How do I document ESG preferences as unique circumstances in the IPS?

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AcadiFi · Accepted Answer

ESG preferences fall under 'unique circumstances' in the standard IPS framework. They are client-specific constraints that shape the investable universe without changing the return objective or risk tolerance. Documentation approach: 1. List exclusions explicitly. Name each excluded sector, activity, or country. Example: 'Portfolio shall not hold securities of companies deriving >5% of revenue from (a) tobacco production, (b) controversial weapons, (c) thermal coal extraction.' 2. Specify materiality thresholds. A 0% revenue threshold is stricter than 5%; most institutional screens use 5-10% to avoid incidental exposure triggering exclusion. 3. Specify look-through. Does the exclusion apply only to direct holdings, or also to index-fund constituents? This determines whether low-cost ETFs are available or a custom separately managed account is needed. 4. Specify positive tilts. Is there an affirmative mandate (e.g., 30% to impact-aligned investments, carbon footprint reduction target)? 5. Review cycle. ESG criteria evolve — annual review clause. ```mermaid flowchart TD A[Client
Values] --> B[Exclusions] A --> C[Tilts] B --> D[Universe
Filter] C --> D D --> E[Portfolio] E --> F[Annual
Review] ``` Impact on portfolio construction: - Narrower investable universe may reduce diversification. Quantify expected tracking error vs benchmark. - Higher management cost (ESG-screened funds often 10-30 bps higher than comparable passive). - Rebalancing more complex — cannot use broad-market ETFs for exposure adjustments. A concrete example: Hilario Pendergast (age 52, $4.2M) adds to his IPS: 'The portfolio shall exclude issuers with >5% revenue from tobacco, controversial weapons, or thermal coal. The portfolio shall reduce weighted-average carbon intensity by 30% vs MSCI ACWI within 3 years.' Implementation uses an ESG-screened SMA for US large cap (20 bps), a fossil-fuel-free ex-US ETF (15 bps), and green-tilted bond funds. Expected tracking error vs a standard 60/40: ~1.5% annualized, documented and acceptable to client. CFA exam: unique circumstances is the right IPS section. Quantify the impact and have the client acknowledge any trade-offs.

How do I document ESG preferences as unique circumstances in the IPS?

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