Broadly, an investment policy statement (IPS) is intended to outline the rules and policies pertaining to a pool of assets. For this reason, it may include asset allocation guidelines, risk tolerance, and liquidity needs. It is important to take into account that allocation decisions pertaining to nearly all defined contribution plans are determined by the individual decisions of the participants in the plan. As a result, the IPS for defined contribution plans is unique and requires more specific policies, documentation, and construction guidelines.
While the Employee Retirement Income Security Act (ERISA) does not require that all committees utilize an IPS, a properly drafted IPS can serve as a roadmap for the selection and monitoring of investment options offered to plan participants. Additionally, the IPS has become a document regularly requested by auditors and the Department of Labor (DOL) when it conducts reviews of plans.
There is no specific format or technical language that an IPS is required to include. However, there are some categories of content that you might considering incorporating into a best practice IPS.
Your IPS should reference the specific plan(s) that the policy pertains to as well as information about when the policy was adopted (or amended). The IPS belongs to the plan, but changes in approach, law, or best practice, will cause you to amend it from time to time.
Statement of Purpose
We’ve found it effective to include the purpose of the document in all policy documents. For a defined contribution plan, the purpose might be to:
- describe the Plan’s investment goals and objectives
- outline the roles of those charged with managing the Plan’s investments
- describe criteria and procedures for initially screening investments for use in the Plan
- define measurement procedures and monitoring criteria to support ongoing evaluation of investments
- describe when participants might have an investment election defaulted
- define how the default investment alternatives are selected
Goals of the Investment Menu
Here a Committee may articulate their goals for assembling an investment menu. Defining objectives will help future committee members better understand how the current investment structure came to be. Frequently, as part of an investment objectives section, the committee may wish to define the architecture of the investment menu.
Behavioral finance research supports the theory of how investments are presented to participants may heavily influence how they allocate their retirement savings. Defining how the committee views investment alternatives as part of the objectives will also aid the committee in partnering with their retirement services provider; this will ensure they are presented to participants in a way that is consistent with why they were included.
Roles and Responsibilities
It takes a village to operate a successful retirement plan. Various parties are responsible for the management and administration of the Plan’s assets. Those parties may include:
- Plan Sponsor
- Retirement Plan Committee
- Investment Adviser
- Investment Manager
Detailing the specific roles of each party relative to investment execution is frequently included.
Selection of Investment Manager
Generally, committees have different processes for adding an investment than they do for replacing or freezing an investment. Clearly articulate in your policy the factors that you would review when selecting an investment manager.
Investment Monitoring Process
Once investment options have been selected, the process for monitoring them frequently differs (at least slightly) from the selection criteria. Good investment products should generate good returns over long periods of time. In articulating your monitoring process, you acknowledge those time-based differences and will frequently see clear, specific circumstances that might trigger additional review by the committee and its adviser.
If there are investments that the committee is not reviewing (self-directed brokerage or individual contracts outside the control of the committee), the policy should clearly articulate those decisions as well.
Termination of Investment Manager
No matter how good your investment selection process is, eventually you will need to replace or terminate an investment manager. As a fiduciary, you have choices when electing to terminate an investment manager. The IPS should describe the options available to the committee, such as removing an asset class rather than replacing a fund, and how the committee may decide the appropriate course of action.
If Applicable - Environmental, Social, and Governance (ESG) Investments
The Department of Labor (DOL) has spent the last decade providing inconclusive guidance on Environmental, Social, and Governance (ESG) Investments in defined contribution plans. Despite that, the growth of ESG in defined contribution has been very consistent and is projected to continue its upward trajectory. If your plan wishes to have ESG products within its array, addressing DOL concerns in your policy document is an acknowledgment of an awareness of what your fiduciary responsibilities are with these types of products.
Participant Investment Education
While the retirement plan committee likely outsources communications with participants to outside parties, the IPS may be a good place to articulate the philosophy of the committee in regard to how the committee educates participants about the plan.
Default Investment Alternative
The Pension Protection Act (PPA) created a safe harbor for participants that are defaulted into an investment product(s) rather than making an election of their own. While a safe harbor exists for the choice of a default investment option, it does not remove the plan fiduciary’s responsibility for evaluating, selecting and monitoring the default investment alternative within the plan.
Most default investment alternatives shift the investment burden from the participant to the investment manager. As a result default investment alternatives require a different kind of investment due diligence relative to single asset class investment options. The DOL has provided guidance to plan fiduciaries for selecting and monitoring the default investment alternative. The IPS should identify the plan’s default investment alternative and address the process by which the Committee will select and monitor these products.
In the majority of defined contribution plans, the plan ends up paying some, or all, of the expense necessary to maintain the plan. In these instances, the monitoring of plan fees is a critical responsibility of the committee. The fee policy may be as simple as an acknowledgment of a committee’s duties to monitor fees and may be more prescriptive relative to how fees can be incurred or allocated.
If Applicable - Self-Directed Brokerage
Plan sponsors may add a self-directed brokerage alternative to their plan as a method to provide participants with greater investment choices within the plan. This grants a small subset of their employee population the ability to execute investment strategies and access investment products that may escape the bounds of a typical investment menu. Generally speaking, plan fiduciaries do not have a responsibility to monitor the investment decisions of participants utilizing the self-directed brokerage but as a service offering of the plan the fiduciary still has a responsibility to evaluate the service selected. If your plan has these alternatives, the policy document should express the extent of fee and investment review the committee intends to provide within these accounts.
Always refrain from drafting an IPS that requires the committee to act based on specific fact pattern. The IPS is a guidance document not an instruction manual. In your IPS, be sure to address the issue that the committee has been selected (and monitored by the board) to execute on the investment philosophy they have assembled. They should retain the absolute right to act (or not) as they deem appropriate.
Organization of Plan Document
Although the IPS is considered a document of the plan, in the hierarchy of your plan’s documents - it is subordinate to the plan document. While a good IPS should not conflict with a plan document, addressing conflicts that might arise is a best practice.
In the coming weeks, we will be sharing a blog delving into a checklist of best practices that should be kept in mind when drafting an IPS.
For a full picture of creating and maintaining a best practice IPS, read our Guide to Creating and Maintaining your IPS.
Multnomah Group is a registered investment adviser, registered with the Securities and Exchange Commission. Any information contained herein or on Multnomah Group’s website is provided for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Multnomah Group does not provide legal or tax advice.