Investment Policy Statements

The power to delegate investment management has been an essential element of trust law for many years. However, as Jill Britton, Director of Supervision at the Jersey Financial Services Commission explained at a recent presentation to trustees in Jersey, the power to delegate is still subject to an “absolute duty of care” remarking that “ultimate responsibility remains with the trustees”. She went on to comment that “the regulator expects trustees to consider and record the specific requirements of each trust on a case by case basis.”

Considering and recording the specific requirements of a Trust in an investment policy statement not only helps meet the requirements of the regulator but also acts as the cornerstone of a successful investment partnership between the trustee and their investment manager. This article looks at some of the key points to consider when developing your policy statements.

Set a measurable objective.

According to a Guernsey Financial Services Commission’s thematic review in 2015 , “the setting of measurable objectives is regarded as an essential means of ensuring that trust assets are preserved and enhanced in accordance with the duties of the trustee.”. However, in their findings, they found that 42% of trust firms did not have a policy for setting such an objective.
Objectives are usually defined in real terms to take account of the effects of inflation using a target benchmark such as CPI +3%. Over the long-term, you should expect a higher return for assuming more risk, and therefore any objective needs to be consistent with the level of risk the Trust is willing and able to take (see below). To illustrate this, the chart below shows the average real return achieved for low, medium and high-risk mandates over the past five years.

Choose a competitor benchmark.

In addition to setting a target benchmark, it is often useful to have a ‘comparator benchmark’ to measure how well your portfolio is doing relative to another investment option. Whereas the target benchmark answers the question ‘is my portfolio on target to meet its objectives?’, a comparator benchmark answers the question ‘how is my manager doing for me?’. There are any number of benchmarks out there you can use; however, if you are investing with an active manager, it seems sensible to compare your performance against the performance of other managers you could have chosen. To help you, MPI publishes ‘peer group’ indices based on the performance of real client portfolios collected from over 50 investment managers.

Risk

Under UK law, trustees are required to consider the ‘standard investment criteria’ when setting out a policy statement with particular consideration to diversification and the suitability of investments. A core component of suitability is the level of risk the trust beneficiaries are ‘willing and able’ to take. Willingness to take risk relates to the emotional response to financial losses and gains and is a more subjective measure. The ability to take risk refers to the capacity for the Trust to endure a financial loss and still meet an acceptable return over the long term. Where there is a single known beneficiary, this assessment is relatively straightforward; however, it becomes significantly more complicated where there are multiple or unknown beneficiaries.

Time Horizon.

It is important to remember that when we think about risk, we should be thinking about the risk of missing the objectives of the Trust and not risk in absolute terms. A low-risk portfolio may sound like a safer option, but if you’re investing for the long term, you are increasing the chance of missing your objective by choosing a low-risk portfolio. Therefore, trustees should consider the whole term of the Trust, and not just their tenure when selecting an appropriate level of risk. The effect of significant settlements and distributions also impacts the effective term of a trust and therefore is an important consideration when agreeing the most suitable level of risk.

Restrictions.

Finally, an investment policy statement needs to set out any investment preferences and restrictions for the Trust. Any tax considerations, income requirements or investment preferences (such as ethical or impact investments) all need to be considered and faithfully recorded before investing.

Conclusion

A well-drafted investment policy provides peace of mind for the trustees and a clear understanding of the requirements for the investment manager, helping avoid any nasty surprises for both. However, writing an investment policy statement can be time-consuming and is probably not the most appealing part of a trustee’s role. Fortunately, MPI, the STEP Member Service, has developed a free online tool to help trustees create and download investment policy statements for their trusts. By answering a series of questions and checklists, trustees and advisors can quickly create a tailored policy based on the template designed by STEP’s UK Practice Committee.

This article first appeared in the November 2019 issue of the STEP Journal