Executive summary:
- An investment policy statement (IPS) is a client-specific document designed to address the objectives, constraints, unique circumstances, and overall oversight procedures that govern the investment-related activities of a non-profit organization.
- An IPS that is well-designed and well-thought-out is important to the success of a non-profit’s investment program, as it plays a vital role in the overall governance structure of the non-profit. Well-defined objectives are important to ensuring that the mission of the non-profit can be achieved. Overall, a great IPS should position fiduciaries well to identify and mitigate potential risks to the asset pool(s).
- We believe there are 13 elements that should be included in all non-profit investment policy statements. This article identifies and briefly summarizes these elements, with a more thorough explanation of each provided in our recently updated research paper.
In today’s challenging economic landscape, having a well-defined, clearly articulated investment policy statement (IPS) is critical to driving investment success for non-profits. An IPS serves as the blueprint for organizations seeking to meet their objectives while minimizing total portfolio risk. Moreover, the IPS fills a vital role in helping lay the foundation of an organization’s overall governance structure and ensuring that all fiduciaries are fulfilling their obligations.
But developing a great IPS is no easy feat. The process is iterative and demands engagement and thoughtfulness from each fiduciary. Yet we strongly believe that such a level of care will result in an oversight protocol that is more integrated and better aligned with the needs of the overall organization, increasing the probability for a non-profit to achieve investment success.
So, how exactly should non-profits go about crafting an IPS? What key elements are crucial to making their IPS great?
In a recently updated whitepaper, we’ve identified 13 vital elements we believe all non-profits should include in their IPS. This article provides a summary of each of these elements. We encourage non-profit fiduciaries to download the full research paper for a more thorough explanation.
Section 1: Purpose and scope
This is typically the first section in an IPS. It provides an overview and sets the tone for the specific guidelines within the body of the document. This section should broadly state the scope of the IPS and its intended purpose and set out the general objectives of the non-profit organization. If the organization has multiple asset pools with distinctly different objectives or time horizons, this is the section where those distinctions should be identified.
Section 2: Definition of duties
It is important for the IPS to clearly state the duties of all involved parties, so that each party can fulfill their duties effectively. At a minimum, the parties should be identified and their duties described. Key parties that should be included are:
- Board of trustees
- Investment committee
- Outsourced CIO provider
- Investment managers
- Custodian
Section 3: Objectives and circumstances
All investment policy statements should clearly articulate investment objectives with an outcome-oriented mindset.
Endowments and foundations often have the objective of maintaining the real asset base in perpetuity while maintaining a certain spending rate. This means that the long-term return objective should account for inflation, fees, and annual spend. An operating pool may have a set return objective or relate the objective to the internal cost of capital or debt cost.
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This means that organizations should evaluate their current goals and constraints against the realities of market expectations to ensure that investment objectives reflect underlying return targets and risk tolerance, striking the right balance between return-seeking and risk avoidance.
Section 4: Strategic asset allocation framework
Strategic asset allocation will be the principal method via which a portfolio is designed and its assets invested to achieve the stated objectives over predetermined time horizon(s). It is imperative that non-profits spend whatever time it takes to clearly define those objectives and to determine which strategic allocation is most appropriate for the organization’s needs.
In accordance with the objectives statement, the allocation should be based on the applicable investment time horizon and should remain within the limits of acceptable risk. Within the asset allocation framework, asset classes and investment strategies should be selected primarily for the roles they are to play in a total-portfolio context.
Section 5: Rebalancing
In addition to describing the target asset allocation, language that articulates the rebalancing philosophy of the organization should be included. Periodic rebalancing of a portfolio is necessary to keep allocations from shifting too far from targets if there is no discretionary portfolio management. Ranges are set at the portfolio role level and at the individual asset-class level. Setting at the asset-class level may be specified in the investment management agreement or other outsourced provider documentation.
This rebalancing may occur on a monthly or quarterly basis. If decision-making and initiation of trades to accomplish rebalancing of the portfolio is delegated by the non-profit to an outsourced provider, that should be noted in the IPS and the governing agreement.
If there is discretionary portfolio management, we would not expect the formulaic rebalancing described above. We would expect a similar process for range setting, but to set the guidelines for the discretionary portfolio management.
Section 6: Liquidity policy
While non-profits differ in their asset allocation and cash needs, liquidity is needed to:
- Meet organizational cashflow needs
- Rebalance as needed/wanted
- Deploy capital opportunistically
- Meet capital calls
The liquidity policy should state how necessary cash levels over various time horizons will be monitored to ensure that sufficient liquidity exists within the portfolio. This will also account for the potential liquidity needed to meet capital calls if some of the illiquid investments are in funds with a drawdown structure.
In this section, mapping the investment portfolio’s liquidity profile vis-à-vis its asset allocation and the roles of the asset classes can be helpful.
Section 7: Spending policy
For organizations that have an annual spend—typically endowments and foundations—they should have a clearly defined spending policy that articulates how annual spend is determined. This section is not relevant to asset pools that do not have an annual spend, such as healthcare long-term pools, even if they do have annual outflows.
This policy should be reviewed periodically, and the organization should consider the impact of economic conditions as well as its other resources when determining whether or not to modify the policy.
Section 8: Risk management
The investment policy statement should set out guidelines around specific risk metrics so that the purpose of each metric can be known, measured, and monitored in the portfolio. Vague statements around risk tolerance can make it difficult for an investment committee to gauge their true level of risk tolerance.
Section 9: Responsible investing
Responsible investing is an area that non-profit fiduciaries are addressing with increasing frequency. There are various approaches for incorporating responsible investing within an IPS and we recommend non-profits go through a governance process to determine a suitable approach for them. It is important to incorporate the motivation and the objectives, along with any constraints, in the investment policy statement. The language can vary based on the different approaches.
Section 10: Unique circumstances
The investment policy statement should contain a section detailing any circumstances specific to the organization. For example, if your organization has a preference or a policy of avoiding unrealized business taxable income (UBTI), this is something that should be stated in this section. This section is an opportunity to include items that a non-profit would like to highlight that are not covered elsewhere in the IPS.
Section 11: Monitoring and review process
Once the asset allocation, investment strategy, liquidity, and spending policies have been established, it is important to create a well-defined monitoring and review process to help assure that the objectives of the foundation or endowment will be achieved. The review mechanisms should center on the investment objectives of the portfolio.
Section 12: Acknowledgement
Typically, the last section in an investment policy statement is the acknowledgement section, which is signed by the non-profit before copies are distributed to all parties. An example of an acknowledgment statement is as follows:
We recognize the importance of adhering to the mission and strategies detailed in this policy and agree to work to fulfill the objectives stated herein, within the guidelines and restrictions, to the best of our ability.
Section 13: Appendix: Asset role strategy statements
Following the acknowledgement section of the IPS, many non-profits include an appendix or a separate implementation and procedures document that further defines the investment strategies and asset roles that make up each of the three broad portfolio roles (growth, return enhancement and risk reduction/diversification). These statements provide additional detail centered around four main categories:
- Strategic role
- Strategies
- Investment objective
- Monitoring and control