Investment objectives and constraints are the cornerstones of any investment policy
statement. A financial advisor/consultant needs to formally document these before
commencing the portfolio management. Any asset class that is included in the portfolio has to
be chosen only after a thorough understanding of the investment objective and constraints.
Following are various types of objectives and constraints to be considered and several steps
to correctly determine these objectives.
According to (Graham et al, 2011) an investment policy statement (IPS) is a document
drafted between a portfolio manager and a client that outlines general rules for the manager.
This statement provides the general investment goals and objectives of a client and describes
the strategies that the manager should employ to meet these objectives. Specific information
on matters such as asset allocation, risk tolerance, and liquidity requirements are included in
an investment policy statement. A financial advisor is therefore expected to present a well-
constructed IPS that offers the investor’s financial objectives, the degree of risk he/she is
willing to take, and any relevant investment constraints that the advisor must consider.
According to Geller, (2016) the process of writing a detailed policy statement in the long run
gives the individual investor greater control over their financial destiny. This is because of
the fact that, drafting the IPS has been an educational process where the investor emerges
better able to recognize appropriate investment strategies and no longer needs to blindly trust
the investment advisor. Furthermore, an IPS is portable and easily understood by other
advisors. If a second opinion is needed, or if a new investment advisor must be introduced,
the IPS facilitates a thorough review and ensures investment continuity.
Therefore, the IPS serves as a document of understanding that protects both the advisor and
the individual investor. If at all the management practices or investor directions are
subsequently questioned, both parties can refer to the policy statement for clarification or
support. Ideally, the review process set forth in the IPS will identify such issues before they
become serious.
A common format for an IPS is to split it into sections covering objectives and constraints.
Each section has its own subsections (DeLisle and Worzala, 2012). The objectives are split
into two parts, Risk objectives and Return objectives.
Risk objectives are the factors that are associated with both the willingness and the ability of
the investor to take the risk. When the ability to accept all types of risks and willingness is
combined, it is termed as risk tolerance. When the investor is unable and unwilling to take the
risk, it indicates risk aversion. It must be noted that investors typically have limits on how
much risk they are willing and able to take with their investments. Typically, the higher the
expected return, the higher the risk associated with that return. Equally, the more risk taken,
the higher the expected return. An individual’s risk objective, or the investor’s risk tolerance
is a function of his or her ability and willingness to take risk.
The ability to take risk depends on the situation of the investor, such as the balance between
assets and liabilities, and the time horizon. If investors have far more assets than liabilities,
any losses that result from risk taking may not alter their lifestyle. If investors have a long
time horizon, they have more scope to adjust their circumstances to cope with losses by
saving more or waiting for markets to recover, although recovery and its timing cannot be
guaranteed. Willingness to take risk is often thought of as a more important issue for
individual investors, but even those who oversee institutional investments will have risk
guidelines within which they must operate and that help define their ability and willingness to
take risk (Gardner, 2012).There may be situations in which an investor’s willingness to take
risk and his or her ability to take risk differ. In such situations, the investment adviser should
