Matt’s Frequency Series (Opinion) - Should You Have an Investment Policy for Your Fund?
Should you have an Investment Policy for your fund?
I got asked the other day about whether a fund should have an investment policy?
My opinion was YES, every fund should have an investment policy.
So the follow up question was what is involved in setting an investment policy?
I thought setting out how such a policy is structured would be useful for all investors. The idea of a formal investment policy is a good one for incorporated societies, charitable trusts and a number of other entities, including larger private trusts.
There are some obvious starting points that we are not going to address here including:
What funds do you want to hold for liquidity? and will this be inside or outside our fund balance?
When are you going to need our money to meet our obligations?
Do you wish to separate our operations from our asset base (perhaps you will have an endowment fund separate from our operations)?
Let’s move past that and look at an actual investment policy. We will assume that we have done any structural work, liquidity is held outside the fund, and that there is a requirement for a perpetual income”.
Asset Allocation
The first step is to look at our asset allocation. That is where we choose how much of our portfolio we will invest into the various categories of cash, bonds, property, and shares.
If we and our group of Trustees or officers don’t understand all that, then it is probably time for us to engage a finance professional to provide us with one. This is generally regarded as the most important investing decision.
The answer for our asset allocation, whether we do it ourselves or use a finance professional, is likely to be expressed in this sort of form.
It may also include other asset categories.
Other Operational Aspects
There are some other operational aspects for us to consider such as:
How often we will assess what our current allocations using at current market values, and;
How often we will adjust our holdings to keep within our asset allocation rules.
We might end up with a statements such as:
We will formally review the asset allocations every six months.
If our review shows that we are outside of the asset allocation policy, we will act to move our holdings back to within the guidelines.
Implementing our asset allocation policy
It has never been easier to invest. As anyone starting a new investment recently will know the one caveat is that the Anti-Money Laundering rules get more and more difficult to comply with.
We can use a full-service Wealth Manager, whether an NZX Market participant or other.
We can also use a range of index funds, accessed a number of different ways.
We can also access a range of funds which themselves have different weightings between the asset classes.
There are also some advantages to be had with PIE funds. That can lower the effective tax rate, as well as simplify all the accounting work involved. That may also reduce the audit overhead involved.
As we make these choices we should also consider whether the organisation has the competencies to deal with these matters. It is also a good idea to see how the organisation will deal with a change of people. Do we have a deep enough bench?
For this discussion, we will take a DIY approach. We will also just use NZX Smartshares funds from the huge range of funds out there to keep things simple. If you want to see the long list of funds available you could have a look at Investnow.
So our implementation is going to involve deciding how to invest for each class of asset. We could go down the route of picking particular bonds or stocks within the asset class but a simpler route is to go with a fund in each category.
So for example, if we have an asset allocation for US Equities, we could decide we will invest that proportion of our funds in a Standard and Poors 500 index fund. So rather than picking individual shares we will buy a fund that is a basket of shares that represents the top 500 listed businesses in America. The choice of those is done by Standard and Poors who run the index. A number of fund managers then put together portfolios which replicate that index. There are lots of S and P index funds around. The one provided by NZX Smartshares is an easy one to use as an example of what is required to invest this way.
So we make this statement about our implementation…
We will make investments in the following asset classes in the following manner:
Cash and Bonds – NZ By investing in a 50/50 split of
The Smartshares NZ Cash ETF
The Smartshares NZX Government Bond ETF
Equities – NZ By investing in NZX Smartshares NZ50 funds
Equities – AUD By investing in NZX Smartshares ASX200 funds
Equities – USA By investing in NZX Smartshares US500 ETF funds.
So that is a simple structure for an investment policy. If you would like to discuss anything further in this area please do get in contact.
And once again, every investor should have an investment policy!