The Cayman chapter of the Society of Trust and Estate Practitioners recently heard from RBC Trust Co Portfolio Managers Dave Stewart and Jean Dutil on monitoring investment portfolios and watching out for potential pitfalls as a trustee.
The STEP event held on 3 June saw 85 estate and trust professionals in attendance, making for a packed house at the Brasserie conference room.
In their role as investment professionals working for the trust company, Mr. Stewart and Mr. Dutil work closely with trust officers to help them monitor and oversee trust portfolios.
‘A trustee’s basic responsibilities when it comes to managing trust assets would be to act in the best interests of the beneficiaries and to preserve trust assets,’ said Mr. Dutil.
Trustees now have larger investment powers when managing trust assets.
‘But with these increased powers come increased responsibilities such as a higher duty care, a duty to ensure that investments are suitable for the trust, that assets are adequately diversified, and a duty to supervise the investment manager.’
Mr. Dutil laid out some pointers for appointing an investment manager.
‘In my experience most professional trustees would now days use discretionary managers rather than advisory managers,’ he said.
‘You also need to look at their experience and qualifications and find out how long they been in business, and ask for biographies of the investment team,’ he said. He noted looking at whether the investment process is simple and well articulated
Mr. Dutil also advised checking out the manager’s track record; whether performance been consistent in both positive and negative markets.
Mr. Dutil brought up the importance of transparent investment strategies, and whether strategies are proprietary or non-proprietary.
‘You should also be wary of hidden fees, so ask about all costs and fees, which are not always clearly disclosed.’
Above all he noted investment managers need to be selected with reasonable care and skill.
‘Don’t appoint them just because you like them or just because they bought you a few beers!’ he said.
Mr. Stewart noted trust officers should be reviewing the portfolio on a regular basis, and the reviews should be used to verify if the portfolio is within the IPS guidelines and if the returns are meeting the objectives in relation to its benchmark. He said above all consistent ongoing communication is key.
Mr. Dutil and Mr. Stewart then outlined potential pitfalls in monitoring trust investments
The first is compliance with the investment policy statement.
‘It gives the investment manager both the structure and flexibility to manage the trust assets in the best interests of the beneficiaries,’ he said.
The second pitfall is credit quality issues.
‘Even though a security might have a good credit rating there are other ways to determine whether a bond may be have a higher degree of risk,’ said Mr. Stewart.
‘A third pitfall is appropriate currency exposure, as the fixed income portion of the portfolio should not be used to speculate on currencies.
He also singled out lack of diversification as a another potential pitfall, noting a portfolio should be exposed to different asset classes and should not be overexposed to one single issuer or sector.
‘Also, having more than one manager reduces the risk: no one has a monopoly on good ideas,’ he said.
‘One of the golden rules as a trustee is to preserve capital or in modern times to limit the downside and minimize the risks,’ said Mr. Stewart.
‘You should not be invested with only one firm or rely on one investment style. You need to determine whether they can provide some downside protection – are they down at least less than the market?’
Mr. Stewart also noted finding out where the custody lies, whether the assets are with a financially sound custodian.
Another key pitfall Mr. Stewart noted is performance monitoring.
‘Performance can be measured on an absolute basis – is the return positive? Or is it a good return relatively, compared to a market index or ideally to a blended benchmark?’
‘It could be irresponsible to let poor performance slide for a year without any action.’
Another major concern is with regard to liquidity issues.
‘You should be aware of potential illiquidity of hedge funds & real estate holdings,’ said Mr. Stewart.
In the case of capital holdings, he noted they have their place in portfolios. However, they take a long time to liquidate. Hedge funds also typically take two to three months, and many have lock ups.
Another thing to ensure is that there is an appropriate deed or letter of wishes.
‘Leverage must be appropriate for the beneficiaries – as per deed and letter of wishes,’ said Mr. Dutil.
‘Leverage is often described as a double edged sword, as using the bank or someone else’s money to make more money is a beautiful thing,’ said Mr. Stewart.
‘So if you have a mortgage from the bank you keep gains in your home’s value. If it appreciates by more than the interest rate you are in good shape. But what if prices go down, like in US where ¼ of home owners are under water?’ he said.
‘With more volatility there is more risk.’
Mr Stewart said is essential to ensure appropriate communication and interaction.
‘Sometimes investment managers forget who their client actually is,’ he said.
‘People move, get married, have babies, so you need to keep in touch as trustee and notify the investment manager, as you may need to change the mandate or IPS.’
‘Communication should be clear and in simple language,’ he said.
‘Don’t be afraid to ask questions if something isn’t clear and keep asking until you are satisfied – and that means you may have to seek a second opinion,’ he said.
‘If the investment manager is not delivering when it comes to service and performance, ultimately it is your decision to change your manager, but it should be done on a case by case basis, as there is no hard and fast rule.’