Creating an investment policy statement (IPS) is an essential step for family offices to formalize investment goals, strategies and processes. A well-crafted IPS provides guidelines for asset allocation, risk management, due diligence, monitoring and reporting. This article will analyze key elements of a family office IPS and provide an IPS template example.
Specifying return objectives and risk tolerance level
The IPS should clearly state the family’s return objectives both long-term and interim, usually over 5-10 years and 1-3 years. The return objectives need to be realistic yet challenging based on historical asset class returns. The IPS also needs to outline the level of risk the family is willing to take, typically defined in terms of maximum portfolio volatility or maximum drawdown.
Establishing strategic asset allocation
The IPS should contain the family’s strategic asset allocation across various asset classes – equities, fixed income, real assets, hedge funds etc. The allocation should aim to maximize returns within the family’s risk tolerance. Diversification and rebalancing ranges for each asset class must be defined.
Selecting benchmarks for performance evaluation
Appropriate benchmarks should be chosen to evaluate performance of the overall portfolio as well as each asset class component. The benchmarks need to closely represent the target asset allocation and risk profile.
Specifying investment guidelines and restrictions
The IPS needs to provide guidelines for security selection, diversification, liquidity requirements, tax considerations and other unique requirements of the family. Any investment restrictions in terms of exposure limits, position sizes, leverage, derivatives use, concentrated positions etc. should also be outlined.
Defining monitoring, evaluation and reporting
The IPS should describe the frequency of portfolio reviews, metrics used to evaluate performance and risk, as well as regular reporting by investment managers to the family office. This enables the family office to effectively oversee the investment activities and ensure adherence to the IPS.
An investment policy statement is a key governance document that guides the family office’s investment process and decision-making. By clearly articulating return objectives, risk tolerance, asset allocation, guidelines and monitoring procedures, a robust IPS helps align investment activities with the family’s goals.