn more or 

searches in particular circumstances to
T r y i t F r e e f o r 3 0 D a y s ! counterbalance the glacial speed with
which some investment committees
deliberate.

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7. Identify QDIA and from fiduciary responsibility when a default arrangement shall conform to the PPA,
investment alternative selected by the plan including its audit requirement.
Establish “Safe Harbor”
sponsor meets certain requirements (29
C. ERISA § 404(c) Relief
CFR 2550.404c-5, October 24, 2007).
Protection for ERISA
Accordingly, if a 401(k) plan wishes to
Generally, participants in a participant
select a default investment alternative that
Plans
directed investment account plan are
qualifies for fiduciary relief under the PPA,
responsible for directing their own
that selection should be identified in the
ERISA imposes the highest fiduciary investments by making selections from the
IPS with an explanation of how the
standard recognized by law. It also plan’s investment alternatives and directing
alternative meets PPA requirements as
provides a number of mechanisms for plan their contributions to the funds they have
either an aged-based life cycle or target
fiduciaries to mitigate their fiduciary selected according to their own allocation
date fund, a risk based balanced fund, or a
exposure. It is sound practice for plans to strategy. ERISA § 404(c) regulation (29 CFR
professionally managed account.
take advantage of these mechanisms, 2550.404c-1) affords plan fiduciaries relief
sometimes referred to as “safe harbors”, from liability for losses incurred by plan
and the plan’s intentions should be participants by reason of their own
reflected in the IPS. One mechanism has B. Participant Fiduciary Advisor investment decisions, provided that the
already been noted in relation to the plan meets a variety of administrative and
Generally, under ERISA, a prohibited
appointment of an “investment manager”. investment requirements. One
transaction arises when an investment
Principal among others that should be requirement is that participants should be
advisor to a retirement plan provides
referenced in the IPS are the following: informed that it is the plan’s intention to
investment advice to participants and
seek this safe harbor protection.
A. Qualified Default Investment Alternative charges a fee in addition to fees charged
Accordingly, the intention to conform to
for advice to the plan. Under the PPA,
ERISA § 404(c) should be stated in the IPS.
Often, plan participants fail to make
exemption from a prohibited transaction is
Note that the information requirements of §
investment designations for their
provided for participant advice
404(c) have been expanded by new ERISA §
contributions. In the past, some plan
arrangements if they meet the
404a-5 regulation (29 CFR 2550.404a-5)
sponsors directed such contributions into
requirements of DOL regulation under the
and that such disclosures are now required
the plan’s money market account as a “safe
PPA (29 CFR 2550.408g-1, October 25,
as a fiduciary responsibility.
investment”. Since such an investment,
2011). Accordingly, if a plan intends to
while “safe”, is unlikely to yield a meaningful
offer an “Eligible Advice Arrangement”, that
return, the DOL has adopted regulation
intention should be reflected in the IPS
under the Pension Protection Act of 2006
together with a requirement that the
(PPA) to provide plan sponsors with relief
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