Investment policy and guidelines (Part One)

INVESTORS NOTEBOOKBy Elias Mugabe

Introduction FIRSTLY, we take this opportunity to thank the Lord, Almighty for giving us the opportunity to write this article. On behalf of sta

ff, management, shareholders, board and clients of Imperial Asset Management let us welcome you all to the second Investors’ Notebook authored by Imperial Asset Management, the company that makes your assets sweat.


Some investors have requested that we cover issues pertaining to personal investments and these concerns will be fully addressed without compromise in our next issues. However, whether you are investing for individuals, corporate bodies, non-governmental organisations, parastatals or quasi-government firms, the issue of investment strategy, policy and guidelines are fairly standard to an extent that even for personal investment, one can also adopt such robust policy position especially where the investments are significant in value terms.


Purpose


Investment policy is a combination of philosophy and planning. On one hand, it expresses the investor’s attitude toward important investment management issues such as, “Why am I investing in the first place?” or “To what extent am I willing to accept the possibility of large losses?” The answers to those questions will vary among investors in accordance with their financial circumstances and temperaments.


Investment policy is also a form of long-range strategic planning. It delineates the investor’s specific goals and how the investor expects those goals to be realised. In this sense, investment policy comprises the set of guidelines and procedures that direct the long-term management of the investor’s assets.


Infact, investment policy statement is intended to provide guidelines for the prudent investment and outline the policies for maximising the efficiency of a fund’s assets. The investment goal is to enhance the economic condition of the fund while ensuring the safety of funds invested.


Responsibilities


Normally an investment committee is appointed to monitor and review all investments for consistency with investment policy and assume full responsibility for those transactions until the delegation of authority is revoked or expires.


The specific responsibilities of the investment committee relating to the investment management of the fund’s assets include:


*Projecting the fund’s financial needs including estimates of expected net cashflow and communicating such needs to the fund manager consultant on timely basis;

*Determining the fund’s risk tolerance and investment time horizon and communicating these to the appropriate parties;

*Establishing reasonable and consistent investment objectives, policies and guidelines which will direct the investment of the fund’s assets;

*Prudently and diligently selecting qualified investment management firms;

*Regularly evaluating the performance of advisors to assure adherence to policy guidelines and monitoring investment objective progress; and

*Developing and enacting proper control procedures: for example, replacing advisors due to fundamental change in investment management process or failure to comply with established guidelines.


Essentially, any relatively permanent set of procedures that guide the management of a fund’s assets fall under the rubric of investment policy.

Nevertheless, a comprehensive investment policy should address a group of issues that includes (but is not restricted to):


*Mission statement – A description of long-run financial goals. For example, an individual might be focusing on savings for a child’s college education.

A pension fund might be intended to accumulate sufficient assets to fund promised benefits;


*Risk tolerance – The amount of risk that an investor is willing to bear in pursuit of the designated investment missions. An elderly retiree may have a relatively low risk tolerance. Conversely, a well-funded pension fund with a young workforce may have a relatively high risk tolerance;

*Investment objectives – The specific investment results that will indicate when the investment programme has been successful;

*Policy asset mix – The investor’s long-run allocation to broad asset classes such as stock, money market and bonds. This choice is by far the most important decision that the investor makes and should be consistent with the investor’s mission, risk tolerance, and investment objectives; and

*Active management – The extent to which the investor attempts to “beat” the market by hiring investment management firms that analyse and select individual financial assets or groups of securities expected to exceed the performance of specified benchmarks.


Crafting


A critical part of any investment policy involves the preparation of a written investment policy statement (IPS). An investment policy statement summarises the investor’s key investment policy decisions and explains the rationale for each decision. The level of investment policy statement detail will vary among investors. Institutional investors who typically have complex investment programmes should generally prepare more-detailed statements than individual investors.


Nevertheless, an investment policy statement serves the same role for all investors. It enforces logical, disciplined investment decision-making and it limits the temptation to make counter-productive changes to an investment programme during periods of market stress.


Generally, each and every investment policy and guideline will be driven by the perceived ideal portfolio mix eg a fund can be driven by money market assets such as Treasury Bills, Grain Bills, Megawatt Bills or Government Bonds that is Gilt Edged Assets only, or a mix of Gilt-Edged Assets and Bankers’ Acceptances, Negotiable Certificates of Deposit, Promissory Notes and unsecured placements with perceived well-established financial institutions or fund managers. It could also be a fund which invests both on the local money market, Zimbabwe Stock exchange and unlisted funds. Therefore, each and every investment policy will have broad aspects that are perculiar to the situation on the ground.


The investment process describes in detail how an investor should go about making the decisions with regard to what marketable security to invest in, how extensive the investment should be made and with who the transaction is going to be facilitated. A five step procedure for making these decisions forms the basis of the investment process:


* Set investment policy;

* Perform security analysis;

* Construct a portfolio;

* Revise the portfolio; and

* Evaluate the performance of the portfolio.


A fund’s investment policy involves the crafting of broad objectives and the amount of investable wealth. However, due to the positive relationship between risk and return for sensible investment strategies, it is not prudent for an investor to expect high returns without qualifying risk profile acceptable to the fund.


Any investment policy must identify potential categories of financial assets for inclusion on the portfolio/fund driven by investment objectives, amount of investable wealth, and tax status of the investor.


The second step in the investment process is security analysis and it concerns the thorough examination of several individual securities or groups of securities within the broad categories of financial assets. The intention is to regulate assets that are tradeable under the fund’s broad investment objective and such decisions are based on asset type, maturity profile and risk profile etc.


The third step of Portfolio Construction includes identification of those specific assets in which to invest, as well as determining the proportions of the investor’s wealth to put into each one. Critical issues that your policy document should cover are selectivity, timing and diversification.


Selectivity – This refers to security analysis and this focuses on forecasting price movements of individual securities, issuer of the underlying asset, it liquidity and prescribed asset status etc.


Timing – This concerns the forecasting of price investments of common stocks in general relative to fixed income securities such as Government bonds, Corporate Bonds and Treasury Bills etc.


Diversification – Refers to the construction of the investor’s portfolio in such a manner that risk is minimised, subject to certain restrictions.


The fourth step in investment process is portfolio revision, and concerns the periodic repetition of all previous three steps. That is over time an investor may change his or her investment objectives which in turn may cause the currently held portfolio to be less than optimal. Another motivation for revising a given Portfolio is that over time, the prices of securities change in terms of attractiveness and quality.


The fifth and last step is portfolio performance evaluation and involves determining periodically how the portfolio performed, in terms of not only the return earned but also the risk experienced by the fund. This is where appropriate measures of return and risk as well as relevant standard performance benchmarking are needed.


Policy and guidelines


The investment policy statement should authorise the fund manager to deposit and/or invest surplus funds in accordance with the signed asset management agreement between the client and the fund manager. The investment policy and guideline should cover the three objectives of safety, liquidity and yield when making investment decisions;


Safety is the primary objective – Safety and the minimising of risk associated with investing refers to attempts to reduce the potential loss of principal, interest or combination of the two. The investment policy and guidelines should authorise investments only in those instruments that are considered very safe, ie Gilt-edged assets such as Treasury Bills, Pension Funds, Megawatt Bills, Grain Bills, Government Bonds etc. The securities to be accepted for money market deals should ideally have a maturity profile of less than 90 days, while above 180 days the trading deals must be marked to market.


Liquidity is the secondary objective – Liquidity refers to the ability to convert an investment to cash promptly with minimum risk of losing some portion of principal or interest. A portion of the portfolio should be maintained in liquid short-term securities which can be converted to cash if necessary to meet disbursement requirements.


Yield is the third objective -Yield is the average annual return on an investment based on the interest rate, price, and length of time to maturity. The fund must attempt to obtain the highest yield possible, provided that the basic criteria of safety and liquidity have been met.


A complete investment policy and guidelines must cover internal controls, methods of selecting the respective fund managers, determination of management fees, address security issues and performance benchmarking etc. In our next issue we will concentrate on the aforesaid areas. The essence of these weekly investment updates from Imperial Asset Management is to facilitate direct communication between the company and its existing and potential clients. If you believe that you need to discuss some of these issues in detail, please feel free to contact, Shadreck C Vera on 791497, Reuben Alberto on 791499, Zororo Mukungunugwa on 773787 or any of our investment executives on general lines 791469/73/76/79.


We say to the institutional investors, fund managers and individual investors: move a step forward by establishing a business relationship with the only fund manager in Zimbabwe that will surely make your assets sweat.


* Elias Mugabe is the finance & risk director of Imperial Asset Management Company and can be contacted through emugabe@imperialasset.co.zw

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