Best practices and important considerations for developing and maintaining effective investment policy guidelines.

The central function of an investment policy statement is to provide structure for an investment entity, laying the foundation for consistency in the decision-making process with respect to all aspects of fund asset management in accordance with the prudent investor rule. That said, how should this document be constructed? How often should language be amended to incorporate current themes, investment strategies and risk controls? Can parameters be too restrictive, in terms of reducing the potential to achieve risk-adjusted return targets? How do certain institutional investors approach non-investment-related factors such as headline risk, special interest group/political influence and home country bias? Do these influences affect decision-making?

To embark on a cross-country trek without GPS navigation, one would need a road map. But, when it comes to navigating the investment landscape, institutional investors may take different paths. While public and corporate defined benefit (DB) plans look to generate stable growth over the long term in order to meet future obligations, foundations or endowments attempt to achieve their target spending rates in order to meet financial goals. What type of road map should these entities follow to satisfy their respective requirements?


Understanding that the Pension Benefits Standards Act already requires many Canadian plans to maintain an investment policy document (along with mandates put forth at the federal and provincial levels), how can the plan sponsor effect a process around investment policy guidelines construction and application to maximize the overall benefit to the fund?

First is the establishment of goals, which often includes language regarding factors influencing diversification components within the asset mix, the benefits of external and/or internal asset management (along with macro-strategy initiatives such as active versus passive investment styles) and risk-budgeting techniques.

Once high-level goals and philosophies have been established, plans should clearly state the performance objectives that the fund aims to achieve over a stated period of time. Often, these objectives include the actuarial assumption rate (the minimum rate of return that the plan must achieve in order to meet expected liabilities in the future), an inflation measure plus hurdle rate (a benchmark that helps to determine if the plan is returning a rate to meet expected liabilities), the policy benchmark and the median performance relative to a universe of peers. Since this declaration of goals is mandatory, there are a number of key considerations. How realistic and achievable are these measures? Beyond return expectations, how will portfolio risk be quantified and measured? What is a risk budget? How should risk-budgeting techniques be incorporated within the investment policy to mitigate the volatility of the asset pool relative to the liability component?

Regardless of the structure of the plan, role definition is vitally important. Overseeing fund assets is just one of many tasks with which trustees are charged. Responsibilities should be defined for all parties including, but not limited to, the board of trustees, the investment committee, internal staff, the investment consultant, the plan actuary, the custodian bank and legal counsel.


Many practitioners believe that asset mix plays a dominant role with respect to its influence on plan returns. Investment policy statements typically define asset mix targets, including minimum and maximum allocation thresholds. Equally as important is the articulation of a rebalancing policy. How useful are asset mix targets if clearly defined rebalancing policies are not stated within the document? Pension plan management should be strategic. Too often, plan sponsors fail to include strict guidelines around the rebalancing of assets, which allows for tactical shifts to influence portfolio weighting. If the risk budget (which incorporates factors such as the length of the funding period, the relationship between the asset pool and the liability profile and the expectations for benchmark outperformance) is defined along with capital market assumptions for each asset class, the asset allocation becomes merely a reflection of those factors.


Once the asset mix framework has been clarified, detail must be provided at the individual asset class level regarding the nature of the investments to be included—and excluded— within a given portfolio. Understanding the need for liquidity and protection against uncompensated risk (based on the investors’ requirements for return), guidelines should clarify that which is prudent given the current market environment.

Since markets are dynamic in nature, ongoing review of the investment policy guidelines is important. Best practices indicate that cursory reviews should be undertaken periodically, if not annually, to determine if the guidelines are still achievable. Since it would be impractical to continually amend the language of the guidelines, formal reviews should be implemented as part of a stated review process. Quantification and clarity are critical when editing or amending guidelines.

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