Peter Begalla: I’m with Eric Hickey and Joseph Zaccardi from Drexel Morgan Capital Advisors, and we’re talking about investment policy statements, the rationale for them, how to manage them and ultimately the impact for financial families. So Eric, let’s start with the basics. What’s an investment policy statement?
Erich Hickey: An investment policy statement or IPS is a formal document between a client and investment adviser which outlines the investment objectives and constraints of the client and sets the investment strategy for the investment adviser. It’s a governing document which both parties can refer to when making investment decisions going forward.
Peter Begalla: So it provides some guidance and some clear expectations, I would imagine. What are the key elements involved?
Erich Hickey: The key element to it is it keeps everyone on plan. So as I said before, it’s something that both parties can reference. In times of stress, especially when emotions can come into decision making, it’s something good to reference. If various market conditions or factors change with the family or with a client, it’s something that can be referred to and changed. It also forces the client to understand the investments that they’re being put into. We advocate that our clients really ask a lot of questions. And the process by which we go through to create the IPS unearths a lot of questions in that process.
Peter Begalla: The IPS is also an educational tool as well as providing a framework for clear expectations and guidelines. So, Joe, talk to me about what the key elements of an investment policy statement are.
Joseph Zaccardi: There are several key components. First and foremost is the investment objective of the portfolio of the family or client. So it could be passing on wealth to the next generation. It could be capital appreciation and a very generic requirement, or in the cases of a family foundation or other endowment, it could be specific spending or income requirements. Second is the risk tolerance of the family or client. That falls into two broad categories. First is the ability to take risk, which is dependent on the need for liquidity, the time horizon and the assets under management. The second is the family’s willingness to take risk. As we all know, every family and every client is very different. Certain generations or certain people just have less willingness to take risk. And we want to make sure that everybody’s expectations are set and they’re happy with their investment. Next, as Eric had mentioned earlier, the IPA sets guidelines for asset classes which generally fall in ranges or bands from a minimal allocation to a high allocation. And then that can be reviewed by both clients and the advisors to make sure everybody’s keeping within the rules and the expectations of the portfolio. And finally, it could set benchmarks to measure performance for the manager and for the client to review.
Peter Begalla: So now that we have the key elements from the investment policy statement, Eric, what kind of adjustments or how often does this need to be revisited?
Erich Hickey: We generally review the IPS with each client on an annual basis and generally things don’t change. But the questions that we ask are if they’re heading towards retirement, if they’ve actually executed on that for families. What, if anything, has changed within the business. A prime example is we have families with real estate that is owned outright and then we have families with real estate that does have leverage on it. And depending on the market environment, their liquidity needs may change drastically or they may have moved into a more conservative tilt as far as risk is concerned. Those are discussions that we like to have. They tend to be multifaceted and we provide a lot of input as well. But it’s important part of the process.
Peter Begalla: So if the IPS is reviewed on an annual basis, you don’t really want to revisit it during the year, you want to let it run. You want its structure to actually work and exercise itself versus be changed by market forces dramatically.
Erich Hickey: Correct. And within the IPS, when we’re setting the investment allocation, we’re generally creating ranges for asset classes. In an environment where, for example, when equities are down 30% and fixed income returns are outsized, we can bump up against the range. When we’re managing the capital, especially in a discretionary environment, we refer to those ranges when making investment decisions and if we’re getting close to those ranges that’s when we’re going to have a discussion with the client. The second thing is that process removes a lot of the emotion around the investment. So everyone’s very rational in normal times. But when things like a global pandemic hits, they may not make the best decisions. Therefore we’d like to have something to refer to when they’re calling us. We have a document that we can refer to when we’re making those decisions.
