Taking control of investment services

Tuesday, 01 April 2014
Martyn Gowar considers how trustees should act in circumstances where they are answerable to beneficiaries for decisions made by investment advisors.

As we know, it is a priority duty of trustees to take advice in relation to investments (s5 Trustee Act 2000 applies in England and Wales). In the modern world, that makes sense, and I, for one, would be loath to stick my neck out when it comes to investment decisions. The intricacies of investment management products are in a world of their own as far as I am concerned, and the jargon that accompanies them generates more heat than light.

However, while the trustees take advice, the investment decisions are still made in their name, and it is the trustees who are answerable to beneficiaries. So it becomes critical to choose investment advisors carefully, but, in so doing, current practice will be to give discretion to those advisors, and the trustees become confined to reviewing their performance.

It all starts with agreeing the investment allocation model suitable for the needs of the particular beneficiaries of a particular trust, looking at time frames, income needs, prospective beneficiaries, and other relevant factors, such as tax considerations. The location in which beneficiaries are resident for tax purposes can impact on the investments held in a trust, especially if a beneficiary is US-resident.

As a trustee, do you run that part of the discussion, or does the prospective investment advisor? As the investment advisor needs to do that work as part of their compliance obligations, they are likely to take the lead. It is a brave trustee who pushes to impose an asset allocation which does not conform to the model. We can see the problem for the investment advisor, but this is not necessarily the right answer for the trustee.

The next stage will be to choose a benchmark, and here, again, I ask the question: who runs that part of the discussion? My concern is that it is impossible for a trustee who is not an investment advisor to be able to assess a suitable investment-led benchmark, because a benchmark only reflects its constituent parts. All I do know is that a beneficiary is generally unimpressed when a fall in the value of the trust fund of 20 per cent is treated as a success just because the benchmark has dropped by 25 per cent.

It comes back to the statement that ‘the trouble with our society is that we try to make the measurable important, rather than the important measurable’. What is it that we are trying to prove with a benchmark? Is it not simply a check that performance is generally in the right direction, on the time basis that is appropriate for the particular trust? Added to that, investments in certain assets, in private equity, for example, may not be testable for a number of years – a point that will have been accepted when the investment was made. So to have a nil-value or a value out of kilter with the time measurement of the rest of the trust fund will distort the checking process to a level that may make it meaningless.

Would the answer be to ask for a benchmark that is more relevant to the beneficiaries’ obvious interests? That would depend on whether the beneficiaries are taking income from the fund or not, and at what level. So inflation plus 1 per cent might be a start, or it might be Libor plus 3 per cent – but I am not suggesting these figures.

What I do ask is whether a trustee who poses the question in that way will challenge the investment advisor to come up with a measure that a trustee can understand, and report back to the beneficiaries in a way to which the beneficiaries can relate. And let us not forget that the missing of a benchmark is only one factor in the checklist of whether a trustee should be concerned with the performance of their investment advisor.

Author block
Martyn Gowar

Martyn Gowar TEP is a Partner at McDermott Will & Emery UK LLP and an Editor of the STEP Journal.

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