Financial advisors who work with high-net-worth individuals, family offices and institutions can enhance their services to clients with the help of an investment policy statement. This formal document is not a legal agreement, but it is an essential tool that details how clients’ money will be managed.
The statement’s simplicity or intricacy depends on the type of client, the family’s needs and the complexity of the investments. The statement is a long-term plan covering 10 years or more, but advisors and clients can update it as situations and goals change.
Here’s what advisors should understand about investment policy statements:
— What is an investment policy statement?
— Creating the investment policy statement
— Implementing and maintaining the policy
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What Is an Investment Policy Statement?
The investment policy statement is the governing document for the investment portfolio of a client, written with a set of guidelines that are crafted to achieve certain objectives, says Andy Hart, CEO of Delegate Advisors, a multifamily office.
He says clients who have multiple portfolios and complex investments need these statements so advisors understand how to address the objectives for each individual portfolio. “The portfolios may have different objectives. Each client should have an investment policy statement, but sometimes they don’t want to go through the hassle of putting one together,” he says.
For example, if an advisor is investing money in trusts for children who are 3 to 5 years old and also investing money for the parents’ retirement, those are different goals. With an investment policy statement, “you know that the portfolio you’re investing in for the children has a very long time frame before any liquidity is required, whereas for the parents, they might need it within 10 years,” Hart says.
[READ: What Advisors Should Know About SLATs.]
Preparing to Create the Statement
Kevin Swanson, CEO of Potentia Wealth, also sees the investment policy statement as an opportunity to plan a legacy for generations, explaining how the family came into wealth and how to shepherd it. That goes beyond simple financial planning, he adds.
“It’s a unique opportunity to come together to shape the family’s future, to create a value statement about how they would like their wealth to impact the lives of their family and the world,” Swanson says.
Michael Zeuner, managing partner at WE Family Offices, concurs, adding that when advisors create these plans, they should spend time on the process of compiling them. “If it’s just a check-the-box exercise, you really miss the nuance and the importance of the conversation,” he says.
During these early conversations, advisors should ask what the clients hope to accomplish, what cash flow they need for their lifestyle and how important it is to pass on wealth to younger generations, experts say. Beyond that, Zeuner asks questions related to behavioral finance to gauge the clients’ understanding of both positive and negative investing experiences. This allows him to dig into quantitative and qualitative factors that define clients as investors and their definition of success.
What Goes Into the Investment Policy Statement
An outline for the financial planning part of the policy statement may contain the following:
— Core purpose
— What investments are covered by the document and what is not covered
— Income and spending breakdown, including income generated outside the portfolio, day-to-day personal spending, and charitable and family gifts
— Expected nominal return and planning time frame
— Risk tolerance and the expected standard deviation of annual returns
— Liquidity needs of the portfolio
— Constraints on the portfolio, including whether to use leverage or restrictions on investments in certain assets or sectors, such as gambling or tobacco
— Tax considerations
— Asset allocation
— Risk-management strategies, such as performance reporting and rebalancing
Swanson says that once he knows the family’s financial goals and objectives, he adds investment management objectives to the plan. These include the type of risk the manager will take and what that means in terms of expected returns and time frame. This portion would also specify whether the family wants to invest according to religious beliefs or criteria for socially responsible investing.
The asset allocation section can be as detailed or basic as the client wants, the sources say. The key is understanding their level of tolerance. Hart says, for some portfolios, he details specific asset classes and how those are allocated in the portfolio. For other portfolios, he may simply quantify the functional purpose of the assets in the portfolio.
Swanson says families may be less interested in the granular detail of specific investments. Their main concern is usually overall return and provisions for their family and future generations. They also want the money handled in a tax-efficient way and possibly to leave a legacy.
Hart and Swanson say policies include information on when clients can expect updates on performance and how the portfolio is managed. Swanson says he also includes a section on the process for removing investment managers, including himself, if the client isn’t happy with performance.
[Read: Protect the Point — How Advisors Can Deliver Tangible Value to Clients.]
Implementing and Maintaining the Investment Policy Statement
The statement covers long-term financial-planning objectives and covers client cash-flow needs if necessary. Near-term liquidity needs are usually addressed first since those are short-term. Hart recommends setting that period at three years, so clients won’t need to tap longer-term assets during market downturns.
Because the policy statement is a conversation between the advisor and client, the two parties should also review and amend it periodically if circumstances change. Aside from scheduled check-ins, advisors should be alert to changes in clients’ liquidity needs. Those could include buying a second home or helping another family member financially.
“You go back to the IPS and say, ‘Oh, does that change (your liquidity needs) in the framework of the IPS that we’re using as our doctrine in managing this portfolio?'” Hart says. “You are responsible to listen for the change in their objectives, but you need to educate the client that they’re a party to the conversation. It’s not a one-way thing.”
Zeuner says one of his clients drafted a statement in the fall of 2019 with certain assumptions for lifestyle spending and sources of income, including a certain percentage of withdrawals. He says throughout 2020 and into 2021, the client, a married couple, did not make any withdrawals. That triggered a conversation with the client about changes in their financial life.
The couple told Zeuner their spending needs were lower than expected after selling a company. After a detailed discussion, he was able to amend their policy statement to take on more risk and greater growth.
“I think it’s incumbent on the advisor to look at what they’re seeing in real life with the family. Is it aligned with what we thought, or is it different?” he says. “And then, how do I amend the investment policy statement as a result of what I’m actually seeing as the behavior of the client?”
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What Is an Investment Policy Statement and Why Create One? originally appeared on usnews.com
