If your company does not have a written investment policy, or if it has been more than a year since you have reviewed the policy, it may be time to focus on this important tool for managing risk.

More senior management teams and corporate boards are taking a hard look at their investment policies. Now that they bear explicit legal responsibility for the accuracy of their companies' financial results, a new focus on using investment policies to manage and mitigate risk is emerging.

While the Sarbanes-Oxley Act may be an impetus for this trend, it is not the only regulation shining the spotlight on corporate governance. Other regulations such as FAS 133 in the United States and the Markets in Financial Instruments Directive (MiFID) and EU Directive 8 in Europe, are promoting greater transparency in prices for securities and requiring ethical practices in delegation of authority, roles and responsibilities.

Components of an Investment Policy
An effective investment policy is restrictive enough to manage risk but not so restrictive that it creates daily exceptions.

As a company grows more complex, certain sections of the policy may need to be expanded, for example to accommodate hedging. The document should, at a minimum, outline the following:

• standards of care related to ethics and delegation of authority
• authorized financial institutions and broker/dealers
• safekeeping and custody
• suitable investments and their parameters
• reporting, record keeping and review periods
• exemptions and exception procedures
• approvals and governing bodies

Main Policy Objectives
There are three main objectives of an investment policy: safety, liquidity and yield. Safety consists of how we define, measure and balance risk. It can involve delineating sufficient internal controls and determining if staff has the knowledge and training necessary to manage the company's investment vehicles.

Safety also includes various ways to limit a company's risk exposure. For example, you could limit the company's credit risk by selecting investments rated only AA or above (or some other rating as determined by your company). Or, you could employ a value-at-risk (VaR) formula limiting a certain instrument type to a total percentage of the entire portfolio.

Another method is to limit counterparty risk by restricting investments in particular companies and/or funds to a pre-determined percentage.

There are numerous other ways to measure risk using tools such as benchmarking, gap analysis, volatility measurement or scenario analysis. If your company is conservative in its risk tolerance, you may need only one of these options. The more appetite there is for risk, and the more complex the company's dealings, the more measurement tools you may need to provide an accurate picture of the risks within your investment portfolio.

At the same time, a policy must provide for adequate liquidity to meet the company's operational needs, including working capital, trade payables and investments. You must understand how easily an investment can be sold or traded to define its liquidity. Maturities and interest rate risk play a role in liquidity, because the longer the duration, the less liquid and more volatile the return may be.

Every company is in business to make money and get the best return on its investment. And, while seeking optimum yields is the ultimate goal, this must be balanced wisely with the amount of risk tolerance a company has and the operating capital it requires.

A Market Best Practice
Developing and using an investment policy has become a market best practice, regardless of the size, type of ownership or complexity of the company. There are inherent risks in not having a policy, not using one, or having one that does not accurately reflect the needs of your company. With the interdependence of various financial risks creating more complexity, now may be an excellent time to write or revisit your company's investment policy.