The investment policy statement is a blessing and a curse. It’s essential when working with clients, yet many financial advi-sors have difficulty implementing an IPS. Many software applications contain embedded IPSes, but most are incomplete or over-the-top long. Creating your own framework and template is easier than you think, and its thickness needn’t rival the Yellow Pages. An IPS should include the following:
> Target Return. A client’s required rate of return is a key input in designing the client’s investment strategy, and it should flow from goals or future spending plans. Avoid setting return targets based on desires or whims, as they’re more likely to be unrealistic.
> Risk Tolerance. Obtaining a better return than those available from guaranteed investment certificates requires some risk-taking. You should flesh out your client’s definition of risk, what types of risk your client is comfortable assuming and a quantification of risk parameters. This is the toughest part of your know-your-client responsibility, which goes far beyond your firm’s KYC form. It is compounded by the fact that risk definitions and tolerances change. It occurs to most investors at a certain age that they don’t have as much time to weather the market’s ups and downs as they once had.
Risk education should be easier after two bear markets in 11 years. However, if your client has materially more wealth today than in past bear markets, you must assume that your client is less risk tolerant because her or she is older — and the dollars at stake are bigger.
> Time Horizon. Too many profiling questionnaires are overly simplistic on the topic of time horizon, assuming only one exists. Clients often have multiple time horizons. Those saving for their kids’ education and their own retirement, for instance, have at least two very distinct time horizons.
> Near-Term Cash Needs. Any planned cash outlay should be “carved” out of an otherwise long-term portfolio. Examples include a business investment or a monetary gift to a child over the next couple of years.
> Taxation. Income tax issues affect asset location and, to a lesser extent, security selection. For instance, you may want to allocate more of your client’s fixed-income exposure across registered accounts while emphasizing equities in taxable accounts. Products offering tax-efficient, fixed-income exposure may also be desired for clients with significant non-registered assets.
> Legal & Special Circumstances. Make note of any other factors that may affect the construction of your client’s portfolio, including heavy concentration in one or two stocks, a pending lawsuit, a possible inheritance or anything that could see a significant amount of cash added to/taken from the portfolio or materially change any of the above factors.
As well as the aforementioned components, your client’s IPS should detail your recommendations, with bullet points summarizing rationale. It should also contain some basic before-and-after analysis and a benchmark against which performance will be measured. Nailing down a process and an IPS template will increase your professionalism and help you create a more consistent client experience. IE
Dan Hallett, CFA, CFP, is director, asset management, for Oakville, Ont.-based HighView Financial Group, which designs portfolio solutions for advisors, affluent families and institutions.