Northrise University

30029 Kitwe - Ndola Dual Carriage Highway. P.O Box 240271, Ndola, Zambia.

ASSIGNMENT COVER SHEET

Student ID: 1905504

Student Name: Patrick Chibabula

Course Code: FIN306

Course Title: Investment Analysis and Portfolio Management

Instructor Name: Mrs. Jessie Mwewa

Essay/Assignment Title: Investment Policy Statement

Due Date: March 13, 2022

Declaration:
I acknowledge that submitting this document binds me to the following:
To the best of my knowledge, I assert that no part of this assignment has been copied from the work of anyone else, be it another stude
or any other author or from any source except where due credit is given in the text below, or has been written for me by someone else
except where the relevant instructors and authorities have explicitly permitted such collaboration .

SIGNATURE:P. Chibabula

Instructor’s Comments:

GRADE [ ]
The Concept of Market Failure in Education 2

This assignment is going to discuss the objectives and constraints that are to be

considered when developing an investment policy statement, explain why asset allocation

decision is the primary determinant of total portfolio performance over time and give reasons

why successful implementation of asset allocation decisions is more difficult in practice than in

theory. The reminder of this paper is structured as follows; In the first section, the paper will

describe an investment policy statement. The next section will discuss the objectives and

constraints that are to be considered when developing an investment policy statement. The third

section will explain why asset allocation decision is the primary determinant of total portfolio

performance over time, followed by reasons why successful implementation of asset allocation

decisions is more difficult in practice than in theory, and the conclusion in the last section.

Investment Policy Statement

An investment policy statement is a client-specific document meant to address the

aims, restrictions, special circumstances and general oversight mechanisms that regulate

the investment-related operations of a non-profit organization. All parties involved in the

investment program - the board of trustees, the investment committee, the investment

advisor, who may be an outsourced CIO provider, and the custodian – should have their

responsibilities clearly defined in an IPS. It will illustrate the financial objectives of a portfolio

in light of the willingness and ability of the investor to accept risk. The long-term strategic

asset allocation of a portfolio should be precise, but broad enough (asset allocation targets

with wide ranges) to allow for flexibility in implementation as opportunities and hazards arise

that may affect investment goals over preset time frames. Finally, the IPS should include

operational instructions and procedures for monitoring and reviewing the investment

program in all of its aspects.

The Concept of Market Failure in Education 3

Objectives of an Investment Policy Statement

With an outcome-oriented attitude, all investment policy statements should explicitly

describe investment objectives. (The portfolio, for example, is obligated to spend 5% per year in

perpetuity.) This entails comparing an organization's actual goals and restrictions to market

expectations in order to ensure that investment objectives match underlying return targets and

risk tolerance, striking the correct balance between risk avoidance and return seeking. Most non-

profits want to keep their purchasing power, which implies the long-term return goal should take

inflation, fees, and annual spending into account. Other items to consider for the Objectives

section include:

Risk Objectives. Risk objectives are portfolio requirements that reflect the risk tolerance

of an investor in absolute terms, relative terms, or a combination of both. For example, the

absolute risk tolerance statement of a Zambian retiree is that he or she does not wish to lose more

than 5% of his or her capital in any given 12-month period. Alternatively, his or her risk

preference might be represented in terms of a benchmark, resulting in a relative risk target.

Institutional risk tolerance of an investor may be based on their liability positions. Standard

deviation and value at risk, for example, are absolute risk metrics, whereas tracking error is a

relative risk measure.

Risk tolerance: Willingness vs. ability. If an investor has a higher-than-average

propensity to accept risks, it has a higher-than-average risk tolerance, and vice versa. If, on the

other hand, his risk tolerance is above-average but his willingness is below-average, the gap must

be bridged, and risk tolerance should ideally be based on the lower of the two. However, if a

client has a low willingness to accept risk but a high ability to take risk, the financial advisor
The Concept of Market Failure in Education 4

must explain the consequences of taking a low risk. Individual investors are not the only ones

who confront such a conflict; institutional investors might also face it. The investors in National

Pensions Scheme Authority (NAPSA), for example, may prefer to assume little risk, whilst the

sponsor may prefer to incur high risk in order to contribute fewer funds in the future.

In summary, the ability to take risks can be quantified using objective parameters like

time horizon, expected income, present wealth relative to liabilities, and so on, but willingness is

a subjective assessment based on each individual personality of investors especially the aged

retirees. Risk can be assessed by talking with the client about it or through psychometric tests.

These tests are done to measure the mental capabilities and behavior of the investor. Aside from

risk objectives, another set merges. These are absolute and relative return objectives.

Returns are measured both in absolute and relative terms. A desired percentage growth in

investment expressed in nominal or real terms is stated by an absolute return objective. A relative

return objective establishes a margin by which the portfolio's return must outperform the

benchmark, which should ideally be investible. A relative return can be calculated using a peer

group or a universe of managers. An endowment, for example, might aim for a return in the top

quartile of the endowment investment landscape. However, such a return goal is confusing

because we may not know the real returns earned by all other similar investors, and they may use

various techniques or methodologies to calculate returns.

Furthermore, a return objective might be stated before or after fees, pre-tax or post-tax, in

which case comparisons must be adjusted appropriately. In any event, the return goal must be

reasonable, taking into account risk tolerance, existing capital market expectations, and limits.
The Concept of Market Failure in Education 5

When an investor has unreasonable expectations, his financial advisor must advise him on what

is feasible. In that regard, what are some of the constraints that might hinder this development.

Constraints of an Investment Policy Statement

Constraints are broad limitations on investments imposed by liquidity requirements,

taxes, legislation, and other factors. A high return, for example, cannot be attained without

allowing for a higher risk tolerance, and so on. Factors that must be considered when

establishing a portfolio are referred to as constraints. Liquidity requirements, time horizons,

regulatory constraints, tax status, and special needs are just a few of them.

Liquidity requirement. Any funds required from the portfolio must be specified in the

investment policy statement, including the amount, nature, and timing. An individual investor

can need funds to cover expenditures. Similarly, an endowment may be required to liquidate

assets in order to achieve the expenditure the goals of the institution, among other things. If this

is the case, a substantial amount of money must be placed in liquid assets, which are assets that

can be easily converted to cash and are low-risk.

Time horizon. The time horizon, or the timeframe over which the investments are

anticipated to be made, must be specified in an investment policy statement. The time horizon is

determined by the point at which the investor would withdraw funds or when the circumstances

of the investors would change dramatically, necessitating a significant change in the portfolio.

The time horizon is significant because it influences the willingness of an investor to take risks.

Tax concerns. Because taxes can have a considerable impact on the final return of a

portfolio, an investment policy statement must explain the tax situation of a client. Income and
The Concept of Market Failure in Education 6

gains may be taxed differently in various countries (for Zambia, the withholding tax on

investments is 15%), with gains being taxed only when they are realized and incomes being

taxed immediately. It would be advantageous to postpone the realization of advantages in such a

case. Any such factors would be ignored by a tax-exempt investment.

Legal and regulatory factors. Legal limits on investment allocations, dividends, and so on

may apply to some investors, such as pension funds, endowments, and so on. The fund sponsors

may apply such restrictions and constraints. The legal and regulatory factors portion of the

limitations lists such considerations. It may also include a list of investments that must be

avoided because of the investor's relationship with a linked party, for example.

Unique circumstances. Depending on the circumstances, an investor's religious, ethical,

and/or ESG (environmental, social, and governance) principles and convictions may have an

impact on the portfolio. In what is known as negative screening, an investor may seek to

eliminate particular investments (such as investments in tobacco company stocks). Best-in-class

investing, shareholder involvement, theme investing, and impact investing are some more topics

to consider. Some investors may even incorporate environmental, social, and governance (ESG)

factors into their decision-making process. Other essential aspects may be listed depending on

the situation. If an investment advisor manages only a portion of a client's total wealth, for

example, the portfolio must be handled in such a way that the overall risk of the investor does

not grow. Because his lifetime earnings have already been 'spent' in IT, an employee of a

technology company must limit the exposure of his portfolio to IT companies.

The Concept of Market Failure in Education 7

Reasons why successful implementation of asset allocation decisions is more difficult

in practice than in theory are: Transaction costs - investing or rebalancing a portfolio to reflect

a chosen asset allocation is not cost-free; expected benefits are reduced by the costs of

implementation.

Changes in Economic and Market Factors - shifting economic backdrops, fluctuating

market price levels, and shifting linkages within and across asset classes all lower the optimality

of a given allocation decision and necessitate rebalancing. On a continuous basis, changes in

economic and market circumstances alter the predicted risk/reward correlations of the allocation.

Changes in Investor Factors - the passage of time often gives rise to changes in investor’s

needs, circumstances or preferences which, in turn, give rise to the need to reallocate, with the

attendant costs of doing so.