Economic conditions, securities markets, people and philosophies tend to be in a perpetual state of flux. Constant change can undermine commitment to a long-term investment plan; however, when an organization has a comprehensive investment policy statement that sets forth long-term strategic direction, investment guidelines, and accountability standards, the course is well established and, over time, goals are more likely to be achieved.

Having a well-drafted investment policy statement gives organizations the discipline to face the uncertainties of challenging investment environments. Removing emotion from the equation positively correlates with better results for the investment portfolio, leaving the healthcare organization better positioned to manage its assets effectively.

Executive Summary

An investment policy statement (IPS) is an investment management document drafted by an asset-owner, often with the help of an investment advisor or consultant. The document serves as a strategic guide in the management of the assets specified in the IPS and outlines the fiduciary responsibilities of those groups and individuals involved in the oversight of the assets. Documentation of the objectives and constraints are critical in determining the appropriate enterprise-wide strategic asset allocations for each investment pool.

Examples of other important information to document include:

  • The purpose and objectives of each asset pool, including examples of what each asset pool is intended to support through distributions.
  • Portfolio parameters, identifying suitable investment styles and vehicles to employ in the portfolio, as well as tactical asset allocation ranges that managers may utilize in order to take advantage of market dislocations.
  • Risk management control procedures, performance, and client service/reporting requirements may also be outlined.

Taken as a whole, this strategy of documentation can help to increase the likelihood of achieving long-term financial goals. We recommend that the IPS be reviewed at least annually and as a response to material changes in an organization’s circumstances or capital market assumptions. The IPS is meant to be a portable document that can be easily understood by anyone involved in the investment process. It is important that parties involved in the oversight of assets acknowledge they have reviewed and acknowledge the most recent IPS.

In this piece, we focus on creating an IPS for healthcare organizations. This can be done through a single IPS with callouts to the different asset pools or through a distinct IPS specific to each investment pool. The decision is ultimately up to the preference of those overseeing the investment function of the Healthcare system.

As a note, we will focus on where the enterprise is responsible for the assets (e.g., cash reserves, foundation, defined benefit plan, and health insurance or captive insurance pools) and exclude where they would not be responsible for the assets (e.g., participant-directed defined contribution plans such as a 401(k) or 403(b) plan). While we would recommend that most participant-directed defined contribution plans have an investment policy statement, we would recommend it is kept separate from the other asset pools.

Components of an IPS

To help organizations develop a robust IPS, we have outlined the sections commonly included (Figure 1).

Figure 1: Sections Outline

Source: PNC

View accessible version of this chart.

Not all of these apply to every type of asset pool. We suggest working with your legal services firm and investment advisor to determine which are appropriate for a given pool. In this paper, we will try to explain the “what” and “why” of each section, as well as noting any special considerations.

I. Governance

Governance largely defines three elements: the purpose and scope of the IPS, the definition of duties for parties outlined in the IPS, and the investment philosophy.

The Purpose and Scope

Purpose and scope often serves as a table of contents or summary of what the IPS will include and will also identify the specific assets governed by the IPS. For healthcare organizations, this should identify each of the asset pools within the investment program. Purpose and scope should clearly state the general goals and objectives of the organization and of the investment policy statement. Providing a clear understanding of the purpose of the funds can help the Investment Advisor to meet your organization’s investing objectives.

This section may further detail what assets are covered by the IPS. Specifically, which assets should comply with the strategic asset allocation set forth within the document.

Definition of Duties

This section identifies possible key stakeholders, those individuals or groups with fiduciary responsibilities, and may outline how they are accountable for the assets governed by the IPS.

The definition of duties outlines the roles and responsibilities of boards and staff. Some of the more important responsibilities to identify individuals or groups accountable for include:

  • Developing and executing investment policy
  • Development and affirmation of capital market assumptions inputs
  • Preparation and review of investment performance & risk management reports
  • Annual review and updates to the IPS
  • Selecting and removing consultants and investment advisors

It is necessary for the IPS to enumerate clearly the responsibilities and expectations of all parties involved. Some of the main parties and responsibilities may include:

Management, board of directors, or trustees — This section lists what responsibilities come under the asset-owners. Typically, such responsibilities include fiduciary responsibility for the investment portfolio and general responsibility for maintaining and reviewing the IPS for accuracy and relevancy. Ultimately, the board is accountable to care for and protect the assets as established by the guidelines of the IPS.

Investment committee — If applicable, this section identifies the investment committee’s responsibilities, which typically include hiring and firing investment personnel, reviewing fund performance, providing governance and oversight of the asset pool, and implementing the IPS in a timely and accurate manner. If there is no investment committee, these responsibilities fall to the board of directors.

Outsourced chief investment officer (OCIO)/investment advisor/consultant — This section identifies who is responsible for guiding the asset-owners in all areas of investing that relate to the assets being managed. These include, but are not limited to, recommendations for and review of the IPS, asset allocation, ongoing investment manager selection (internal or external), portfolio review, and performance assessment. In addition, it is important to determine whether fiduciary responsibility is shared.

Investment manager(s) — Investment managers refer to the managers of the various investment vehicles used to construct the investment portfolio. Specifically, these refer to the separately managed accounts, mutual funds, exchange traded funds, hedge funds, etc. in the investment portfolio. The IPS should specify exactly what the investment managers are being hired to do, in addition to the level of discretion and authority the they have over their segments of the portfolio(s). Whether tasked with maintaining diversified portfolios or implementing a single strategy, investment managers are responsible for investing within the confines of the IPS.

Custodian — The custodian safeguards specific financial assets. Their responsibilities might include controlling access, settling trades efficiently, collecting investment income and principal, and/or collecting and disseminating investment portfolio performance.

Investment Philosophy

Finally, the investment philosophy outlines the asset owner’s preferences and expectations for the investment process, the investment advisors, and other general considerations.

It is important to establish expectations at the onset of any endeavor. Without expectations, it is impossible to measure success or the attainment of goals. This section should outline the expectations for both the parts and the whole of the investment assets, cover the process, expected behavior, and the definition of success. A few topics we recommend discussing include:

  • The need for and benefits of diversification across asset classes
  • Expectations of active managers and passive managers
  • How risk management is defined, executed, and reviewed
  • The inclusion or exclusion of alternative investments

These expectations and beliefs may be specific to your organization. By defining them, your organization will be properly able to measure success.

II. Objectives and Constraints

Note: For healthcare organizations with more than one asset pool, we recommend documenting part two and part three for each asset pool.

The long-term strategic asset allocation(s) is the culmination of capital market expectations, and objectives and constraints. The OCIO/investment advisor/consultant typically provides the former, but the latter requires input from your organization.

When defining objectives and constraints, we recommend addressing: statement of goals, return objective, risk tolerance, time horizon, liquidity requirements, and unique circumstances. In this part, we address what may be appropriate considerations when defining these factors.

Statement of Goals

For healthcare organizations, a statement of goals generally describes the use or purpose of each asset pool. While this list is not intended to be comprehensive of the variety nor definitive for specific asset pools, examples of goals might include:

  • Operating cash, where turnover is expected every 30-60 days and distributions are intended to support funding short-term operating expenses
  • Reserve cash, where turnover is expected every 12-18 months and distributions are intended to support funding intermediate-term obligations such as prefunding acquisitions or paying for unexpected expenses
  • Strategic cash, where cash is reserved as a “rainy day fund” and distributions are intended to prevent disruptions to the long-term investment strategy
  • Long-term operating pools, where cash is set aside for long-term growth toward supporting future strategic opportunities or large capital expenditures
  • Endowments and foundations, where investment objectives are generally to provide a permanent asset base for funding specific activities or meeting required spending rules
  • Defined benefit plans, where the primary objective is generally to fund the payment of pension liabilities and secondary objectives might include minimizing the year-to-year volatility of future contribution payments, minimizing funding status volatility, or increasing year-over-year funded status
  • Defined contribution plans, where the primary objective is to provide a framework for supervising, monitoring, and evaluating a broad range of investment options in appropriate asset classes
  • Captive insurance pools, where the primary objective might be to invest insurance premiums within an appropriate risk profile to help cover potential insurance claims   

Within each of these categories, the investment objectives should be sufficiently specific to be meaningful, but adequately flexible to be practicable. These objectives are designed to establish an attitude and philosophy that will guide the investment advisors toward the desired policies and performance.

Spending Rule (typically for Foundation or Endowed Asset Pools only)

This section is applicable to investment programs that are intended to fund a distribution. We recommend that the board and the investment committee adopt a spending rule, by defining the amount of distributions, to instill discipline into the budgeting and financial management process. A spending rule assists decisionmakers determine the pool’s required rate of return and risk tolerance objectives, which in turn may lead to less volatile distributions from year-to-year and improve the visibility of distributions. There are generally three main spending rules to consider to determine target distribution (Figure 2):

Figure 2: Three Main Spending Rules

Spending Rule Calculation
Simple spending  Spending rate * beginning period market value
Rolling 3-year average spending  Spending rate * average of the previous 3 years’ market values
Geometric spending  (Prior year’s distribution adjusted for inflation * smoothing rate) + (beginning market value * residual of the smoothing rate)
  1. Simple spending rule
  2. Rolling 3-year average spending rule
  3. Geometric spending rule

For more information on spending policy considerations, please see our white paper Spending Policy: Development and Implementation.

Return Objective(s)

The investment objective and return requirements should clearly define what the organization hopes to accomplish over a full market cycle and/or multiple market cycles. It is also sometimes important to consider the spending policy or distribution plans when setting a return target. Precisely outlining the organization’s needs for growth and liquidity helps the investment advisor determine and execute a strategy to achieve the objective. It is important to note that each asset pool should have its own specific return objective.

In defining a return objective, there are number of different approaches. Within the limits of this paper, we focus on three common methods: risk-focused, targeting above the return of a benchmark index, and targeting an absolute return level. We suggest working with an investment advisor to determine the best approach for a given asset pool.

  • Risk-focused return objectives — Some asset pools can be classified as “risk-focused pools,” including short-term cash, insurance, and pensions. These pools typically define return in terms of acceptable risk, whether in statistical terms (e.g., below a certain standard deviation level), financial terms (minimizing the funding status volatility of a pension), or in investment universe terms (e.g., only being allowed to invest in investment grade fixed income).

    As an example, the risk tolerance of a defined benefit plan is determined by the plan and plan sponsor characteristics. Specific factors include the current financial condition of the sponsor and the funded status, time horizon, and liquidity needs of the plan. As a result, the return objective for a defined benefit plan is often calculated by an actuary as a balance of the risk tolerance of the plan sponsor (e.g., with regard to contributions and funded status volatility) and the return needs of plan assets necessary to fund future benefit payment obligations.

  • Targeting above the return of a benchmark index — This category is one of the most common types of return objectives. Examples include both portfolio-specific measures, such as a blended benchmark (e.g., 60% S&P 500, 40% Bloomberg Global Aggregate Index), and portfolio-agnostic measures, such as “Consumer Price Index Inflation + 5%.”
  • Targeting an absolute return level — Targeting an absolute return level is as straightforward as it sounds: calculating a level of return that will meet a financial objective and optimizing a portfolio that minimizes risk against that return level.

 As an example, Figure 3 provides an example of using a desired annual distribution level (4.25%) to determine an appropriate return objective that will help to preserve the purchasing power of the assets.

Figure 3: Desired Annual Distribution Level Example

number  
Distribution 4.25% of market value
Inflation 2.00% over the long term
Fees  0.50% of market value
Return Objective [(1.0425) * (1.02) * (1.005)] -1 = 6.87%

Thus, for the example, the return objective would be rounded to 6.87%. By solving for the return objective this way, the organization will have an absolute benchmark for measuring the success of the investment program at meeting its distributions while preserving real purchasing power.

Risk Tolerance

Healthcare organizations can benefit from taking a holistic approach to managing their investment assets. Many organizations today focus on the strategic role of unrestricted assets and how the inherent risk of managing these asset pools contributes to overall organizational risk. Furthermore, healthcare organizations generally have more than one investment pool with distinct objectives, including retirement plans, operating reserves, foundations, and self-insurance pools.

As a result, healthcare organizations should take operational matters, liabilities, debt covenants, and other enterprise financial factors into consideration when managing the overall investment program.

Unlike required return, which an organization can solve for quantitatively, evaluating risk tolerance may be difficult to assess. This difficulty is exacerbated by the need to aggregate the risk preferences of multiple decision makers.

A key principle of determining the risk tolerance for an organization involves assessing “willingness vs. ability.” Even if the organization is willing to reach out as far as possible on the risk scale, the appropriate level of risk should not exceed the ability of the fund, given a proper assessment of the fund’s constraints. The risk tolerance section should speak clearly to the acceptable level of risk in as much detail as necessary, while remaining within prudent levels of practicality.

An example of a risk tolerance statement for a general asset pool is as follows:

“It is understood that a certain level of risk is required in order to meet return requirements; however, the investment advisor(s) are expected to seek to minimize risk against the return objective.”

Certain pools, such as defined benefit plans, might require more specificity. To continue the example for the case of a defined benefit plan, some of the factors that affect risk tolerance include: funded status, plan status (open, closed or frozen), contribution policy, benefit structure, and organization objectives. An example of a risk tolerance statement for this type of asset pool is as follows:

“It is understood that a defined benefit plan should balance risk tolerance, defined as funded status volatility, with return requirements.”

We recommend working with your investment advisor and legal counsel to determine an appropriate risk tolerance statement for each of your investment pools. For more information on enterprise investment risk management, please see our article, A Holistic Approach to Investment Management for Healthcare Providers.

Time Horizon

Your organization should state in this document the time horizon for each of the asset pools. This is important for making decisions related to the management of the assets, including acceptable volatility levels, liquidity needs, credit quality, and other factors.

As a general rule, there is typically a positive correlation between time horizon and return expectations. Taking too short of a time horizon with investments reduces return potential, while taking too long can cause liquidity risk for the plan.

Liquidity Requirements

Liquidity needs will vary by asset pool. Generally, the risk tolerance of a portfolio decreases as the uncertainty around spending and liquidity requirements increase. For example, a portfolio with volatile timing around cash outflows would generally have a lower risk tolerance than a portfolio that defines cash outflows on specific dates. Specificity here can help investment advisor(s) determine the appropriate strategic asset allocation and portfolio investments relative to the distribution objectives of the asset pool.

As an example, for defined benefit plans, a given plan’s liquidity requirement is equal to the net cash outflow in a given year. Net cash outflow is defined as benefit payments minus pension contributions. Explicitly stating the expected net cash outflow and/or schedule of expected net cash outflows can help the investment advisor to match the time horizon of plan assets with that of plan liabilities.

Unique Circumstances

In this section, an organization can list any special objectives, constraints, rules around abnormal distributions (i.e., for emergency purposes), or other policies that could affect the investment program. An example of this is responsible investing (RI). Here the organization would list any preferences they expect the investment advisor(s) to follow, such as removing companies that produce revenue from alcohol, tobacco, and firearms from the portfolio. This section can also include whether or not the investment program is allowed to invest in alternative assets, in addition to any policies around the approval process (i.e., if the board needs to approve each alternative investment).

For more information on responsible investing, please see our white paper, Responsible Investing: A Ripple in Still Water.

III. Portfolio Parameters

Note: as previously mentioned, for healthcare organizations with more than one asset pool, we recommend documenting part two and part three for each asset pool.

This section of the IPS should explain the investment process. This includes: strategic asset allocation and benchmarks, rules for manager selection and retention, types of securities allowed, and rules for portfolio rebalancing.

Strategic Asset Allocation and Benchmarks

We recommend the target asset allocation reflects the organization’s long-term strategic view and the stated goals for the designated funds. Asset allocation guidelines will vary in specificity by organization and asset pool. Some organizations may prefer broad parameters, setting targets for equities, fixed income and/or cash for each asset pool. Other organizations may be more precise, segmenting the major asset classes into smaller categories such as large cap, mid cap, and small cap equity (Figure 4).

Figure 4: Asset Allocation Guidelines

Asset Class Minimum Target Maximum Evaluative Index
U.S. Equity        
Large Cap        
Mid Cap        
Small Cap        
REITs        
Non-U.S. Equity        
Developed        
Emerging        
Global        
U.S. Fixed Income        
Short        
Intermediate        
Long        
High-yield        
Non-U.S. Fixed Income        
Developed        
Emerging        
Global        
Alternatives        
Hedge Funds        
Private Equity        
Private Debt        
Private Real Estate        
Natural Resources        
Cash or Cash Equivalents        

This section of the IPS may also set restrictions on how much or how little an investment advisor may deviate from the allocation target for a given asset class or category. Restrictions should be considered carefully given the potential benefits of allowing investment advisors to tactically allocate assets based on prevailing market opportunities and conditions. While narrow ranges may overly restrict asset managers, too much latitude may allow asset allocation to deviate from the overall investment objective.

We also recommend using this section to establish the benchmarks for measuring the relative performance of each asset and sub-asset class. Further, we recommend establishing an absolute benchmark, or hurdle rate, to serve as a measure of success in meeting the overall goals of each asset pool in the investment program. Investment returns below the absolute benchmark would imply failure to meet the asset pool’s objective, whereas above this number would imply that it is meeting its objective.

Selection and Retention Criteria for Investments

Managers should be given discretion to manage funds in accordance with the style for which they are employed, provided they comply with the restrictions and limitations set forth in the IPS. Important criteria for investment selection may include: 

  • Manager’s investment style, discipline, and track record
  • Past performance, considered relative to other benchmarks and other strategies having the same investment objective
  • Historical volatility and down-side risk management
  • Size of the organization as measured by the amount of assets under management with respect to the investment style under consideration
  • Experience of the organization as measured by the tenure of the professionals with respect to the investment style under consideration 

Types of Securities Allowed

While risk and volatility are present with all investments, high levels of relative risk are to be avoided in every asset class.

Diversification by asset class, sector, industry and issuer limits, maturity limits and, to the extent possible, management style, can be used to reduce risk. We recommend this section clearly outlines prohibited investments as well as any other restrictions, such as types of securities, weighting limits, quality standards, or liquidity requirements. Mutual funds, if used, should have investment objectives consistent with the investment guidelines set forth in the IPS.

Exclusions and limitations can help reduce risk, but they can also reduce the investment opportunities available to managers. A list of prohibited investments can prevent unfamiliar and/or undesired securities, perhaps for responsible investing purposes, to include in the portfolio.

Portfolio Rebalancing

The purpose of rebalancing is to maintain the asset allocation within the ranges set around the strategic baseline. This section may specify how often the portfolio is rebalanced and how much discretion the investment advisor(s) have in managing asset class weight drift from the targets established in the strategic asset allocation. We recommend outlining the procedure for remedying weight drift outside of the ranges for investment advisors.

In certain circumstances it may make sense for the weights to remain outside of the targeted ranges for a period of time. In these cases, the IPS should provide a procedure by which the decision makers would approve these temporary deviations from the policy.

IV. Risk Management

This part may cover both the operating and investment risks of the investment program. We recommend the control procedures section discusses the investment review schedule for performance and compliance. Performance objectives should define to measure the investment program’s success.

Control Procedures

In this section, the healthcare organization may reiterate its performance expectations and establish an investment program and asset pool(s) performance review schedule with the investment advisor(s). This section can clarify the performance periods that are important to the organization. Measuring performance over full market cycles may more accurately reflect progress toward the organization’s stated goals, while analysis of shorter time periods may help explain the impact that certain investments have on the portfolio(s).

It is important to state the focus of the reviews, including topics such as:

  • Investment advisor’s adherence to the policy guidelines
  • Comparison of results to the benchmark(s)
  • Material changes in the investment advisor’s organization, such as philosophical or personnel changes

This section may also include circumstances in which your organization would consider terminating an investment advisor, such as: deviation from the IPS guidelines or from investment disciplines and processes, or when the organization has any material problem or concern regarding the investment advisor.

Performance Objectives

Investment performance should be reviewed regularly, such as on an annual basis. However, performance should be focused on results over a full market cycle (typically a three-to-five year period). The organization should review overall policy and investment objectives on at least an annual basis and adjusted, if necessary, after consultation with the appropriate parties.

We recommend measuring advisor and manager performance against policy objectives for consistency with the total return objectives, evaluated on a net-of-fees basis.

Regarding benchmarking, the overall portfolio should be measured against an appropriate, often blended, index that measures both the return and risk profile of the portfolio. This blend should be based on the strategic allocation, incorporating the target levels of equity, fixed income, and/or alternative assets comprising the portfolio(s).

V. Client Service

This section may include expectations regarding communications and reporting from the organization’s investment advisor(s) and/or consultant. This section may also address the frequency of in-person meetings and the method(s) of communication. Clearly establishing these expectations at the onset can help a board manage the investment program and lead to better interactions between the organization and those assigned to manage its assets.

Communications

It is important for the investment advisor(s) provide performance evaluations on a regular basis. This section may require that managers provide regular accounting of transactions, portfolio holdings, yields, current market values, summary of cash flows, and calculations of the portfolio’s total rate of return.

Establish a reasonable, baseline frequency of communication, such as on the basis of “as market conditions and the portfolio warrant,” to ensure full transparency.

It may be stated that significant changes within the investment advisor’s operations or personnel, and the anticipated impact on the portfolio(s), should be brought to the committee’s attention.

Reporting

Setting the expectations for reporting can facilitate transparency and access between the healthcare organization, investment advisor(s), and other relevant parties. A schedule for portfolio activity and asset holding reports, in addition to tactical and strategic updates, may be established at the onset of the relationship. The language may further specify that the investment advisor is responsible for frequent and open communication regarding all significant matters pertaining to the investment of assets.

Organizations should schedule account and report reviews at the appropriate time. Quarter-end and year-end reports take time to produce, reviews and reports scheduled soon after a period’s end will necessarily lack some of the details and clarity that later reports can provide.

We recommend balancing the need for urgency with the level of detail desired, sometimes the two are mutually exclusive.

VI. Acknowledgment

The last part of the IPS should acknowledge the importance of following the guidelines, rules, and best practices incorporated within the document. A sample acknowledgment would be as follows:

We, the undersigned, recognize the importance of adhering to the policies and strategies detailed in this policy and agree to work to fulfill the objectives stated herein, within the guidelines and restrictions, to the best of our ability.

The acknowledgment signifies that all parties read the IPS and states their mutual intention to follow the letter and the spirit of the document.

Conclusion

In summary, the points to address in an IPS include: naming those with fiduciary responsibilities, documenting objectives and constraints, outlining a strategic asset allocation, defining how success is measured, and setting standards and a schedule around performance reviews.

Every IPS should address the preceding points in some detail. When addressing each point, the organization should be certain to set forth not only “what,” but also “why.” Once a draft of the statement is complete, the entire document should be carefully reviewed to identify and resolve inconsistencies. When all points are consistent and the organization’s leadership agrees, they should adopt the final document.

Thus, the IPS may serve as the blueprint for institutional investment programs. It may serve as a foundation for the organization’s overall governance structure and can ensure fiduciaries fulfill their responsibilities and obligations. At PNC, we believe that a document created with such a level of care will result in an investment experience that is fully integrated and aligned with the needs and objectives of the overall organization and increase the likelihood and probability of success over the long term.

Ready to Help

For more information, please reach out to your PNC Representative or Todd McCullough, Managing Director of Healthcare Solutions, at todd.mccullough@pnc.com.


Accessible Version of Charts

Figure 1: Sections Outline

 
I. Governance
Purpose and scope
Definition of duties
Invesment Philosopy
II. Objectives and Constraints
Statement of goals
Spending rule
Return objectives
Risk tolerance
Time horizon
Liquidity requirements
Unique circumstances
III. Portolio Parameters
Asset allocation and benchmarks
Selection and retention
Types of securities
IV. Risk Management
Control procedures
Performance objectives
V. Client Service
Communications
Reporting
VI. Acknowledgement