Imagine yourself IN the future meeting a potential buyer of your practice and standing by while one of your staff members demonstrates the efficiency of your business by reviewing each client’s signed Investment Policy Statement and explaining who is responsible for what and who is accountable to whom under the terms of that IPS. Imagine how impressed the buyer would be with a presentation of such order, control, and predictability.
Many advisors have not recognized this invaluable function–writing investment policy statements for every client–as a business system. But the IPS process can help build a successful practice because the process can become mechanism for updating and retaining clients, and even attracting new clients. It can also help differentiate your business from other advisory practices in the minds of clients and potential buyers.
The IPS was developed originally by pension consultants who worked with qualified plans to protect their fiduciary clients from personal liability while also defining plan responsibilities and obligations. However, the simple premise on which it is based provides an IPS with the flexibility that enables it to be used with individual clients to help make difficult decisions easier. Since accountability and responsibility are defined in the statement, each step becomes a small component of the overall decision-making process.
There are other benefits to an IPS. It provides a framework for evaluating investment performance and aids in clear communication between advisor and client. Finally, it helps dispel the root causes of dysfunctional client/advisor relationships based on the old sales model of emotional transactional selling. A functional business model does not rely on psychological and emotional rationale to get someone to say yes.
Using the IPS as a business system ensures that advisors hold rational and logical client discussions and that those clients have acknowledged an investment decision-making process in writing, adding an extra layer of compliance protection to your firm or to you as the advisor. This process ensures that both the advisor and client are in sync and serves as a guideline for managing clients’ assets and expectations. When used properly, the IPS can be a practical tool that embodies the essence of the financial planning process.
The initial steps involve organizing and preparing for client meetings. At the first meeting, the advisor addresses the issue of accountability and the fact that it works both ways, and sets out the rules for working with clients. For existing clients, advisors can explain that they have added a management tool called an IPS and describe what it entails.
The basic presentation can be given in a one-on-one setting or conducted in a client workshop format; either format is effective. If you decide to follow the workshop approach, team up with someone on your wealth management team.
You should view every meeting as an opportunity to uncover additional client needs and provide additional services to build client satisfaction. Satisfied clients talk to their friends and associates, and that translates to referrals.
The second or third meeting is designed to actually create the “policy.” To accomplish this, a full review of all relevant information is required including risk profiles and tolerances, tax situation, past or future investment biases, and goal identification. This review typically includes income tax returns for the previous two years, recent financial statements, bank statements, mutual fund statements, brokerage statements, life insurance policies, employee benefit statements, wills, and trusts.
Be sure to make it clear to your clients that you are collecting this information to create an effective IPS tailored to their particular needs, objectives, and values. Clarify that an IPS does not replace a financial plan but is an additional tool.
The advisor’s next job is to draft an IPS that communicates the essence of the relationship with the client in terms of investment management and expectations. The IPS is then reviewed with the client, and once agreement is reached, both parties sign the document, thereby acknowledging the terms of the relationship and how the portfolio is to be structured and managed.
Further meetings may be quarterly or ongoing, but you should review clients’ financial circumstances and investment needs regularly and specifically, anytime there is a major life event such as a birth, adoption, or change of employment status to determine whether the event warrants a change to the investment policy. This is particularly important as clients get closer to retirement and begin to contemplate distribution options from pension and profit-sharing plans, 401(k) plans, IRAs, 403(b) plans, or other arrangements.
Writing the IPS
The actual drafting of the IPS entails correctly capturing the key aspects of the relationship, as well as identifying who does what. It also entails making sure there is true agreement on the key components of the investment management process. Obviously, this step is critically important since the end result is the governing document itself. The actual document is composed of nine distinct steps:
1: Outline duties, responsibilities, goals, and objectives
In this step, a broad introductory statement that summarizes client information, needs, objectives, and goals is drafted; in essence this is the bare essentials of the relationships between the parties to the agreement.
2: Explain the strategy for managing risk
Today’s investment strategy is not about the avoidance of risk but the prudent management of risk. If client shortfalls are uncovered or needs change, methods for managing risk may also need to change. Risk management should include a consideration of all hazards that may follow from inflation, volatility of price and yield, lack of liquidity, and other “non-investment-specific” risks. These other considerations should be documented in this section of the IPS.
3: Identify risk tolerance parameters
Included in this section is a discussion of the risk tolerance and risk attributes for each asset class, as well as the total portfolio. Volatility ranges as well as investment quality, required credit ratings, or other risk restrictions that clients may have or investments they may carry should be disclosed here.
4: Establish guidelines for asset classes
The investment policy document should provide clear guidelines for asset classes to be considered. Basic asset classifications might begin with cash equivalents, bonds, asset-backed securities, real estate, and corporate stocks. Both debt and equity categories should be further divided by their general risk/reward or income/growth characteristics, and by domestic, foreign, tax-exempt, and other characteristics of the issuers. Any investment class restrictions (prohibited investments), size or position constraints, as well as individual biases for or against a particular investment or asset class should be included. There should be a provision for an ongoing review of these provisions in light of changing marketplace circumstances, new alternatives or opportunities, or other unpredictable circumstances that may arise during the term of the relationship.
5: Set the asset allocation policy
Asset-allocation decisions are a fundamental aspect of an investment strategy and a starting point in formulating the client’s individual asset allocation planning. This entails a thorough review of historical market patterns as well as historical performance of various asset classes.
6: Agree on investment methodology
To achieve clients’ goals you may consider a number of investment vehicles. Document the investment methodology currently used or the planned one. This is also the place to coordinate risk tolerance with methodology; anticipate any changes in client needs; add new time horizons, types of assets, or investment vehicles that might be considered for implementation of the entire policy.
7: Outline cost and expense guidelines
In this step, unbundle each service and give clients the knowledge of all costs and expenses and how best to pay for each service or product. Fully disclose how investment managers and other service providers are compensated, how the financial advisor is compensated, and the range of acceptable fees so that all the parties are aware of how the money flows among the parties to the document. This section can alleviate the potential for future disagreements among the parties over who is responsible for what and for what services providers are being paid.
8: Describe additional wealth management planning services (optional)
This step, though not included in many IPSs, can help demonstrate added value by providing a list of your wealth management services, which may include tax planning and preparation, bill paying, risk management, longevity and healthcare issues, legacy and charitable giving strategies, and asset protection tactics for the high-risk professional. This is purely optional depending on the extent of the overall financial planning engagement.
9: State investment monitoring and reporting procedures
This is crucial to any IPS since it establishes a process of review, and clarifies expectations. It is essential that a method and a schedule for investment reporting, monitoring, and investment manager reviews are established. Agree on appropriate benchmarks for evaluation and monitoring purposes and, on the process for hiring and firing investment managers. This section of the IPS is the one that does the most toward establishing a functional relationship with your client. It also serves as the forum for an ongoing two-way communication between you and your clients.
Delivering the IPS
During the discussion with your client of the IPS’s provisions, the opportunity for further refinement becomes available. Fine tuning should be the goal of the delivery meeting. An agreement should be reached and both parties should sign the agreement signifying their acceptance of the provisions. From this point forward, all aspects of the client relationship are governed by the provisions of the IPS, which helps foster a functional and healthy experience between client and advisor.
Following this process establishes your credibility and expertise in your client’s mind by communicating two things: you truly are client-centered, and you are willing to do whatever is necessary to insure that the client’s financial goals and objectives are successfully met.
Ken Ziesenheim, JD, LLM, CFP, is president of Thornburg Securities and managing director of Thornburg Investment Management in Santa Fe. He can be reached at email@example.com.