Trustee Investment Advice and the Financial Crisis
Any practitioner involved in reviewing trust investments over the past 12 months will know how sensitive an issue this has become.
The Association of Private Client Investment Managers’ (APCIMs) benchmark indices, used for trust funds that have an income and/or growth objective, have fallen by over 30%.
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Despite these falls, trustees still have a duty to invest for growth. This inevitably means risk – and falls in value. However, if there has been suitable diversification, and regular reviews are conducted, these values will have a better prospect of recovering. If the fund values have fallen so far that the prospects of recovery are limited, trustees and investment advisers should be wary of increased claims of negligence. These are more prevalent in a falling market.
A topical issue for trustees is that many trusts have held a high proportion of company shares from the financial sector, particularly high street bank shares. In a common scenario, where a trust has held shares in say four or five high street banks, the effect on the trust has been falls of far greater than the APCIMs index over the same period. This is because the falls in bank shares have been up to 70 – 90%, and more. Falls of this magnitude will see increased claims for loss made against trustees and/or investment advisers.
Bank shares were seen by many as major blue-chip companies that “could not fail”. This painful example stresses the importance of considering diversification in any trust investment. Diversification can be across different asset types (property, cash, shares, fixed interest), industry sectors, and geographies.
Many are now advising, and the APCIMs benchmarks are regularly updated to incorporate this, that a diversification into overseas investment is important. It is no longer sufficient to invest entirely in the UK stock market for instance. The banking crisis has demonstrated this. Likewise, one dominant industry sector is not a suitable diversification. Unit trusts, each holding a hundred or more different shares or securities, can assist greatly with this diversification: both by enabling a broad range of managed investment, and allowing this diversified investment overseas.
In fact, it is likely that the benchmarks will continue to evolve to hold an increased weighting in overseas shares. Many commentators are now discussing the diverging prospects for growth in different geographies over the long term: Europe, USA, and particularly the Far East and Emerging Markets. This is a trend that is likely to intensify, and further stresses the need to diversify – and review.
The Trustee Act 2000 has also put in place an expectation that trustees regularly consider the suitability of the trust investments in relation to the changing needs of the trust. In most cases this review should be conducted at least annually. If the practitioner, as trustee or adviser to trustees, is obtaining investment advice, and regularly reviewing the risk and diversification of the trust investments, then their duty of care is very likely to be met.
The need for frequent reviews can easily be demonstrated by using the example of a life interest trust. A sole life tenant may, unexpectedly, become terminally ill. This can happen at any time. If the life tenant’s life expectancy has shortened to less than say three years, a long-term growth objective will no longer be suitable for the trust remaindermen. A regular review will pick up unforeseen changes.
Practitioners should not take these good practices for granted. It is not uncommon to discover that a trust has never been reviewed, years after having been established. Trustees can find themselves in unexpected difficulties, which can lead to complaints and negligence claims.
The Client Cash Account
A loss in trust value is not restricted to falling share and property markets. Funds awaiting a suitable long-term investment under the terms of a deceased’s Will can also sit idly in a client cash account for years. It does happen, and with surprising frequency. If the trustees (and beneficiaries) are fortunate, the market will have fallen, not risen, during that period.
A rising market is likely to have caused the capital value of the trust to have suffered in the absence of being invested suitably. In such cases a model benchmark and index performance data over the period can be used to establish the mean loss.
It is good practice to diarise regular reviews and have a strict system in place that will identify the needs of the trust and enable the practitioners to arrange a suitable diversification. This can go a long way to preventing undesired outcomes, such as unfiled tax returns, unsuitable investment risk and diversification, long-term falls in asset value, unsuitable fund distributions, and ultimately, negligence claims.
The APCIMs Benchmarks
As well as the industry wide standard for monitoring performance at annual review, the APCIMs benchmarks are a useful starting point in setting a suitable risk and diversification profile on initial investment.
Clearly there is not an “off the shelf” solution for every trust. The circumstances of each trust should be carefully assessed, and any benchmark moderated on the basis of those needs. The APCIMs benchmark is generally suitable for use where long term investment, greater than 5-10 years, is being considered.
Therefore, if the proceeds of the trust are likely to vest on a beneficiary within say two years, it is not likely to be suitable to invest in anything other than cash deposits or gilts for such a period of time. This is because it is unsuitable for the trustees to expose the fund to the short and medium term volatility that higher risk will bring. However, what if the likely trust period is five or six years? On these occasions it is harder to judge a suitable level of risk. It is likely in these circumstances that some risk will be suitable, but that the longer term benchmark risk should be moderated downwards. This is not an exact science and trustees should carefully consider the level of risk suitable to the likely timeframe and needs of the beneficiaries.
Trustees often have the discretion to invest as they please. Despite this discretion, case history and accepted industry practice do require a prudent trustee to have some justification for their investment decisions, initially, and at review. It may later assist the trustees if their decisions have been documented and tested against an external measure. Benchmark indices do provide a useful starting point in establishing a suitable investment, as well as a gauge of market performance and review through time.
Trustees are very likely to have discharged their duty if they have retained suitably qualified investment advice, and maintained an ongoing review of this investment advice. Even then, complaints will arise (with good cause or not). This is especially so in a falling market.
Common examples of negligence claims include:
- Holding a suitable asset allocation and risk, but not suitably diversifying. As in the example of holding an overweighting in high street bank shares, and individual shares from the financial sector. This may have caused significant falls in value recently.
- Funds being held at too high a risk, and falling dramatically in value close to the end of the investment period. At the annual reviews in the years proceeding the end of the likely investment period, the risk might suitably have been reduced, year on year, to a lower risk, in anticipation of the likely needs of the beneficiaries.
- Conversely, funds being left in too low a risk, perhaps on deposit or in fixed interest securities, for many years. This is likely to cause lost growth during a market upturn, and so an effective capital loss to the beneficiaries.
- Using an unsuitable investment type for the type of trust. For instance, using an investment bond within a life interest trust. As the investment bond is a non-income producing asset this does not generate an income to the life tenant. This is a common error, often made with the motive of securing a high investment commission. Establishing the loss can be made difficult by the withdrawals of capital, made in order to supplement the life tenant’s income, but there may be no power in the trust to advance capital to the life tenant.
- Establishing a trust investment in a suitable manner and then not reviewing the investment for many years. In that time the trustees’ objectives have changed and the investment has therefore become unsuitable, causing a loss to the beneficiaries. In such cases a model based on a benchmark allocation and index performance can be used to establish the loss.
- Not checking the personal circumstances and needs of the beneficiaries through time. The health of the beneficiary is an example of this. This has repercussions for the change in the likely timing of trust benefits, and the eventual beneficiary(s).
In such cases the beneficiaries may have, or believe they have, a strong claim for loss against the trustees or investment advisers. If a level of loss can first be established, have the trustees done all that they could reasonably have done?
This financial crisis has been a difficult time for trustees, beneficiaries, and investment advisers alike. Dramatic falls in the capital value of trust investments do bring the practices of trustees and advisers into sharp relief. The goodwill that comes with a rising market will soon evaporate when a market turns downwards.
For practitioners involved in advising trustees, it is useful to stress the importance of a systematic approach to discharging their duties. It is not advisable to leave this area of practice to chance.
Sustained market falls will result in an increase in claims against investment advisers and trustees. Expert advice is needed to guard against the likelihood of this happening in the future, and in dealing with it in the present.
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