Basics of Portfolio Planning and Construction: practice question

Torvald Grange has just agreed to let Fenwick Row Advisors manage a portfolio for his family. Before any money is invested, the adviser insists on drafting a written investment policy statement. Grange objects that the two of them have already agreed on a strategy in conversation and that a written document would only tie the adviser's hands. The most appropriate reply is that the investment policy statement primarily:

1. commits the adviser to achieving the stated return objective, making the target return legally enforceable as a contractual promise
2. records the agreed objectives and constraints, keeping decisions disciplined and giving a fixed basis for judging results
3. shifts legal responsibility for any future portfolio losses from the adviser to the client who signed the document

Show answer and explanation

Correct answer: B

Explanation: B is correct. The investment policy statement records the client's objectives, constraints, and benchmark before any capital is committed, which keeps subsequent decisions consistent with what was agreed and provides an objective standard for later evaluating the manager's performance. A is incorrect because an IPS is a planning document, not a promise of results: no part of it obliges the adviser to deliver the target return. C is incorrect because signing an IPS does not transfer responsibility for the adviser's professional conduct; its purpose is disciplined decision-making and evaluation, not reallocating blame for losses.