What is an Investment Policy Statement and Why You Should Have One
The cornerstone of successful retirement plan management is having well-established and documented processes and rigorously following them. For example, if you can’t perform a certain task due to lack of time or expertise, delegating this work to someone who can is a prudent act. But delegation of fiduciary responsibility to a service provider isn’t a panacea. To meet your fiduciary duty, you still have to follow a prudent process when selecting who to delegate the responsibility to. The same is true for monitoring selected service providers. If you neglect to monitor hired service providers you may be held liable for the wrongdoings of the providers you hired.
Remember, even though you can delegate a part of your fiduciary responsibility, you can never abdicate it.
The investment component of retirement plan management is even harder to manage as it requires ongoing oversight of available plan investment options and it can directly affect the investment results of participants. That is why it is extremely important to have an investment policy statement (IPS). The IPS serves as a road map for committee members and contains an explicit set of rules for designing the investment menu, selecting and monitoring investments, and managing the plan’s assets in general.
The IPS is a voluntary document, but more and more plan sponsors are adopting one. If you haven’t adopted the IPS yet, here are a few good reasons to do so.
It helps to document all the processes and decisions behind managing a plan’s assets.
It provides a “paper trail” and proves that you followed a prudent process. In the event of an audit or litigation, it is often the first document to be checked. It shows that a plan sponsor followed a prudent investment process when selecting and replacing investments.
It avoids chasing “hot managers” or swaying decisions during periods of overconfidence or market turmoil by being focused on the overall investment goal and strategy of the plan.
A high quality IPS isn’t easy to draft as there is no one-size-fits-all solution here. In some cases, plan sponsors use generic IPS templates just for the sake of having it. Far be it for me to explain to you that this approach is far from being prudent. Each retirement plan is unique with its own goals, needs, time horizon, and demographics. The IPS adopted by your plan must be based on the thorough analysis of the plan, and be drafted in cooperation with an investment adviser and legal counsel.
What Should be Included in the IPS
At the minimum, the IPS should outline the following sections:
The philosophy and investment objectives of the plan.
Duties and responsibilities of all parties involved in selecting investments and execution. The involved parties usually are: investment committee members, investment adviser, investment manager, and custodian.
A list of asset classes to be included in the menu, including qualified default investment options.
Due diligence criteria for selecting specific investments within each asset class. Be as specific as possible.
Due diligence criteria for monitoring and replacing investments, including specific criteria for comparing existing investments with benchmark indices and peer groups.
Due diligence criteria for controlling and accounting for investment expenses.
Frequency of the IPS review. A good rule of thumb is to review the IPS annually.
Tips for Drafting the IPS
Avoid complexity. An effective IPS has to be flexible and contain enough detail and guidance that a competent third party can implement it.
Avoid constantly changing the IPS. Frequent changes of the IPS indicate that the IPS is written poorly. Update the IPS only to reflect material changes to the plan. It is important to involve your investment adviser and legal counsel in the process.
Avoid referring to responsible parties by name. Instead, describe a job function or use a job title.
Avoid too much detail. For example, it is a good practice to describe a list of investment strategies allowed, rather than listing specific funds. By doing so, the replacing of a fund won’t lead to an IPS revision.
The IPS is essentially a business plan for managing plan assets and having one is extremely important. It serves as a comprehensive guideline for a plan sponsor, and provides a detailed step by step action plan for each stage of the plan’s asset management process.
Without one, how can you be sure that existing investments are appropriate and managed in the best interest of participants? How can you be sure that the fees charged by investment managers are reasonable? Or, more importantly, how can you prove that you have a prudent process and protect yourself in case of legal action?
Having a well-drafted IPS can certainly help address the above issues and more. It helps create a prudent process you can rely on to ensure that the interests of plan participants are above all else.
So if you don’t have an IPS, adopt one as soon as possible. But if you already have the IPS in place, make sure to follow it. There is nothing worse in the event of litigation than having one and not following it.