14th August 2015
Friday, just one day before the weekend……yaaaay!!… I got to the office and was immediately summoned, we were doing reconciliations and accounting for things that needed to be cleared up with the firs (federal inland revenue service). Things like the vat of the management fees, and pension contributions for the employees for 2009, 2010 and 2011. Since the basis period for tax is on the preceding year basis, we had to look at records of 2008 for the tax year of 2009. I was saddled with the tax of reconciling the pension contributions by matching up the records in the system with the records in the cheque register. It was fun though, and surprisingly I ended up enjoying it.

Anywaiz, I got home after that and read something on investment policy statement:

Investment policy statement 

An investment policy statement is the starting point for an investment process. It is used to assess the required return and the risk averseness of a client. A written investment policy will typically begin with the investor’s goal in terms of risk and return. It is advisable to start off with the required return and risk level and do it jointly, because even though investors prefer low risk and high returns, it is unlikely to happen because they are mutually exclusive. Investors’ returns in terms of risk must be compatible with investor’s tolerance for risk.

Components of an IPS

The major component of an ips typically addresses the following:
1) Description of client circumstances, situation and investment objectives
2) Statement of the purpose of the IPS
3) Statement of duties and responsibilities of investment manager, custodian of assets and the client.
4) Procedures to update the IPS and to respond to various possible situations.
5) Investment objectives derived from communication with the client
6) Investment constraint that must be considered in the plan
7) Investment guidelines such as how the policy would be executed, asset types permitted and leverage.
8) Evaluation of performance: The benchmark portfolio for evaluating investment performance, and other information on evaluation of investment results.
9) Appendices containing information on strategic (baseline) asset allocation and permitted deviations from policy portfolio allocation as well as how and when the portfolio allocation should be rebalanced.

 

RISK OBJECTIVE

Some examples of risk objectives include:
1) Absolute risk objectives: An absolute risk objective might be for example ‘’to have no decrease in value during any 12 month period”, Or “not to decrease in value of more than 0.5% during any 12 month period”. An absolute risk objective may be stated in terms of nominal or real.

Relative risk objectives relates to a specific benchmark, ie a comparison with a bench mark or another measure eg returns will not be less than 12 months euro Libor over any 12 month period.

The investor ability to bear risk is based on the financial capability of the investor to enter into risks. But rewarding investments based on their time horizon, wealth insurance etc.

As an investment manager, the riskiness of the portfolio of an investor is should be based on . If the investor is the lower of the willingness to bear risk.If the investor is unwilling to take trisks and experts at a higher return. He should be educated that there is a correlation between the level of risk and expected return.

However the investment manager should act in an advisory role and not should not attempt to change the behavioural characteristic of an investor.

 

INVESTMENT CONSTRAINTS

Investment constraints may exist when choosing a particular portfolio of an investor.
This includes:
1) Return. This is expected return the investor is hoping to earn on his investments.

2) Risk: As discussed earlier, should be discussed with the client and the lower of the client’s ability to take risk should form the basis of his portfolio construction. It is paramount for an investor be comfortable with his investment.

3) Rate: This is the rate of return the investor expects to earn on his investments.

4) Time horizon: The risk or return should not be the only factors to be considered, an investment manager should consider the needs of the investor as regards to the timing of fund. Ie an investor might need to acquire new subsidiaries later in the year and with funds tied up in illiquid investments, this might be impossible.

5) Tax situation: The tax situation of clients should also be put into consideration when choosing the portfolio of clients. For example high net worth individuals may be subjected to high marginal tax and fully taxed income might be meaningless to them. They would prefer securities that are tax deferred and seek long term capital gains and tax exempt interest income.

6) Liquidity: Liquidity refers to how fast investments can be turned into cash. When choosing a portfolio for investors, be it individuals investors or institutional investors, an investment manager must put into consideration the liquidity needs of the investor and asset classes that are highly liquid can be held to deal with the liquidity needs as they arise.

7) Unique needs of investors: The asset class to make up the composition for the portfolio should be discussed with the investors because investors might have preferences based on religious beliefs, personal preferences and so on.

8) Legal and regulatory matters: Aside the financial market regulation, there might be more specific legal and regulatory constraints that may apply to particular investors. For example trusts, corporate and qualified investment accounts may all be restricted by law from investing in a particular type of securities and asset. There may also be restrictions on percentage allocations to specific types of investments in such accounts.

 

STRATEGIC ASSET ALLOCATION

This specifies the percentage allocations to the included asset class. High correlations of returns within an asset class indicate that the assets within the class are similar in their investment performance. On the other hand, it is low correlation of returns between asset classes that lead to risk reduction through diversification.

 

Recommended Reading 

Rocco DiBruno., How to write an investment policy statement