Avoiding a potential mine field

Recently, Jean Dutil and Dave Stewart, portfolio managers with RBC Wealth Management, presented to the Cayman branch of Society of Trust and Estate Practitioners. Their topic was “Monitoring Investment Portfolios” which proved to be a popular theme as ninety people jammed into the conference centre at The Brasserie. The recent economic downturn, volatile equity markets, credit defaults and downgrades have created a potential minefield for professional trustees.

With great power comes great responsibility” may sound like a line from the movie Spider Man, however it equally holds true for trustees in their role in managing investment portfolios for their clients. Stewart and Dutil work closely with trust officers at RBC Wealth Management where they monitor investment portfolios on behalf of their beneficiaries.

During the presentation they outlined a number of strategies for trustees to keep front and centre. Most pitfalls can be avoided by having a detailed plan in place. As a traveller plans out a trip in advance, outlining destinations, a schedule and mode of transportation, a professional trustee must also have a structured plan in place. In the investment world this plan or road map is called an investment policy statement or IPS. An IPS is a document that outlines the parameters for investing wealth on behalf of the trust and its beneficiaries. Investment objectives, targets and ranges for asset classes, types of stocks and credit ratings for bonds are all details that should be in the IPS. This allows the investment manager the flexibility to do their job but also provides guidelines to ensure the funds are invested appropriately. 

The IPS normally mandates the diversification of trust assets. The prudent man would not put all his eggs in one basket and neither should a trustee put all their assets in one investment nor with a single investment manager.

“Nobody has a monopoly on good ideas,” quipped Dutil.  “So why take the risk and invest all funds with a single manager?”  Over concentration in an individual security creates increased risk for a portfolio. A single stock or bond that is greater than 5 per cent of a portfolio could have a significant effect on investment performance if things go wrong. Furthermore, investing all trust assets with a single manager opens up the trustee for critics from the Beneficiaries.
Unless there is good reason, the days of simply placing funds in a laddered portfolio of bank issued bonds, and “rolling over” the maturities are likely gone forever after the credit crunch and the increased risk of defaults.  AIG and Lehman are sure to be case studies at business schools around the world for years to come. Credit ratings cannot be accepted as gospel anymore; one needs to do their research.  Evaluate the credit based on company financials, the business model, etc, or hire a professional with industry experience, real credentials and a track record.

“Don’t hire a manager because they wear nice suits or because they buy you lunch” said David Stewart.

Performance needs to be evaluated based on the market returns. A balanced portfolio that is weighted equally between global stocks and global bonds should be compared to the performance of the a blended benchmark that includes a 50 per cent weighting to a global equity benchmark such as the MSCI World and an appropriate global bond index as well. Benchmarks need to be relevant and reflect the qualities of the portfolio. Investment managers should be forthright in presenting both portfolio performance as well as blended benchmark returns to make it easy for their clients, which include trustees, to evaluate performance.  Too many investment people hide behind ambiguous reporting.

Trustees should be suspicious when an investment manager promises a return that is much higher than current market rates. If it sounds too good to be true it probably is too good to be true.

With interest rates near zero at the short end of the yield curve, it has become a challenging market to generate income from capital. US treasury bills are yielding about a half a percent.  Trustees need to take a more holistic view and look towards a total return concept where returns are generated from interest, dividends and capital growth and gains.

Keeping in touch with clients allows a trustee to manage the assets and adjust strategy with the changing needs of beneficiaries.  A child or grandchild moving off to school to the UK may require a need for Sterling distributions from the trust.  However, investing heavily in foreign currencies when there is no real underlying need could be construed as speculation and makes the trust vulnerable to wide swings in returns due to the volatility of the foreign exchange markets.

Hedge funds have their place in well diversified trust portfolio however they do present a challenge to trustees as they are normally highly illiquid. Getting funds out can normally take months. Consider hedge funds carefully and when suitable allocating 5% to 20% of the overall portfolio is a reasonable range.
Leverage too is a tricky area and can be a double edged sword when investing. Using borrowed money can greatly enhance returns however, the dark side to leverage is when performance turns negative and you still have a loan to pay.

In summary, having an investment policy in place, keeping in regular contact with beneficiaries, and having a checklist of potential pitfalls can assist trustees in staying on top of their trust assets and can help avoid many of the pitfalls in the current investment climate. And, if problems do come up, at least these practices will help trustees address and resolve issues quickly. And while it has become a more complicated world for everyone including investors, investment managers and trustees, the benefits of getting it right will be happier clients and happier trustees.



Jean Dutil and Dave Stewart, portfolio managers with RBC Wealth Management