Author: James Painter, CEO, Enhance Jersey
In today’s low interest environment, it has become increasingly challenging for trustees to preserve and enhance the value of trust funds under their duty of care, as few asset classes currently provide a low risk solution that will likely outpace inflation and annual fees. Also, due to the need for consideration of the interests of both present and future beneficiaries, it has become almost impossible to generate acceptable returns without taking some risk. This creates a dichotomy that can be tricky to balance, as protecting the trust’s value in the present could potentially jeopardise its future growth. Getting this balance right requires successful navigation of the complex range of investment opportunities in today’s market, which is why many trustees are increasingly turning to discretionary portfolio managers and consultants for expert advice and assistance.
Donald Trone, former President of the Foundation for Fiduciary Studies, made the following observation, which summarises the position of the fiduciary in relation to investment activities rather well:
“The legal and practical scrutiny a fiduciary undergoes is tremendous, and it comes from multiple directions and for various reasons. It is likely that complaints and/or lawsuits alleging fiduciary misconduct will increase…. Fiduciary liability is not determined by investment performance, but rather on whether prudent investment practices were followed.”
What this means is that effective monitoring of both investment portfolios and investment management providers is more important than ever. Whereas settlors fifty years ago may not have been financially astute, today’s beneficiaries almost certainly are. The majority of beneficiaries today have a good understanding of the investment returns their trustees should have earned, bringing into focus not just how the manager was originally chosen many years ago but the monitoring that has since taken place to ensure the manager was continually up to the job.
This growing awareness on the part of beneficiaries has also contributed to a significant increase in investment related litigation. This litigious era is also a consequence of the fiduciary industry reaching maturity. It has become apparent that when trust funds pass to beneficiaries in today’s climate the duties carried out by the trustees, perhaps over many decades, come under scrutiny. Increasingly this has led to beneficiaries seeking legal recourse where they feel investments have underperformed reasonable expectations.
A further issue for trustees of this development is the unwelcome publicity that inevitably ensues when the courts become involved. Although the majority of cases pertaining to investment performance have been settled out of court, there remains a reputational risk for both companies and jurisdictions.
As a consequence outsourcing arrangements appear to be a current topic across international regulators. As an example, the following extract came out on 27th July 2016:
“The Monetary Authority of Singapore recently released outsourcing risk management guidelines putting a strong focus on conducting due diligence on service providers and materiality of outsourcing arrangements. The new guidelines, which took two years to finalise following a public consultation in 2014, replaced the old guidelines and have already taken immediate effect.” (Source: Bovill 2016)
The GFSC also alluded to the need for due diligence on service providers with its informative Thematic Review 2015 “Fiduciary Decision Making in Respect of Assets Under Trust”. In the introduction it states “Trustees are expected to ‘manage the investment and custody of trust assets professionally and responsibly. Common sense and good intentions are not sufficient to demonstrate that a trustee has appropriately discharged their duties in relation to trust assets. Furthermore, good corporate governance dictates that comprehensive documentation should be maintained, which in turn can reduce the risk of future litigation.”
To mitigate the associated risks and meet regulatory requirements and expectations it is clear that professional fiduciaries need increasingly robust processes for appointing service providers and investment managers. Whilst this can be done internally, the cost of doing so means that many trustees are considering delegating this to a trusted advisor.
Delegating this function to a reputable firm has two distinct advantages over the establishment of an in-house department:
1. Cost savings – The costs involved in running an in-house investment services function are considerable. The smallest team will require one senior qualified personnel, one junior qualified personnel and a data processor. Specialist systems are also required, including a market information terminal such as Bloomberg and a specialist review platform. This can bring the headline cost of such an internal function well in excess of £200k per annum.
2. Conflict of Interest – Providing investment services from a fiduciary business creates concerns over the targeting of retrocession, which can be perceived as a conflict of interest, interfering with a fiduciary’s independence and thus objectivity. By using a delegated function, this is completely removed as the initial decision to promote an Investment manager will be made external to the Trust. Furthermore, commission agreements have been abused in the past with IFA style arrangements such as 5% front-end fees being applied to initial investments. As a consequence, the use of commission arrangements between financial intermediaries has become slightly tarnished.
By leveraging delegation in the right way, it is possible to efficiently implement an investor services function in a cost effective manner without the need for complex systems or recruitment of specialist investment personnel.
For the beneficiaries, this means:
• improved potential for superior performance
• access to a broad spectrum of investment managers that are continuously monitored
• unambiguous objectives detailed in an Investment Policy Statement
• objectives that are matched with investment manager pedigree
• user-friendly, regular monitoring
• peace of mind
For the trustee the benefits include:
• the elimination of a cost centre within the business
• access to specialist, experienced and qualified resources without incurring costs
• A reduced risk of litigation due to improved strategy suitability
• robust processes for the regulator
• peace of mind!
An intelligent delegated arrangement drives up standards while reducing costs, delivering a positive outcome for all stakeholders in a fiduciary structure.