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Prudent Investor Update, February 6, 2019

The Investment Policy Statement – The Path to a Good Night’s Sleep

One of the key elements to effective municipal investing is developing a strong Investment Policy Statement that sets clear parameters for investment decisions. That is because the policy statement details what a municipal government’s investment objectives are as well as their risk tolerance, timeframes for investing different monies, and asset mix. Getting this right is good for the municipality’s financial future, and good for your peace of mind.

Under the regulations for Prudent Investing, an investment policy statement (IPS), approved by Council, is required. The IPS is the basis for the investment plan that will be developed and implemented by the Investment Board (or Joint Investment Board). That’s why it needs to clearly articulate how the municipality expects its money to be invested.

Similarly, even a municipality investing under the “legal list” of investments would have a statement of investment policies and goals to guide internal investment decisions.

Elements of the IPS
Retired Toronto Chief Financial Officer Roberto Rossini says municipalities should first start building a policy statement by understanding their goals and objectives. This would include, for example, the need to preserve and protect capital, while at the same time realizing some growth. It would also cover the need for adequate liquidity, so that the municipality can meet cash flow needs, as well as the need for a diverse portfolio to manage risk.

The objectives then help to understand risk tolerance. As public sector investors, municipal governments will be almost universally conservative with a high need to protect the principal investment. The major difference in risk tolerance would be based on the size of the municipality and their portfolio. Very large municipalities may have larger cash reserves that would allow them to take on slightly higher risk. Small to medium-sized municipalities may be even more conservative because they have less flexibility and a lower ability to ride out big market fluctuations.

The policy statement will also identify if the municipal government wants to be a more passive or active investor. For example, given the risk/reward trade off, passive investments in an equities index fund would be appropriate for a long-term investment of 15 to 20 years. Over such a long-term, a “buy and hold” approach to these funds will deliver fairly consistent returns of about 6% to 7%, Rossini notes. It’s unlikely that a municipality would be an active investor buying and selling equities to maximize revenues at the right moment, since this approach involves much greater risks.

Building the policy according to timeframe
Funds need to be set aside in short, medium and long-term investments to ensure there is always cash available and to help deliver on asset management plans. The IPS would outline the appropriate mix of investment assets, such as equities, bonds and cash for each timeframe. This is a specific outline, providing either a percentage or dollar maximum and minimum for each asset class. The IPS  may also include a section on “Environment, Social and Governance” factors or ESG. This would outline the ethical and environmental standards for investing in certain types of companies.

It's more manageable than you think
While the IPS is comprehensive and may feel daunting for municipal finance departments, Rossini stresses that there are plenty of examples to draw from. While different in nature from municipalities,  pensions and trusts, for examples, have long been held to the prudent investor standard and were a resource when the City of Toronto was crafting its IPS, he notes. The good news is that ONE is reviewing a variety of sample statements to help inform and support municipal investors.

ONE Investment is dedicated to developing a range of tools and templates to support municipal finance leaders through the process, whether they choose prudent investing or stay on the legal list. This includes templates for investment policy statements and other regulatory requirements. ONE’s new  service team of finance experts will also be supporting municipal investors. The goal is to provide all municipalities, regardless of staff capacity, the ability to benefit from the long-term financial benefits of investment revenues.

Watch for the next newsletter issue that will highlight what goes into a municipal investment plan.