The times they are a changin’

Thursday, 01 October 2009
A look at prudent investment management in a changing world.

‘The times they are a changin’… When Bob Dylan wrote those lyrics in the 60s, few people knew that the world was entering an unprecedented period of economic growth and wealth creation that would last for 40 years. Yet in a relatively short period of time we have seen this unwind, starting with the subprime crisis, the banking collapses in Europe and the US and Madoff’s Ponzi scheme. The so-called ‘offshore world’, which constitutes a large part of the trust universe, is being forced to evolve, not only because of the current economic turmoil, but also because of related tax and regulatory changes.

These forces, combined with an increasing appetite for litigation, have created an environment where trustees have to be more mindful than ever of the way they invest and monitor trust assets.

Here, we aim to set out the steps that trustees can follow in order to manage risk and avoid litigation. Ultimately, a trustee may need to be able to demonstrate that he has fulfilled his duty of care in relation to investments and has done so to the appropriate standard. How high that standard is will depend on the stipulations of the trust’s governing law, perhaps as modified by the trust deed and any other relevant factors. This article is not intended to be a detailed discussion of the trustee’s duty of care regarding investments, but rather a common-sense guide, from the perspectives of an investment consultant and a lawyer turned trustee, to the steps involved in investing trust assets.

Before starting down the steps, it is necessary to acknowledge that many trusts are created by settlors who have in mind specific investment objectives or specific investment mechanics. Such objectives and mechanics are discussed elsewhere and this article focuses on best practice in a plain vanilla situation. These situations are the exception rather than the rule, but they represent a logical starting point.

Step 1: Discuss the settlor’s requirements

The trustee needs to understand what the settlor wants to achieve and how to achieve it. At a basic level, this will mean understanding the short-, medium- and long-term income and capital requirements of the beneficiaries. There will also need to be an understanding of the risk profile of the settlor and beneficiaries: the agreed target returns will need to be consistent with the risk profiles. This may mean re-educating the clients if the desired returns are inconsistent with the risk profiles.

Ideally, detailed risk profiling will be undertaken. Trustees should have at their disposal a detailed investment questionnaire as part of their policies and procedures, which can be used to determine a trust’s optimum risk profile. This can only be achieved via detailed profiling of the settlor and the beneficiaries and the aggregation of these in an appropriate way is a complex exercise. Risk profiling is not a one-off exercise and should be undertaken periodically in order to take into consideration changing circumstances so that adjustments can be made. Only after a full risk profiling exercise has been conducted can any informed investment decisions be taken.

Step 2: Agree trust documentation

It will be no good if Step 1 is followed, but the resultant trust and other documentation does not reflect what was agreed. (In extreme cases if the documentation does not reflect what was agreed there is a risk of sham.) While there is often a desire to reflect closely what the settlor has requested, appropriate precedents should enable the wishes to be reflected, but still leave room for flexibility in case circumstances change. Put another way, short form trust deeds are often superficially attractive, but they can lead to problems.

The trustee faces challenges in appointing investment managers and avoiding conflicts of interest. Depending on the circumstances, it may be appropriate for investment powers to be reserved by the settlor or to appoint the bank who referred the business; alternatively it may be appropriate to appoint an independent third party to oversee and advise on the investments. Care will need to be taken to ensure the trust documents are appropriate whichever arrangement is chosen.

Basic errors at this stage of a relationship and failure to follow investment policies and procedures can lead to complications and increase the risk of litigation in the future.

Step 3: Agree investment policy

The trustee should have a detailed investment policy document setting out the investment objectives and any restrictions.

There is no legal issue per se (subject to the specific requirements of the governing law) and there may be client variables to take into account such as tax or religious prohibitions. These will need to be reflected in the investment policy document. With a substantial family structure, such overarching restrictions may be reflected in overarching family governance documents and it must not be assumed that any new investment manager is aware of such restrictions.

The long-term strategic asset allocations should be agreed as should the rationale for those allocations. The allocations should seek to achieve the investment objectives of the trust over an agreed timeframe.

In some cases, the investment manager may be appointed before asset allocation decisions are taken. However, with a larger trust fund, it is possible that a number of investment managers will be appointed to invest in different asset classes or investment styles. For this to be done in a logical and coherent way the strategic asset allocation decisions must be taken first.

Step 4: Choose investment manager(s)

The documents must reflect what was intended and, if there is a possible conflict of interests relating to the choice of investment manager, the documents should provide the trustee with appropriate protection. Furthermore, if the trustee does have a free hand to choose the investment manager, the choice must be made in an appropriate way. Conflicts of interest can also arise where trail fees are paid by the manager if the fees are not disclosed to the beneficiaries.

Ideally, investment managers should only be put forward for selection after careful quantitative and qualitative due diligence has been carried out. This should be conducted in consultation with an internal or external gatekeeper or consultant. Risks can only be uncovered through detailed investment manager analysis following a logical step by step process.

Where multiple investment managers are used, the multiplicity should bring diversification benefits.

Step 5: Formal appointment of the investment manager(s)

If the investment criteria have been chosen and clearly set out, this step should be relatively easy. If there are very detailed restrictions or specialist monitoring is required, however, the trustee may need to seek expert assistance. Further, where multiple managers are being appointed, thought will have to be given to the detail of each mandate and attention paid to which elements should be the same and which different. For example, all portfolios may have to be hedged back to the same reference currency, but two apparently similar mandates (for example international equity) may require subtle differences to achieve the diversification of style required (one growth, one value).

Errors at this stage are often mechanical. It is very important to document correctly who will be giving the instructions to the investment manager: the trustee, the protector or someone else? This is obviously critical with advisory mandates, but may still be important even where an investment manager has absolute discretion.

Step 6: Ensure proper transfer of existing portfolio or cash

Realistic expectations and consistent and timely execution are what matters here. The worst scenario is where a client thinks a new mandate has been put in place, the investment manager is ready to invest, but the cash or existing portfolio are still held with the existing manager because someone has not completed all the paperwork. Any unreasonable delay leading to loss may be actionable.

All agreements and application forms should be reviewed and the process monitored to ensure timely execution at each stage. At the time of transfer, contract notes and statements should be reviewed, cross referenced and values checked.

Step 7: Put in place monitoring arrangements

The trustee should consider whether to retain this function or delegate it to a specialist third party who is fully independent. Clearly there are advantages and disadvantages with both, but trustees should at least ensure that their investments are being reviewed quarterly and the performance measured against appropriate benchmarks agreed at the outset and probably set out in the investment policy document. Disputes often arise from the trustee’s failure to address performance issues when they arise, usually because of not following their own investment policies and procedures.

It is clear that delegation is a continuing process and even if the delegation itself has been effected properly, the trustee may still become liable if the delegate is not adequately monitored and there is loss as a result.1

Step 8: Receive and consider reporting and communicate with client as necessary

An issue for the trustee to consider is the extent to which they can be relieved of responsibility by passing the reporting to, for example, the settlor, protector or the beneficiaries.2 This will largely depend on the relative responsibilities set out in the documents. Nonetheless, whatever arrangements are put in place it is difficult, if not impossible, for the trustee to absolve himself of all potential liability.

Independent advice and monitoring is one potential solution for trustees, although the relationship must be clearly defined and the breadth of responsibility fully understood. Reporting should be concise, understandable and allow the trustees to make informed decisions.

Step 9: Inflection points/active recommendations

The trustee needs to consider who provides the ongoing advice, including tactical asset allocation recommendations when appropriate. Strategic asset allocation relates to long-term objectives, while tactical allocation is used to adjust portfolio weightings at specific points in time. Will the managers selected provide proactive advice and recommendations? Or will the trustee need to take independent advice?

The passive versus active discussion is a topic within itself, but what it does highlight is that trustees need to consider how dynamic their investment managers are and whether they will invest proactively to meet the trust’s long-term investment objectives.

Step 10: Consider changing manager if necessary

It is part of the trustee’s ongoing responsibility to monitor the investment manager’s performance and consider taking action if, for whatever reason, the investments are underperforming or there are indications that they may do so in the future.

Issues that can lead to a manager being removed are diverse, but include:

  • Performance – has the manager met the objectives? If not, why not?
  • Strategy drift – is investment manager investing in accordance with his mandate? Is a ‘value’ style manager suddenly investing with a ‘growth’ style bias?
  • Investment team changes – have they remained stable or have key personnel moved on? If so, how hard-coded is the investment process?


This list is by no means meant to be exhaustive, but could form the basis for a discussion regarding investment policies and procedures. Many of the steps suggested are common sense, but the extent to which they are being followed varies substantially between jurisdictions and different practitioners.

What is certain is that times are ‘a changin’ and that the global trust industry will evolve. We cannot predict the future with certainty so we can only do our best using the resources and information we have available now. This is never truer than in the case of succession planning when there is no viable option other than to plan ahead in an attempt to maximise benefits and minimise problems in the future.

  • 1. See for example article 25(3) of the Trusts (Jersey) Law 1984 and the express reference to liability for permitting delegation to continue.
  • 2. This issue arose in Unilever Superannuation Fund v Mercury Asset Management plc during 2001. The case settled, but it threw up a number of points which are relevant to the present discussion.
Author block
Fred Milner, Ray Scott

Fred Milner TEP is Head of Private Client Services at Carey Group.
Ray Scott is a Senior Client Consultant at Peritus.

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