5 Big Mistakes With Investment Policy Statements

The end of a record-long bull market and the return of greater volatility are presenting new challenges for fiduciaries. Many are discovering that their current investment policy statement (IPS) documents can be a hindrance rather than a help. It may be time for a rewrite.

A well-written IPS helps defined contribution plan fiduciaries establish and follow a prudent, thorough and well-documented investment process through market cycles. Unfortunately, not all IPS documents are well-written, and even a well-written IPS may no longer meet the changing needs of a plan.

In a discussion with regional retirement consultants and clients, Brad Campbell shared five tips for getting more flexibility from the language of your IPS.*

Don’t Let the IPS Tie Your Hands

“While it’s not technically required, we advise most plans to have [an IPS],” said Campbell. “You need to have a prudent, thorough and well-documented investment decision-making process. That's ultimately what protects you under ERISA. That process is your protection, and the IPS documents describe that process—but the IPS should describe how fiduciaries decide and doesn’t tell them what to decide.”

Campbell highlighted a common misconception many plan sponsor fiduciaries have about the IPS and investment monitoring outcomes:

Even if the plan’s IPS was adopted years ago, before the historic bull market, it still may not be well-suited to addressing current conditions of negative performance and volatility. Therefore, fiduciaries should periodically review and revise their IPS to ensure it meets the plan’s needs.

Focus on a Prudent Process, Not "Underperformance"

An effective IPS should not replace a fiduciary’s discretion to make a prudent decision simply because of performance. While past performance is among the relevant factors fiduciaries should consider, it is not the only consideration, said Campbell.

“When you periodically review an investment and decide whether to retain it, you're essentially making a new decision based on current circumstances. It could be the prudent answer to say, even though this investment has underperformed in the past, it is well-situated for the new market conditions we anticipate, and given our plan needs, it remains a prudent part of our overall portfolio,” stated Campbell.

Take for example a target-date fund with a moderate glide path that underperformed in sharply rising markets. A fiduciary prudently could determine that it is well positioned to meet participant needs in the next cycle and therefore retain it. The fiduciary using discretion, not the mechanical text of the IPS, should decide which glide path is prudent for plan participants based on each plan’s unique facts and circumstances.

Having a sound process—and documenting it—makes your decision prudent, even if the market goes down and an investment loses money, according to Campbell.

Know the Power of Words in the IPS—and One "Magic" Word

Write your IPS with flexibility in mind. For example, rather than specifying that plan fiduciaries must divest an asset after a certain period of failing to meet a benchmark, the IPS could instead provide a process for putting the investment on a watchlist for additional review.

Discussing a recent Department of Labor (DOL) enforcement investigation, Campbell gave an example of how IPS language could be read to require fiduciaries to take action rather than preserve their discretion.

One way Campbell identified to help maintain the flexibility needed to make prudent decisions in all types of market conditions is using “may” in place of “shall.” “May lays out what the fiduciary gets to decide, while shall defines what they’re compelled to do.”

Have the Allocation Debate on TDF Glide Paths

There are answers that make sense on both sides of the “to” vs. “through” glide path debate, said Campbell. The DOL explained in its 2013 guidance, “Target Date Retirement Funds - Tips for ERISA Plan Fiduciaries ,” that selecting an appropriate glide path for your plan is an essential part of a prudent fiduciary process. Campbell recommended reviewing this guidance and incorporating its requirements into IPS language addressing the target-date fund (TDF) selection process.

Campbell suggested plan sponsors ask themselves these questions when debating whether to choose a less or more conservative allocation at a target date:

• What do participants typically do with regard to contributions, distributions and rollovers?

• Are they accessing the money immediately upon retirement?

• If not, when are they accessing their retirement savings? Upon achieving the target date? After the target date?

Adopt a Change to the IPS—Plan Amendment Not Required

Sometimes, IPS documents can be too prescriptive in the metrics they’re using to monitor investments. As a result, fiduciaries may find themselves in a situation where they believe the most prudent decision is to keep an investment but feel compelled not to because of the way the IPS is written.

“Take a look at your IPS, especially if you haven’t in recent years,” Campbell urged plan fiduciaries. “If you're not happy with what it's telling you to do, go ahead and adopt a change. Doing so is typically quite easy, and not nearly as formal as the process for a plan amendment.”

^{*Comments have been edited for length and clarity.}