People sometimes joke that trustees are scared to make decisions and, as absurd as this may sound, many a truth is spoken in jest. The reality is that, on a daily basis, a trustee will make a myriad of informed decisions which may at some point in the future be challenged, no matter how innocuous or trivial they may seem at the time the decision is made.
Experience demonstrates that decisions concerning the investment of trust assets are a recurring chagrin for trustees and they are too frequently open to challenge from beneficiaries. Subject to the terms of the trust deed, the manner in which a trustee can invest assets is wide and trustees often find themselves owning a wide variety of investments. These investments can range from emotive and illiquid investments, highly volatile risky assets, and undiversified portfolios, to the trustee panacea of a discretionary managed portfolio. Each asset is so distinct with its own inherent pitfalls that, if reviewed in detail, would merit its own article.
In this article, we will discuss trustee considerations when investing assets with a discretionary manager. Interestingly, although most trustees consider this to be ideal, if it is not properly communicated, considered, documented, and monitored, it can prove to be a costly decision for a trustee.
Before embarking on any investment, it is essential to have detailed communication with the trust beneficiaries to gauge attitude toward risk, any income and capital requirements, and to understand the family’s investment philosophy. The rights of the beneficiaries as per the trust instrument may also be an important consideration if the beneficiaries have different rights to the income and capital of the trust fund. In addition, it is important to ascertain whether there are any specific tax considerations which need to be considered. Any trustee working with a multi-jurisdictional family will wince in pain at the thought of not properly considering the tax implications of trust investments. Ignoring the tax consequences is one of the quickest ways to dissipate a trust fund. A dispute over such actions can become particularly contentious if a professional trustee has been engaged, especially if they hold themselves out as having jurisdictional expertise or being experts in managing structures for families with a diverse jurisdictional footprint.
Once this information has been duly considered and documented and the investment policy has been set, a trustee will need to invest the assets accordingly. In advance of making the investment, and arguably even if acting as trustee of a reserved powers trust, a trustee needs to ensure that the funds will be invested with a suitable manager. It is vital to consider factors such as the manager’s assets under management, fee transparency (including hidden stamp duties and retrocessions being taken), the level of the proposed fee, the risk being taken to achieve the return, the size of the team, their qualifications, the firm’s professional indemnity insurance, the firm’s reputation, the reporting available, their performance versus an agreed benchmark (and peer group if the information is available), historic performance (which is of course not a guarantee of future performance), ability to invest assets within agreed tax restrictions (no passive foreign investment companies (PFICs) or non-reporting status funds, French or UK situs assets, co-mingling funds in accounts), investment restrictions (positive and negative screens for an ESG mandate), the platforms used, etc. The trustee should not be blindly investing assets at the behest of an individual or group of individuals, especially if the trustee has concerns about the manager after conducting its due diligence.
Once the funds have been invested, it is important for the trustee to ensure the agreed investment strategy is able to run its course. This, however, does not mean that investments should not be reviewed on a regular basis (quarterly being the most common). If the trustee does not have such resources in-house, it can be outsourced to a dedicated investment monitoring firm. These firms will tend to not only monitor the assets against an agreed benchmark but also, ideally, against a peer group, and provide commentary on where a manager is failing to add alpha or taking too much risk for the returns being achieved. Given the ever-present volatility in the market and the ongoing geopolitical pressures, the active monitoring of managers is all the more important and expected from a professional trustee.
If a manager shows continued underperformance, if there is an immediate threat to the trust fund or if there is a material breach of mandate, decisive action needs to be taken by the trustee. To be indecisive in such a case and sit idly is likely to result in the trust fund incurring further losses and leave the trustee open to criticism and even a potential negligence claim.
Even though investing assets in a discretionary mandate may be considered a trustee’s panacea, it is not without its pitfalls. So long as the actions mentioned earlier are properly considered and documented, most potential pitfalls will be avoided. There are however some pitfalls which may remain. Such a pitfall may include where a settlor has reserved investment powers and directs a trustee in relation to the investment of trust assets.
For simplicity reasons, let's assume the trust is a Jersey proper law trust and the investments are all held through a wholly owned Jersey company (not too uncommon). In this instance the shares in the Jersey company are held directly by the trustee and not via a nominee relationship. When considering this example, it is important to remember that when the settlor provides the trustee with investment directions it is the trustee that will be indemnified by the deed (which should clearly set out the settlor’s reserved powers, contain appropriate trustee exoneration clauses and robust anti-Bartlett provisions) and not the directors of the company, even though the directors will be the ones actually making the investment decision. It is therefore the directors of the Jersey company who are potentially on the line if the investment does not perform as expected and if there is a future claim. This exposes the directors to unintended risk and as such it would be prudent to use the tools available to negate such risk as much as possible. With this in mind, and depending on the directed investment, it may be prudent for the trustee to provide the directors of the company with a shareholder’s direction in line with the one it received from the settlor. It may even be worth them seeking an Article 74 authorisation which will prevent the directors becoming personally liable for any loss occurring on account of the investment direction.
Whatever a trustee decides, it must be in the best interest of the beneficiaries. The importance of ensuring that investments are appropriate for the beneficial class cannot be over-emphasised. It is important to be extremely clear on limitations and requirements when issuing mandates. Depending on the complexity, it may be necessary to work with an expert legal or tax advisor to achieve this (any trustee that has found they are holding PFICS in a foreign non-grantor trust distributing undistributed net income (UNI) to a US persons will confirm this).
There is no escaping that trustees need to make decisions on a daily basis. Some of these decisions may be more difficult than others, however, no matter the decision, it is always important to consider the relevant facts and properly document the decisions taken. Not doing this is foolhardy and will expose a trustee to the risk of a future challenge that could otherwise be avoided.
Arguably, only persons who do not appreciate the higher standards that professional trustees are held to, or do not fully understand a trustee’s fiduciary duties or the recourse to which beneficiaries are entitled, would take any decision lightly. Therefore, even a relatively simple decision, such of appointing a discretionary investment manager, can be complicated and if not done properly, cause serious loss to the trust fund.
Michael Giraud and Simon Grant
A version of this article was first published in the STEP Journal:, ‘Digital Gold into Digital Ash’, STEP Journal (Vol30 Iss6), pp.72-73