Choosing investments, or indeed choosing investment advisers, is a task that weighs heavily with large and small investors. Although small i...

Choosing investments, or indeed choosing investment advisers, is a task that weighs heavily with large and small investors. Although small investors may believe that the large ones have solved the difficulties involved, the truth is that they rarely have. Before the bursting of the high-tech bubble, many investment professionals will remember the pressure that they came under from their clients who were no longer satisfied with returns of 10 per cent or 12 per cent; they were being dazzled by returns that were being “achieved” of 30 per cent and more. In 1999 and early 2000, even the venerable investor Warren Buffet was coming under pressure from shareholders and the media that his methodology was perhaps no longer appropriate in the “new paradigm” of a high-tech driven economy. We know now that the spectacular gains were short term indeed, leaving many of those investors nursing significant, and in some cases devastating, losses.

Thankfully, declining stock markets tend to give investors a health reality check whereby many have now moved to investment strategies that are partly or wholly measured as an “absolute return” rather than returns that fluctuate relative to stock indices. Investors, seemingly, are now prepared to sacrifice upside potential in order to avoid the ultimate pain; a decline in investment capital.

The upshot is that “the average investor” now realises that investing is hard work and it is not the easy pickings that momentum investing brought in the 1990s. For trustees, who are investing funds not for their own account with their own level of risk tolerance, but for the benefit of (and under the scrutiny of) others, the task is even more onerous.

In law, lay trustees have an obligation to make investments for other persons for whom they feel morally obliged to provide. A paid or professional trustee will be charged with a higher duty or a higher standard of care: in England, The Trustee Act 2000 not only creates a statutory duty of care which reflects any special knowledge or experience that the trustee has or holds himself out as having but also, for professional trustees, requires that any special knowledge or experience that it is reasonable to expect of such a person be taken into account.

Trustees traditionally were required to make all investment decisions themselves, but were allowed to obtain investment advice to help them make those decisions. They were not allowed, unless specially authorized under the deed, to delegate the decision-making aspects to professionals. That approach may have been appropriate in an age of exchange controls, limited investment opportunities and undeveloped capital markets, but today, the nature of the capital markets and the range of investment services available means that that it is increasingly inappropriate.

Happily, the law has now been reformed by legislation in a number of jurisdictions (England & Wales by the Trustee Act 2000; Bermuda by virtue of the Trustee Amendment Act 1999; Jersey under the Trusts (Jersey) Law 1984; Guernsey under the Trusts (Guernsey) Law 1984) to allow trustees as of right to employ professional investment managers and to delegate to them the decision-making power in respect of trust funds (within certain limits).

While this more enlightened and modern approach has certainly improved matters for beneficiaries in that greater investment expertise should now be available for trust funds, the ability for trustees to choose a professional fund manager to manage trust assets raises a possible area of conflict for professional trustees, particularly those corporate trustees that are owned by investment management companies or banks.

The appointment of a professional investment manager involves in law an act of delegation by the trustee. The trustee is required to exercise the power of delegation properly, which will require it to make a considered decision after applying its mind to the facts and circumstances of the particular trust in question.

If the bank-owned trust company routinely appoints an affiliated entity as the manager of its trust portfolios and does not consider alternatives, there are a number of areas where there may be a conflict between the legal duty of the trustee and the commercial self-interest of the trustee:

1. Has the trustee considered whether the bank’s investment offering is appropriate for the trust funds in question, or has it simply acted as a vehicle to support the growth of the investment management business?
2. Even if the appointment of the group company was appropriate, has the trustee reviewed the performance from time to time and considered alternatives?
3. Will the trustee replace the investment manager if it is clear that the investment performance is failing, or will corporate pressures prevent such a course of action from being considered or acted on?
4. Will the trustee seek to achieve a favourable fee arrangement or will it always pay the scale charges no matter what the size of the trust fund is?

Some private banks have in recent years attempted to demonstrate that they can offer a universally superior investment management service by moving to a “best in class” investment model. This involves the private bank branding the investment offering as its own but in reality the investments are managed by a portfolio of third party asset managers chosen on the basis that they are the “best” managers for each asset class.

The adoption of this approach effectively concedes that the private bank was not able itself to achieve the best performance in all asset classes because it has now ‘outsourced’ this service. But doubts remain that the “best in class” investment model can really deliver the best all round investment performance, as it is still necessary to make decisions in respect of asset allocation and in the appointment and reappointment of investment managers, which are decisions for the private bank itself.

In many cases, individuals who have used bank investment management services for many years establish trusts with the same organization, and for one generation of the family at least there may be genuine consent to the choice of investment manager. The consent of one or more beneficiaries does not remove the liability that the trustee may have to other beneficiaries who may choose to complain about the trustee’s behaviour many years after the settlor has died and ceased to have an interest in the trust.

The conflict problems for a bank-affiliated trustee are particularly acute where larger trusts are concerned, particularly for those whose needs may be served by Family Offices where a wide range of professional service providers, including money managers, are coordinated. It is unlikely that such families would entrust all of their investable wealth to a single organization, and the need in such cases is for a genuinely independent trustee that owes no favours to a particular investment manager or private bank and can hire and fire investment managers and reallocate funds for management according to an objective appraisal of the performance, aptitude, service levels, capital strength and reputation.

Some of the factors that a genuinely independent trustee would take into account in evaluating potential investment managers include:

1. Selecting investments or managers of investments that have a superior track record in declining as well as rising markets over a long period of time and not just being dazzled by recent performance figures.
2. Diversifying investments and/or investment managers. To put all of the trust funds with one investment manager, no matter how big or how successful, is simply not appropriate for many high net worth individuals’ trust funds.
3. Monitoring the investments on a regular basis and making continual comparisons with other investment managers – this will involve in depth discussions and regular meetings and contact and sometimes the use of professional evaluation and comparison analysis.
4. Periodically challenging the incumbent investment manager to raise performance and/or reduce costs in a competitive “beauty parade”.

Given that the fundamental duty of a trustee is act in the best interests of the beneficiaries and to avoid abusing the position that the trustee holds, it is possible that the organizational pressures in many banking institutions may conspire to prevent captive trust companies from fulfilling their overall responsibilities. The solution can only be to seek independent trustees who are immune from such pressures so that the interests of the beneficiaries can be given the overriding priority that the law requires.