The first step of the portfolio management process is to develop a policy statement. The statement covers the types of risks the investor is willing to assume along with the investment goals and constraints. It should focus on the investor's short-term and long-term needs, familiarity with capital market history, and expectations and constraints. Periodically the investor will need to review, update, and change the policy statement.
A policy statement should incorporate an investor's objectives (risk and return) and constraints. It should address the following issues:
Moreover, the policy statement should attempt to answer the following questions:
A policy statement is like a road map: it forces investors to understand their own needs and constraints and to articulate them within the construct of realistic goals. It not only helps investors understand the risks and costs of investing, but also guides the actions of portfolio managers.
Performance cannot be judged without an objective standard. The policy statement should state the performance standards by which the portfolio's performance will be judged and specify the specific benchmark which represents the investor's risk preferences. The portfolio should be measured against the stated benchmark rather than the portfolio's overall performance.
Major components of an IPS include an introduction, statement of purpose, duties and responsibilities, procedures, investment objectives, constraints and guidelines, evaluation and review, and appendices.