Best Practice: The Investment Policy Statement

“The will to succeed is important, but what’s even more important is the will to prepare.”
– Bobby Knight

In order for you, the plan sponsor, to fulfill your fiduciary obligations and avoid related liabilities, it’s important to understand how to develop your plan’s Investment Policy Statement (IPS).

Why Create an IPS?

Among a plan sponsor’s responsibilities is to offer sound investments options to participants. Your plan’s IPS is a double win on that count. It not only helps you think through how best to fulfill this important fiduciary duty, it also is one of the most powerful tools available for protecting yourself against fiduciary liability by formally documenting the process you’re using to select and monitor your plan’s investment selections.

Indeed, it’s so critical to you and your participants that the Department of Labor has commented in an Employee Benefits Security Administration report as follows (emphasis ours):

“If an investment policy statement has been properly formulated and memorialized, all prudent procedures covered will fall into place. This is predicated upon the fact that liability usually occurs when the fiduciary has failed to act in this area as opposed to acting improperly.”

Here, the DOL makes it clear that a well-built IPS can go a long way toward helping you establish those sound investment options they have in mind. “All prudent procedures covered will fall into place” seems like strong language from a regulatory body.

Building a Solid IPS

Of course all this wonderful protection is predicated on the assumption that the IPS is “properly formulated and memorialized.” Let’s explore what we believe the DOL means by that.

“Memorialized” simply means it should be in writing, reviewed and updated regularly to ensure it remains relevant. If there’s one overarching theme to protecting yourself against fiduciary liability, it’s to leave a wide and well-organized paper trail in your wake!

“Properly formulated” requires additional explanation. Key components include the following:

Identifying the plan’s governing tenets – As described in Investopedia’s description of fiduciary duty, “Most fiduciaries go about this by employing modern portfolio theory (MPT) because MPT is one of the most accepted methods for creating investment portfolios that target a desired risk/return profile.” (MPT and related prudent investment practices have been evolving since their 1950s origin and are beyond the scope of this article. But to summarize, the goal is to offer a dependable model that plan sponsors can use when offering participants solutions for maximizing exposure to available returns while minimizing exposure to associated market risks.)

Describing implementation – Providing specifics on:

  • Risk, return and time horizon parameters
  • Diversification and rebalancing guidelines you’ll use to maintain those parameters
  • Procedures for managing and minimizing investment expenses

Describing roles and responsibilities – Identifying who is responsible for what, among the various parties involved.

Defining available asset classes – What they are, as well as how and why they have been selected. Here, it’s wise to offer access to all major asset classes to ensure the ability to diversify and maximize return while minimizing risk. Because any rule in the investment program that has the potential to limit return becomes a red flag for a fiduciary breach, it’s worthwhile to include riskier asset classes that can be expected to add to a diversified portfolio’s net returns, and/or smooth the ride in seeking market returns. Examples include:

  • US and international small-cap stocks
  • Commercial real estate
  • Commodities

Documenting how you are selecting, managing and monitoring your money managers and their (or your) fund selections – Avoiding the common pitfall of basing decisions on recent performance alone; conducting more telling due diligence on factors such as:

  • Performance relative to appropriate benchmarks
  • Organizational stability
  • Style consistency and composition

To help you begin to envision how your own IPS may look, the 401(k) Help Center offers a sample “picture” of an IPS, which may go far in replacing a thousand more words on the subject.

Selecting Professional Alliances

Some of the details above may feel daunting to those less experienced as investment decision-makers. By hiring a Registered Investment Advisor firm as your Fiduciary Investment Manager, the fiduciary responsibilities related to your fund selections – and associated potential liabilities – can be fully delegated to that manager (although this, too, should be in writing).

It’s also worth inquiring whether that fund manager is willing and able to provide experienced guidance to help you establish and maintain a robust IPS. By building your plan from a well-constructed IPS, you’ll be doing yourself and your participants a substantial favor.

Next Up: The Investment Committee

As powerful as the IPS can be in strengthening your retirement plan and protecting you against fiduciary risk, a policy statement is only effective when it is actually implemented. In our next post, we’ll cover establishing an Investment Committee, to ensure that your best-laid policies become well-managed procedures.

 

Do you like what you’ve read so far? We also offer a complimentary presentation to further explore these best practices with you and other key retirement-plan decision-makers at your company. Please contact us to learn more.

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