Insights from the experts in investment fiduciary responsibility.

Fiduciary Excellence Part 2: Formalizing the Investment Strategy

Posted by Terra McBride, MBA, AIF®, Vice President of Marketing & Professional Development on January 15, 2019

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Fiduciary Excellence Part 2: Formalizing the Investment Strategy

In my previous post, we reviewed what it means to act as a fiduciary and we discussed what we here at Fi360 believe is the first step to enacting a fiduciary process – Organize. Step two of the Fiduciary Quality Management System is to Formalize your process. Michael Muirhead, AIF®, PPC®, senior vice president, learning and development at Fi360, hosted a great webinar focused on the second step of the Fiduciary Quality Management System, during which he gets into some details we won’t touch on here, like how to approach diversification, defining the investment profile, calculating risk and asset selection. I encourage you to check out that webinar for a deeper dive.

Let’s dig into one of the most important pieces of building any plan – the Investment Policy Statement or IPS. As an employee at Fi360, I feel like we talk about the IPS non-stop. However, it is the foundational document that formalizes the overall strategy for investment fiduciaries. While ERISA never uses the term “Investment Policy Statement”, case law suggests not having an IPS could constitute a breach of fiduciary duty.

Benefits of an IPS

Creating an IPS is 100 percent worth the effort. Here are four reasons why.

  1. In the event of an audit, litigation or some type of dispute, the IPS provides a paper trail for how the portfolio is being managed.
  2. The IPS will help mitigate what we like to call “Monday morning quarterbacking”. In other words, the IPS documents how the portfolio was being managed and that the process was agreed upon by everyone involved. Should a new trustee or advisor take a look at the portfolio, the IPS will help eliminate any second guessing about how decisions are being made.
  3. During stressful market scenarios, the IPS is the sort of North Star for how to proceed through the turmoil, helping to insulate the decision makers from market noise.
  4. Fiduciary excellence can only be achieved through prudent processes, consistently applied. The IPS is the governing document that allows for consistency in that prudent application.

The Essential Elements of an IPS

There are tons of resources out there that can help you construct an effective IPS. We have a few of our own. Whatever method you choose to develop your own document, make sure it includes the following components.

  • Plan purpose including governing law
  • Duties and responsibilities
  • Risk, return and time horizon parameters
  • Diversification and rebalancing guidelines
  • Due diligence criteria for selecting investment options and service providers
  • Procedures for controlling and accounting for investment expenses and service providers
  • Monitoring criteria for investment options and service providers
  • Signatures

It may seem silly to include signatures on the list of essential elements, but you would be shocked to see how many IPSs are created but not signed by all relevant parties. Without signatures, the legal standing of your IPS could be challenged.

Using the IPS to Limit Liability

The primary reason a plan sponsor will outsource functions related to the plan is to mitigate their fiduciary liability. The IPS clearly helps with that purpose, but an IPS isn’t effective unless it’s formally adopted.

We strongly suggest having the document reviewed by an attorney who has some familiarity with the laws and regulations associated with the applicable portfolio. Again, have the IPS signed by all parties named in the document. Next, be sure to implement the policy by following the written guidelines when selecting and monitoring plan investments and service providers. Remember, the IPS is the advisor’s roadmap for making investment selections. Use it! And finally, document that the IPS is being followed during annual reviews and update it if necessary.

Practical Takeaways

If you’re new to a plan and an IPS exists, review it. We have found that most IPS documents could be improved or updated. So, understanding the key components of IPS construction can open doors and provide opportunities. 

The process of selecting and monitoring plan assets is one of the most critical functions a plan fiduciary can take on. Understanding the important aspects of the IPS is a vital fiduciary function for existing clients but it also creates a new business opportunity for advisors to demonstrate their worth as educators and experts for prospects.

Fun fact: References to fiduciary principles can be found dating back to 1790 B.C. In fact, the core facets of fiduciary principles can be found in ancient texts of each of the major religions. So, we’re obviously understating things when we say the concept of fiduciary duty isn’t a new one.

Feb. 28, 2019 is National Fiduciary Day! In celebration of the occasion, we are featuring each our Prudent Practices® right here. Stay tuned to the blog throughout this month for subsequent posts that highlight the other steps of the Fiduciary Quality Management System.

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