Investment constraints
Also written Investor constraints · Investment constraint
Limits on the investments an investor can take exposure to — liquidity needs, time horizon, regulatory and tax constraints, exposure limits, and unique needs and preferences — recorded in the IPS.
In plain language
Objectives say what an investor wants. That might be return, keeping capital safe, or income. Constraints say what stands in the way or narrows the choices.
The workbook defines constraints as limits on an investor taking exposure to certain investment opportunities. They relate to the investor's:
- liquidity needs, which means how soon they may need cash;
- time horizon, which means how long they can stay invested;
- other unique needs and preferences.
Constraints belong in the investment policy statement (IPS). The IPS is a road map. It sets out how much risk the investor is willing to take. It also sets out their investment objectives, goals and investment constraints. Writing it is the first step in managing a portfolio.
How it works
The constraints the workbook describes (Chapter 9, section 9.3.5):
| Constraint | What the workbook says |
|---|---|
| Liquidity | Varies by investor; younger people usually need less. Three categories: emergency cash (usually 2–3 months' spending, more if income is volatile), near-term goals (due within a year, in liquid assets), investment flexibility (to exploit over- and undervaluation). Too much liquidity hurts return; too little forces untimely sales. |
| Regulatory | Individuals have few, but they must be followed. Examples: under the Liberalised Remittance Scheme, a resident individual can remit up to USD 2,50,000 per financial year; insiders cannot trade on unpublished information. |
| Tax | Income (interest, dividend, rent) and capital appreciation are taxed differently, and the tax bracket matters, so the IPS needs an understanding of the applicable tax code. |
| Exposure limits | Limits on sectors, entities and asset classes to avoid concentration risk, set after considering objectives, risk appetite, liquidity, tax, regulation and time horizon. Under the SEBI PMS Regulations 2020, the agreement must include the investment approach. |
| Unique needs and preferences | Personal, social, ethical or cultural. Examples: avoiding companies selling environmentally harmful products; reluctance to sell an employer's shares because of emotional attachment. |
The IPS may also include reporting requirements, rebalancing schedules, frequency of performance communication, and investment strategy and style.
Time horizon is named in the definition and appears in the PMS risk questionnaire as the period of investment, which must be the same as the term of the agreement (section 9.3.3).
A worked example
Illustrative figures. Dr. Menon, 58, opens a PMS account with ₹2 crore. Her monthly spending is ₹1.5 lakh.
| Constraint | Her situation | IPS wording |
|---|---|---|
| Liquidity — emergency cash | 3 months × ₹1.5 lakh = ₹4.5 lakh | Keep ₹4.5 lakh in liquid assets |
| Liquidity — near-term goal | Daughter's wedding in 10 months: ₹25 lakh | ₹25 lakh in instruments maturing before the date |
| Time horizon | Retires in 7 years | Long-term portion invested for 7+ years |
| Tax | Highest tax bracket | Prefer growth over interest income where suitable |
| Regulatory | Wants to fund her son's overseas studies: ₹30 lakh a year | Within the LRS limit of USD 2,50,000 per financial year |
| Exposure limit | Concentration worry | No more than 10% in any single stock (illustrative) |
| Unique preference | Will not invest in tobacco companies | Exclude tobacco |
Money available for long-term investment: ₹2 crore − ₹4.5 lakh − ₹25 lakh = ₹1.705 crore.
Without the constraints, a manager might put the whole ₹2 crore into equity. With them, ₹29.5 lakh is ring-fenced and the rest is shaped by tax, exposure and ethical limits.
Why NISM asks about it
Chapter 9 (Portfolio Management Process), section 9.3.5, sets out investment constraints within the investment policy statement, with the liquidity categories, the LRS example, tax, exposure limits and unique preferences. Section 9.3 places the IPS as the first step of the process; Chapter 9's sample question 1 asks exactly that. Chapter 17 (section 17.3.10) returns to exposure thresholds under concentration risk.
Common exam traps
- Constraints ≠ objectives. Capital preservation, income and appreciation are objectives; liquidity, time horizon, tax, regulation and unique preferences are constraints.
- Emergency cash is usually 2–3 months' spending in the workbook, more if income is at risk or volatile.
- The LRS limit in the workbook is USD 2,50,000 per financial year; the scheme began on 4 February 2004 with USD 25,000.
- Younger investors usually need less liquidity than older ones.
- Too much liquidity is also a problem — it hits overall portfolio return.
- The PMS investment period in the risk questionnaire must match the term of the agreement.
Where this is taught
- Series XXI-B · Chapter 9: Portfolio Management Processintroduced here
- Series X-A · Chapter 15: Portfolio Construction Processintroduced here
Related terms
- Liberalised Remittance SchemeThe RBI facility letting a resident individual remit up to USD 250,000 per financial year abroad for any permissible current or capital account transaction, including investment in offshore funds.
- Risk profilingEstablishing how much risk an investor should carry by weighing three separate things — the need to take risk, the financial ability to take it, and the psychological willingness to bear it.
- Concentration riskThe risk that a few positions are large enough, against the fund's capital, that one loss damages the whole portfolio — capped by SEBI at 25% of investable funds for Category I and II AIFs and 10% for Category III.
- Investment approachA broad outlay of the securities and permissible instruments a portfolio manager will invest in for a client, set out in the PMS agreement and tagged to exactly one strategy.
- Investment Policy StatementThe written roadmap, drafted with the investor, that sets out objectives, goals, constraints, preferences and risk tolerance. Developing it is the first step of portfolio management.
- Psychographic analysisProfiling an investor's personality and behavioural traits to set the risk profile — treating the investor as a normal human prone to bias rather than a purely rational actor.
- Investment ObjectivesAn investor's goals expressed in terms of risk, return and liquidity preferences — such as capital preservation, capital appreciation, current income or tax saving.
- Endowment biasAn emotional bias in which people value an asset more simply because they own it — its two attributes are valuing ownership and loss aversion.
- Absolute return objectiveA return goal stated on its own, such as 15% a year, with no comparison to a benchmark — the opposite of a relative return objective.
- Relative return objectiveA return objective stated against a benchmark rather than as a standalone number — for example, to earn 5% a year more than the Nifty 50 for the next several years.