Investment Policy Statement

Parts of the IPS

Background and Investment Objectives

This section outlines the goals for the wealth management program. It is discussed in more detail in the next Los.

Risk Tolerance

This portion of the IPS states the client's ability and willingness to assume risk. In this section, the manager should talk about how they came to the conclusions in the section, such as risk tolerance questionnaires.

Investment Time Horizon

This section states the life of the plan in terms of years. It should be filled out by the investment manager as clients may be prone to misjudge their own timelines.

Asset Class Preferences

This section lists the investments which may be used in pursuit of the investment plan. It should include a list of appropriate assets, and also list inappropriate assets which do not fit into the plan. An example could include a client who has a bad childhood experience with a certain company stock, and therefore wants to be sure it is excluded from the portfolio.

Other Investment Preferences

This section is a catchall that describes unique individual client attitudes. One common addition to this section is the desire for Environmental and Social Governance investing (“ESG”). This is also commonly known as socially responsible investing.

Liquidity Preferences

Liquidity refers to how quickly an investment may be turned into cash without having to reduce the price to achieve a sale. This section should list the major cash flows into and out of the portfolio (to the extent they can be known in advance), and should also touch on the way this impacts the asset allocation.

Constraints

Investing in or implementing certain investment strategies are commonly restricted for some clients. For example, a client may be constrained by investment options in accounts such as a defined contribution retirement plan account (which may allow only a small menu of mutual fund or ETF choices). Another common constraint are those investments that have large unrealized capital gains and would create significant tax liabilities upon sale.

Question

Which of the following sections would be the least appropriate place in an IPS for an overview of the client's attitudes toward ESG investing:

1. Other.
2. Constraints.
3. Liquidity.

Solution

The correct answer is C.

The “Liquidity” section of an IPS focuses on the client's cash flow needs and requirements for readily available funds. ESG preferences are not directly related to liquidity, and including information about the client's attitudes toward ESG investing in the “Liquidity” section would be the least appropriate. ESG considerations are more about the client's values and investment preferences rather than their immediate cash flow needs.

A is incorrect. The “Other” section in an IPS is typically used for information that doesn't fit into the standard categories but is still relevant to the client's investment preferences or needs. Attitudes toward ESG investing are a specific and important aspect of a client's investment preferences, so it would be quite appropriate to include this information in the “Other” section.

B is incorrect. The “Constraints” section of an IPS typically covers factors that limit the investment manager's flexibility or the client's investment options. Constraints often include items like liquidity needs, tax considerations, risk tolerance, and legal restrictions. While ESG preferences can be considered a constraint if the client has specific requirements related to ESG investments, it's not the least appropriate place to include this information.

Reading 7: Overview of Private Wealth Management

Los 7 (i) Discuss the parts of an investment policy statement (IPS) for a private client