Why is a well-crafted investment policy statement vital?

A comprehensive investment policy statement is vital to your foundation sustaining its organizational purpose and achieving its giving goals.

The benefits of a well-crafted investment policy statement

Strive for an IPS that does more than simply allow you to “check the box.” A valuable IPS goes beyond establishing basic investment guidelines. It will deliver other important benefits too.

Reduce the impact of emotions and subjectivity

Following your IPS’s guidelines can reduce portfolio risk and increase return, particularly when turbulent markets occur. Portfolio changes that are based on emotion rather than process can best be described as guesses and subjective. These decisions are usually unsupported by thoughtful analysis or evaluation of the potential impact on the portfolio.

Instead, using the IPS’s portfolio management rules means that a well-defined process guides decision making. It also eliminates (or greatly reduces) the potential negative impact of emotions or individual opinions about the most suitable course of action.

Eliminate or address conflicts of interest

In addition to a duty of care in decision making and duty of obedience to the foundation’s mission, trustees are bound by a fiduciary duty of loyalty to avoid or address conflicts of interest that might result in personal benefit.

For example, whereas it may be convenient or “tradition” at many foundations for a board or family member to manage the investment portfolio, the potential for a conflict of interest exists if he or she is compensated for this task.

What may be an appropriate investment strategy for the individual portfolio of a board member may not serve the best interests of the foundation and its corpus. Moreover, the compensation of brokers and dually registered firms may wholly or partially depend on the products they recommend for your investment program.

Establishing written investment guidelines and portfolio management rules will set clear boundaries for the roles and responsibilities of all parties engaged in the process.

Protect the corpus

Some organizations adopt separate spending and withdrawal policy documents. Others include spending and withdrawal guidelines within the IPS. In either case, how the organization chooses to manage its spending can have a dramatic impact on the corpus, and may result in unintended spend down.

For example, a simple spending plan normally includes at least a 5% annual allocation for grants and expenses, but might also include provisions for increased spending in years when actual portfolio returns are higher than 5%. Assuming the portfolio achieves the IPS’s targeted (average annual) rate of return of 5% or greater, the corpus remains stable. However, investment markets are inconsistent and do not provide guaranteed returns every year.

When markets have down years, portfolio returns may be less than the targeted average annual rate of return. Spending at the 5% level in these years can trigger an unanticipated spend down of the corpus, unless prudent advance plans have been adopted in the spending and withdrawal sections of the financial governance documents.

Even though changes in fiduciary and trust statutes have given trustees greater latitude in spending interest, dividends, and capital gains above the historic dollar value of the initial corpus, it can still be a challenge to manage the variable portfolio returns and mandatory spending levels.

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