Investment policies for defined benefit plans, including pensions and other post-employment benefits (OPEB),1 govern how plans will carry out their investment program, in order to strengthen both the financial condition of the plan and the promise to deliver benefits to plan participants. Investment policies:
- Define fiduciaries’ due diligence process and compliance with applicable federal, state, provincial, and local investment laws;
- Provide communication tools to convey investment goals and priorities and to convey performance review and measurement criteria to all interested parties; and
- Define the internal controls of the system and aid in mitigating various kinds of risk.
In addition, investment policies for defined benefit plans are often used to formally articulate the system’s asset allocation strategy and provide benchmark index targets for investment manager performance evaluation.
An investment policy is a governing document in which the governing board and other key stakeholders formally set broad policy parameters. Detailed guidance about implementation and oversight of the investment program may be contained in the investment policy or other documents, such as investment procedure manuals and agreements with third parties. GFOA’s Best Practice Investment Policy recommends that all governments establish a comprehensive written investment policy, which should be adopted by the governing body.
GFOA recommends that defined benefit plans establish and adhere to a formal investment policy to regulate and monitor the system’s investment program. Such a policy should be viewed as a long-term governing document. The formal investment policy should be adopted by the governing board(s) and should be reviewed at least annually and updated as deemed appropriate.
The development of an investment policy must be made within the framework of the legal restrictions set forth in federal, state, provincial and local laws as well as those established by common law and fiduciary standards. Fiduciaries, such as members of governing bodies and other key decision makers, have the responsibility to invest the system’s assets for the exclusive benefit of the participants.
GFOA recommends that an investment policy contain the following elements GFOA recommends that the investment policy address at least the following elements in addition to those outlined in GFOA’s Best Practice Investment Policy:
- Statement of goal, purpose, or mission: Articulating the rationale for having the policy, as well as the investment goals (e.g., to meet or exceed a certain benchmark for the overall portfolio while taking into consideration the appropriate level of risk);
- Statement on managing risks of individual investments: Identifying investment guidelines, such as environment, social, and governance,2 for investment professionals to follow in order to mitigate risk related to individual investment purchases (e.g., limits on holdings of individual securities and credit ratings). It would also identify factors that fiduciaries would review in assessing the individual investments and the plan’s long-term asset allocation strategy; 3
- Liquidity of investments: Identifying the process the system will take to identify its liquidity requirements so as not to compromise cash flow needs;
- Guidelines for other investment-related service providers: Defining guidelines for selection and periodic performance evaluation of professionals, such as investment consultants and custodians. Measures of evaluation may include service quality, cost, and communications;4
- Investment management guidelines: Defining selection criteria and manager watch list/termination guidelines, which may include criteria and procedures related to specific benchmarks for placing an investment on a watch list or terminating an investment;
- Cost management: Defining expectations for evaluation of total cost and fee transparency, e.g., transaction cost, investment management fees, custodial fees, performance-based fees, and other investment-related expenses;5,6
- Performance measurement (benchmarking) and reporting: Defining:
- The frequency of reporting and monitoring;
- The way external and internal parties report investment results (e.g., performance, risk metrics, characteristics, etc.);
- The evaluation process, with clear definitions of strategies; and
- The performance benchmarks for permissible asset classes, expectations, and criteria for investment manager performance measurement.
- Corporate governance – Identifying guidelines for proxy voting, including who has responsibility to vote, and other issues related to corporate governance.
If applicable, GFOA recommends an investment policy for defined benefit plans include the following elements:
- Foreign currency management: If the plan has foreign assets, identifying the plan’s parameters for establishing foreign currency positions and how they will be managed (e.g., a position of no more than a certain amount hedged in foreign currency); and
- Transaction or brokering trades: Outlining the guidelines for such transactions to avoid any real or perceived conflicts of interests and to avoid all revenue or expense sharing (soft dollar) arrangements between the plan and its service providers.
2 See GFOA Best Practice, Understanding Pension Fund Investment Risk.
3 See the GFOA Best Practice, Asset Allocation for Defined Benefit Plans.
4 See GFOA Advisory, Selecting Investment Advisers for Pension Fund Assets.
5 See GFOA Best Practice, Investment Fee Policies for Retirement Systems.
6 See GFOA Best Practice, Public Employee Retirement System Investments.
CFA Institute, Elements of an Investment Statement for Institutional Investors (Charlottesville, VA: CFA Institute, 2010).
Nicholas Greifer, Pension Investing: Fundamentals and Best Practices (Chicago, IL: GFOA, 2002).