In volatile times, it pays to revisit the IPS

With financial markets careening up and down amid new financial, en-vironmental and geopolitical crises, investors are justifiably nervous about whether seemingly desperate times call for desperate measures.

Financial stewards, as well as the financial advisers who serve them, are under tremendous pressure to act.

Some have responded by shifting to more conservative capital preservation strategies. Others have reacted by becoming more aggressive and tactical in their approach to investing.

Either approach may be justifiable, but both could expose fiduciaries to a claim of breach of fiduciary responsibility if they aren’t consistent with the terms spelled out in the investment policy statement governing the portfolio.

By laying out the strategy and processes used to manage a portfolio in a manner that best serves the interests of investors, the IPS is essentially a business plan for the portfolio.

Unlike a standard business plan, however, the IPS is a governing document that sets directives and constraints. Consequently, stewards and advisers should be careful to amend the IPS if they intend to depart from its terms.

In light of the extraordinary investment environment, as well as the likelihood that portfolio decision makers have already made significant changes in their portfolio management practices in response to these conditions, fiduciaries should review their IPS documents now. If current practices conflict with provisions of the IPS, the practices, the documents or both should be revised to achieve alignment.

There are two sections of a typical IPS that are most likely to need adjustments.

First, the goals-and-objectives section may not be current. This section normally states the overriding purpose for which funds are being invested.

For trustee-directed, or centrally managed, portfolios, this section also establishes the levels of acceptable risk and expected total return. These parameters will need to be updated if (1) the fiduciaries think that the expected return and risk levels of the markets have changed in the investment climate, or (2) the investment strategy being employed for the portfolio has become more aggressive or conservative.

For participant-directed plans, fiduciaries should consider whether participants should be provided access to more investment education or personalized advice to deal with challenges posed by the prevailing market conditions, in which case the plan may be able to take advantage of special safe-harbor provisions of the Employee Retirement Income Security Act of 1974.

Second, most IPS documents include an asset allocation section, which establishes the asset classes used to fulfill the funding strategy of the portfolio. This section also usually addresses such special portfolio restrictions as minimum credit quality for debt instruments.

If the fiduciaries have decided to diversify more broadly, new asset classes under consideration should be added to the policy portfolio reflected in the IPS. If the fiduciaries want to reduce or eliminate exposure to certain types of investments, this section of the IPS should reflect the change.

For centrally managed accounts, the policy portfolio will not only reflect the list of asset classes used but also the percentages to be allocated to each. It will normally show a strategic or target allocation, and lower and upper thresholds that give the fiduciaries some latitude for tactical-allocation decisions and serve as triggers for re-balancing.

This section of the IPS is probably the source of the greatest fiduciary risk because it is crystal clear if the policy portfolio reflected in the IPS isn’t being adhered to. The policy portfolio and actual investments must be brought into alignment, and consideration should be given to broadening the lower and upper thresholds if the managers are finding it difficult to stay within these boundaries.

For participant-directed plans, the existing asset classes and investment menu choices should be evaluated to determine if they provide adequate opportunities for participants to address the prevailing market conditions.

The single most important responsibility of an investment fiduciary is to execute faithfully a well-crafted and carefully maintained IPS. This is the surest path to achieving fiduciary excellence on behalf of investors, because investment success is directly related to the extent to which sound processes are consistently applied.

By recognizing the crucial role of the IPS and making sure that it is current, fiduciaries maximize their effectiveness in serving investors and help mitigate a source of fiduciary risk.

Blaine F. Aikin is chief executive of Fiduciary360 LLC.

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