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15 Tips to Fine-Tune Your Investment Policy

Is your local government investment policy comprehensive and well-developed? Does it include, among other things, clearly stated investment objectives, allowable investment instruments, and compliance with relevant statutes? Is it time to fine-tune it, to remove vague, contradictory requirements that may artificially constrain your investment program? Does your local government have an investment policy or an investment procedure? Remember, a policy sets out what you are able to do, whereas a procedure spells out how you should do it.

Below are tips for helping develop a more sound and comprehensive investment policy. Bullet points include recommendations for what should be in the policy and help contextualize why this information is important.

  1. Clearly describe what funds are covered by the policy and what funds are covered by a separate policy.
    The policy should be clear on what funds are covered by those particular policy guidelines. Some funds, such as bond proceeds or pension funds, may have different investment objectives or different investment horizons that may be better managed under a separate policy.
  2. Write a clear and concise statement of objectives.
    Investment policy objectives should be descriptive while elaborating on how the entity will seek to achieve its objectives thus providing more guidance. GFOA’s Sample Investment Policy includes explicit statements of objectives.
  3. Include a Standards of Care section addressing the delegation of authority, prudence, ethics, and conflicts of interest.
    The delegation of authority states who is responsible for the investment program and cites the derivation of authority. A reference to the prudent investor standard by which investment decisions are made should be included and ethics and conflicts of interest should reference formal codes and internal policies.
  4. Know your investment statutes and determine if all of the allowable investment instruments are appropriate for your investment program.
    Be aware that some investment policies may borrow language from state statutes and include investment instruments not necessarily suitable for some public entities’ investment programs. Many public entities may opt to have an investment program that is more restrictive than that allowed by state statute. In addition, the state statute may not provide the level of detail regarding maturity structure, security-specific asset allocation, and reporting requirements desired.
  5. Use explicit language to describe allowable investment instruments; include clear definitions of investment types, credit criteria, maturity restrictions, and diversification requirements.
    Clear, explicit language describing allowable investment instruments can reduce the possibility of misinterpretation and better protect the government from imprudent investment decisions.
    Manage diversification by assigning maximum percentages of the portfolio to security types and issuers. In addition, some policies artificially limit maturities; maturity restrictions should make sense for the entity’s cash flows and investment horizon.
  6. Avoid arbitrary percentages when discussing diversification requirements; instead, use target guidelines such as “no more than 5% of the portfolio can be invested in the securities of a single issuer” or “no more than 20% of the portfolio may be invested beyond one year.”
    Many investment policies include specific diversification guidelines such as “the portfolio must be invested in 50% Treasuries, 30% certificates of deposit, 10% commercial paper, and 10% local government investment pool.” Arbitrary percentages can restrict the entity from implementing an effective, dynamic investment strategy. Asset allocation limits should be used as a guide and allow for flexibility as market conditions and investment opportunities change. The purpose of diversification is to reduce risk in the portfolio by investing in a variety of maturities and avoiding over-concentration in a specific business sector (with the exception of U.S. Treasury securities).
  7. Require governing body review and approval for new security types, securities that are not clearly allowed by the policy, and deviations from the policy when new securities come to the market.
    With the required governing body approval, the investment official will analyze the security in question. This can allow for a more thoughtful approval process.
  8. Include collateralization requirements in the policy.
    Public entities often require collateralization for their deposit-type investments such as certificates of deposit and repurchase agreements. Investment policies should specify allowable collateral securities, collateral ratios, and third-party safekeeping requirements.
  9. Require that securities be held in third-party custody arrangements.
    This requirement can help protect the public entity from the bank’s credit risk. Should the bank holding the securities fail, the entity can simply transfer the securities they own to another custody provider.
  10. Require a formal process for selecting financial institutions and broker/dealers and describe this process in the policy.
    Specify what process will be used to screen firms . This section should require a due diligence review of prospective firms, specify minimum credit criteria for financial institutions, and limit transactions to only those firms on the approved list. The list should be included as an appendix item. It is also important to update the list of approved financial institutions and broker/dealers periodically.
  11. Require competitive quotes from at least three financial institutions and/or broker/dealers.
    Many entities obtain competitive quotes for their investment transactions but do not specifically require them in the investment policy. Adding this requirement means that the competitive quoting process will be used so that the entity can seek the best trade execution for its investments.
  12. Address reporting requirements and specifically state-required portfolio holdings information.
    The policy should state how frequently investment reports should be prepared, to whom they’ll be presented, and a list of essential portfolio and individual holdings information, such as yield, security type, and maturity to be included in the report.
  13. Determine relevant benchmarks to gauge performance. Some investment policies specify a certain benchmark in one section and then state that the portfolio must maintain a weighted average maturity (WAM) that is not relevant to the benchmark in another section.
    The benchmark maturity should be similar to the WAM of the portfolio in order to provide an appropriate performance comparison over time. Since investment programs are dynamic and the WAM may change over time, providing a statement that the benchmark and the investment portfolio should be similar in WAM allows for flexibility. Governments must also be careful that the way the performance of their portfolio is measured is consistent with the method used by the benchmark.
  14. Adopt your investment policy as a resolution or an ordinance.
    Many entities develop an investment policy as an internal document and do not require formal governing body approval. By adopting the policy as an ordinance or a resolution, the policy becomes an official document.
  15. Put specifics such as authorized personnel, authorized financial institutions, and broker/dealers in an appendix attached to the policy.
    Policies that include names rather than titles of personnel and specific names of authorized business partners can become outdated and require governing body approval when updated. Using only titles and referencing appendix items in the policy allows the policy itself to stay more current. Appendix items can be easily updated, and do not require governing body approval.

By using this article as a checklist, public entities can help ensure that their investment policies are complete. The Government Finance Officers Association provides a Sample Investment Policy to include expanded examples of sample policy language. The sample policy is available on GFOA’s website at https://www.gfoa.org/materials/financial-foundations-framework3.

All comments and discussions presented are purely based on opinion and assumptions, not fact. These assumptions may or may not be correct based on foreseen and unforeseen events. The information presented should not be used in making any investment decisions. This material is not a recommendation to buy, sell, implement, or change any securities or investment strategy, function, or process. Any financial and/or investment decision should be made only after considerable research, consideration, and involvement with an experienced professional engaged for the specific purpose. Past performance is no guarantee of future results. Any financial and/or investment decision may incur losses.