To trustees, the various investment obligations and duties imposed on them can seem onerous, daunting and confusing. In a climate of increased trust litigation cases, it is not surprising that trustees, and their investment advisers, look for advice and clarity over how a trust fund should be invested. The ability to invest in almost any type of investment available, with the prospect of complaining beneficiaries if anything goes wrong, might be enough to make even the most experienced trustee lose sleep.
The good news is that there is quite a bit of guidance out there, both from the court and in legislation. There is also a lot that trustees, their advisers and the trust’s investment managers can do to work together effectively and get the best results for (and no complaints from!) the beneficiaries.
This article focuses on trustees of discretionary or life interest (sometimes called interest in possession) trusts. Trustees of bare trusts arguably have no duties of investment – their duty is to act at the direction of the beneficiary who is absolutely entitled to the trust fund.
Not only do trustees have wide powers of investment, especially since the introduction of Trustee Act 2000, they are also under a positive duty to invest. Warning bells should start to ring if a significant element of the trust fund is uninvested (held in cash) for a long period.
A trustee may invest in almost any type of investment. “Investment” does not include an asset from which no income or profit is expected – although not often an issue, it can come up in certain family trusts, particularly where beneficiaries might request that the trustees consider some more unusual so-called investments.
With the ability to invest in almost any type of investment available, what duties do trustees have in exercising this wide power of investment, and what guidance is available to them? Can and should they use professional investment managers, and how should that relationship work?
Prior to the introduction of the Trustee Act 2000 (the “Act”), trustees were under a general duty of care in exercising their investment powers to use the same diligence and care as an ordinarily prudent person would use in his own affairs. The Act introduced a statutory duty which, at first glance, seems broader and in some ways less helpful than the general duty that was previously applied. Section 1 of the Act states that a trustee must exercise such care and skill as is reasonable in the circumstances, in particular having regard to any special knowledge or experience that he holds himself out as having.
Various cases have provided some slightly more helpful guidance and suggest that the trustees should use the care that an ordinarily prudent person would take if he were making investments for someone for whom he felt morally bound to provide.
The Act also introduces a ‘standard investment criteria’ which, unlike the statutory duty, cannot be excluded by the terms of the trust deed. The standard investment criteria means that, when selecting an investment, the trustees must consider: (a) suitability to the trust; and (b) whether to diversify so far as it is appropriate to the circumstances of the trust.
The first point to note is that the duty of care and standard investment criteria do not mean that the trustees must take zero risk. However, investments cannot be a speculative gamble.
Recent cases have been quite helpful in breaking some of this down for trustees. Judges have explained that modern trustees need not be stuck in the Victorian era. Modern trustees may apply modern portfolio theories and current investment trends when considering what an ordinarily prudent person might do. When considering risk, modern investment theory means that the trustees may look to the risk of the whole portfolio and not a single investment only (Nestle v Westminster Bank Plc). Sometimes, certain investments which might be rejected by trustees when considered alone might have a place in a well-managed and balanced portfolio, notwithstanding that the particular investment might be slightly more risky than others.
This guidance can be particularly helpful in certain ‘real life’ family situations. For instance, certain families might have trustees to retain a significant shareholding in a Plc that was a former family business – a ‘sacred cow’ which should not be touched. How is the trustee to balance that potentially risky investment against his duties? First, the standard investment criteria explained above only requires diversification insofar as it is appropriate to all the circumstances of the trust. If the trust was created to hold the family business then arguably diversification is not appropriate, although the trustees should consider this and minute their discussion. In terms of risk, the answer might be to look to balance the risky shareholding against the investments made in the wider portfolio, and the trustees should look to obtain professional advice from an investment manager on this point.
Further issues could arise when there is a conflict of needs and interests between the various beneficiaries. This is particularly noticeable where trustees of a life interest trust are torn between the income needs of the life tenant and the desire to preserve and grow capital from the remainder beneficiaries. There is no fixed answer, but a careful, recorded discussion and professional advice is essential.
As is apparent from these brief examples, it is vital that the trustees take appropriate professional advice from investment managers. Helpfully, the Act expressly gives the trustees the ability to delegate their investment powers and asset management functions (this previously required an express power in the trust deed which was not always present). There are certain special requirements in relation to delegation and in particular trustees and advisors should think about whether Section 15 of the Act, which requires that the agreement between trustees and investment managers is evidenced in writing and includes a ‘policy statement’, should apply. In any event, whether the Section 15 formalities apply or not, it is sensible for the trustees and advisers to meet at least annually to regularly review the performance of investment managers and consider whether the mandate (and policy statement if Section 15 is in point) is being complied with.
A good relationship between investment managers and trustees is vital for getting the best from an investment portfolio held in trust for the beneficiaries. Investment managers can help by asking and understanding about the type of trust, the beneficiaries’ needs and plans for the future (for instance investment managers should be alerted to likely significant calls for capital, for instance to purchase a property for a beneficiary). Another vital point for the investment manager is to consider whether there are other assets held within the trust fund outside the investment manager’s remit that will ‘skew’ the risk profile of the investment portfolio.
Overall, whilst the investment powers granted to trustees are wide and the duties imposed on them in exercising those powers onerous, helpful guidance is out there and, provided communication with investment managers (and beneficiaries) is maintained and performance is regularly reviewed, it should be possible for trustees and their advisors to enjoy a good night’s sleep!