An investment policy statement (IPS) is the governing document that provides directional and procedural guidelines for the inclusion or removal of any investment in either a retirement plan or endowment. Though not required by law, it is highly advisable as it provides a clear roadmap to the plan fiduciaries for the selection and ongoing monitoring of the plan’s investments. In addition to a retirement plan, this is also important for a pension or endowment. For a pension or endowment, asset allocation parameters are also outlined. There is a need for a written document that everyone has agreed to that will guide decision making, and puts forth standards on how to make investment decisions and who is responsible for what.
An IPS also creates institutional memory for the organization as committee members or trustees come and go. Committee members can read this document and immediately be up to speed on the ‘why’ and ‘how’ of the investment strategy. It also creates a framework for decision-making regarding the investments. For example, if people on the board of a foundation or endowment are concerned about market volatility or a potential downside and they want to cash out, doing so may be in conflict with the policy and as such they could be prevented from doing so. A properly crafted IPS would take into consideration the time horizon and needs of the fund and help to prevent these types of emotionally charged decisions from being made potentially to the detriment of the fund.
Having a written document that provides the framework for decision-making is critical, so if the Department of Labor (DOL), Internal Revenue Service (IRS) or a beneficiary of the plan were to question why you made a certain investment decision, the IPS explains the rationale. If the DOL or IRS were to ask why a decision was made and there isn’t an investment policy statement, telling these government agencies, “I don’t know,” won’t go over too well.
An IPS will outline that the plan committee has a duty of loyalty implicit in its fiduciary obligations. A duty of loyalty means that a fiduciary has an obligation to act in the best interest of the participants and beneficiaries of that plan. Part of that obligation in the duty of loyalty means fiduciaries must put participant’s best interest ahead of their own, which is built into ERISA and DOL regulations.
There is one thing that is worse than not having an investment policy statement: having an investment policy statement and not following it. It is critically important to have one written, review it periodically to make sure it is still relevant and to follow it.