One of the biggest trends in financial planning today is the shift towards managed accounts. This is primarily an exercise in increasing efficiencies and lowering costs to serve clients, but it also has created risks and shifted the financial planner’s role closer to that of fund manager. This means taking on different skills, knowledge and risks.

To aid in this shift by advisers towards a more professional approach to all things investing, this article provides a guide to one of the foundations of quality funds management – the investment policy statement (IPS).

What is an investment policy statement?

An IPS defines the rules of investment portfolio management but it can easily apply to all investment decisions, whether it be model portfolios, construction of approved product lists or the workings of a self-managed superannuation fund. Establishing a comprehensive IPS is a step towards stronger risk management and governance of all investment businesses, whether implementing managed accounts or traditional advice approaches.

Chart 1 (below) shows one version of the structure of an IPS. Central to it are the objectives, with surrounding components designed to maximise the achievement of those objectives. Namely, philosophy, process, implementation and the ongoing review. Also, covering all aspects of the IPS is a system of governance focused on execution and accountability of all policies. Here are brief – not comprehensive – descriptions of each of these components.


The governance function is usually performed by the investment committee, which is a specialist sub-committee of the business’s Australian Financial Services licence (AFSL). The investment committee owns the IPS, is responsible for its creation, and ensures it is executed accordingly. There may be portfolio managers, analysts, external consultants, and an internal research department, and the investment committee’s responsibility is to hold them accountable for the day-to-day running of investment activities.

The committee is typically established by way of a charter, which may form part of the IPS, outlining the following:

  • Committee membership and voting rights. This may include:

o   Senior management

o   Compliance/legal/risk management representation

o   Portfolio management

o   Independent experts

  • Committee purpose – Ownership and implementation of the IPS, which includes:

o   Strategy development

o   Due diligence procedures for investment selection

o   Investment performance review

o   Sometimes operational finance and business development review

  • Meetings are typically quarterly
  • Minutes and all procedures are documented
  • Investment and portfolio decisions are documented and communicated appropriately to stakeholders (advisers, staff and investors)
  • The committee should ideally review the overall IPS on, at least, an annual basis.

The investment committee plays the most crucial role of the IPS, due to its role in accountability and execution. So, while a well-functioning investment committee is no guarantee of strong investment returns, it is a leading indicator of a firm with a strong risk-management culture, which should reduce the likelihood of left-field investment disasters. Similarly, whilst an IPS may look good on paper, unless its rules and procedures are adhered to, it becomes worthless and a risk.

Chart 1 – Investment Policy Statement design


Source: Delta Research & Advisory


Central to all investment decisions are the objectives. All investment decisions should be made with consideration of objectives and they should be defined based on the SMART principle:

  • Specific…may be absolute, such as 8 per cent a year, or relative to a benchmark, such as to outperform the S&P/ASX 200 by 2 per cent a year over three years
  • Measurable…this seems simple enough, as all investments produce performance, but when cashflows are involved, it does get a little more complex and portfolio performance measurement is not perfect across managed account platforms, particularly with respect to Global Investment Performance Standards.
  • Achievable…Equity markets have outperformed cash and bonds in Australia by no more than 4 per cent a year over the last 50 years. Aiming for high returns may be appealing to potential investors but if objectives are too ambitious, and therefore not achievable, based on the investment strategy employed, then they may put credibility and, ultimately, business at risk
  • Realistic…an achievable return objective is not necessarily a realistic one; particularly over the long term. For example, a 10 per cent a year return objective may be achievable in any one year across most asset classes, but in this world of low interest rates and historically high valuations, setting any expectation that 10 per cent a year can be achieved regularly is not realistic and is setting up for failure
  • Time related…the more aggressive the return objective, the more time may be required to achieve it, due to the additional risk required. All objectives must be associated with a timeframe and rarely should that be less than three-to-five years, unless dealing with lower-risk strategies (such as conservative bonds)

More and more investment strategies are also including risk in their objectives. Risk can have multiple definitions, whether it is absolute (such as overall volatility) or relative (such as less risk than the S&P/ASX 200). It is worth noting that risk objectives should also follow the SMART principles, as opposed to being vague, such as motherhood statements like, ‘low risk’.


The investment philosophy is an articulation of beliefs around what works and perhaps what doesn’t. The investment philosophy of a strategy or portfolio is typically what an investor is buying into because the future is largely unpredictable. This makes clear articulation of the philosophy a powerful tool for communicating with clients and a guide for setting the principles behind portfolio construction.

The Australian financial planning industry has embraced much of modern portfolio theory, with core beliefs such as:

  • Diversification: spreading your eggs across various asset classes, investment styles, and securities
  • Higher risk is required to achieve higher returns, hence there is the expectation that equities will outperform cash and bonds.

These beliefs are challenged, however, with strategies around increasing return potential with less diversified and more concentrated strategies. Then there is the anomaly in certain markets such that less volatile securities have a tendency to outperform the more volatile or risky ones, challenging the belief that higher risk is required for higher return.

The first question of philosophy typically comes down to whether passive or active management is best, and whether it is applied to asset allocation or security selection, and in what asset classes.

Some of the more recently emerging beliefs changing investment portfolios around the world include passive-style investing (commonly called smart beta) and the re-embracing of skill as investors move away from traditional markets towards broader-scope hedge fund-like strategies. On the flipside of this has been the biggest trend of all: massive inflows for passive market-cap index exchange-traded funds, suggesting many have stopped believing active management can add value.

The best portfolios will have a clearly articulated philosophy that investors can understand, which has evidence to support it and is reflected in the selections within it. If the portfolio clearly reflects the philosophy, then investors who agree with it are more likely to stay the course during the tough times that inevitably hit.


This refers to the means for portfolio construction, leading to the ultimate design of the portfolio. It is intended to achieve the stated objectives, and reflects the stated investment philosophy or beliefs. An example of some of the questions to answer in the process design include:

  1. What is the investment universe?
  2. Which asset classes are included or excluded?
  3. Which securities or investment types are included or excluded?
  4. What is the expected return and risk of those asset classes or investments within the universe?
  5. Depending on methodology this question may also include the more complex relationship between asset classes or investments (for example: correlation or co-variance)
  6. What are the investment vehicles used to access the investment universe?
  7. This could relate to:
  8. Platform availability/limitations
  9. AFSL limitations such as limited products (managed funds, securities)
  10. What are the required hurdles to being placed in the final portfolio?
  11. Qualitative factors
  12. philosophy, people, process
  13. Quantitative factors
  14. Performance, risks, style, added value (past/expected)
  15. Research/consultant ratings
  16. Expected returns and/or risk/return
  17. Alignment with philosophy
  18. Cost budget
  19. Risk budget

The above is a relatively simple snapshot of some of the questions that could be answered to build the portfolio.

Most investment managers apply the above questions to a simple, two-step portfolio construction approach involving asset allocation and selection of an investment or strategy.

An investment philosophy with beliefs around market efficiency will lead towards passive index investing. One that believes in market inefficiency will bias strategies with various levels of non-market risk.

Investment objectives and philosophy will determine the type of process required. That said, implementing it in the portfolio does require the greatest level of specialist investment expertise so process design should also consider capabilities of the key people involved.


The execution of the investment portfolio is one of the most overlooked components of the process. Considerations include:

  • Cost of execution

o   Buy/sell spreads or brokerage can be significant return reducers. This is particularly true for high-turnover strategies

o   Managed account platforms may reduce costs of execution compared with other platforms when implementing complimentary strategies. For example, if one strategy is buying BHP while the other is selling BHP, instead of two independent transactions there may be none or a reduced number of transactions saving numerous basis points in cost

  • Timely execution

o   Portfolio risk and return expectations are made at a specific point in time and the time between the investment decision and the execution may be costly

o   Some investments, such as IPOs or various corporate actions, have deadlines, and if they are not addressed appropriately may also have costly implications.

  • Rebalancing (which may also be part of process)

o   Establishing clear rules around rebalancing, whether it be at the asset-class level, investment level, based on frequency (for example, quarterly or annually), or movement from desired allocations (for example, plus or minus 10 per cent) creates transparency and clarity for appropriate execution of the ongoing management of a portfolio

Good portfolio implementation with clear rules can add return via the reduction of performance drag caused by poor implementation. When decisions are made to invest today based on today’s information, ideally transactions are made today, instead of adding the risk of short-term market timing, which has little evidence of adding value. Implementation guidelines should not be taken for granted.

Ongoing review

The one constant about investing is that nothing is constant. Markets go up and down, styles go in and out of favour, beliefs are constantly challenged, and every investment or manager underperforms their objectives or benchmarks at one time or another.

The ongoing review looks at the portfolio with a focus on:

  • Ensuring it is aligned to meet objectives and reflects investment philosophy
  • Is the asset allocation appropriate?

o   Capital market views and valuation considerations

  • Investment and performance review

o   Are the investments doing what’s expected?

o   Are investments still satisfying required ratings?

o   Are investments according to stated styles?

o   Are the drivers of portfolio returns and risks aligned with intentions?

The answers to these questions re-start the portfolio construction cycle, leading to new recommendations (which may be to do nothing) and the cycle continues.

While investment teams will consider portfolios daily, the formal review presented at the investment committee is typically quarterly. The frequency of the formal review should depend on investment style and level of expected activity. Sometimes, reviews are undertaken more frequently; many are monthly. This may occur during highly volatile times when market valuations fluctuate, potentially creating opportunity for a highly active strategy.

One of the challenges of the ongoing review is to avoid shot-termism. Changes in monthly or quarterly (or even annual) performance often form too short a timeframe to make a meaningful assessment of potential success, as styles that are out of favour today may be in favour tomorrow (and vice versa).


This article provides a starting point for those looking to improve the risk management of their investment business. The IPS is a key part of all successful investment management businesses, from the largest sovereign wealth funds to the smallest boutique fund managers or advisory firms. Creating the rules of the investment game with IPS is a step in the right direction of good governance and risk management that is becoming even more crucial in these increasingly complex times.

Michael Furey is principal of Delta Research and Advisory.

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