COVID-19 has caused much disruption around the world, including to asset values. As at 31 March 2020, the average medium risk portfolio (as measured by the ARC Balanced PCI) was -11.0% from the start of the year. Although markets have recovered to a certain extent since those lows in March, what should trustees be doing to fulfil their fiduciary obligations to a trust’s beneficiaries and thus help minimise the impact felt by such disruption?
In most discretionary trusts, trustees will have wide powers and authority to invest and otherwise deal with the assets held on trust. While trustees are not expected to be investment experts – and indeed may engage professional investment advisers or, more often, delegate the power of investing to professionals who manage portfolios on a discretionary basis – they still have a fiduciary duty to monitor and ensure the financial stewardship of their clients’ assets.
Communication with beneficiaries is important in any event (how else can a trustee act in their best interests, one would argue), but it is now especially crucial for trustees to provide reassurance that they are in touch with the investment managers, that they have been monitoring the portfolio’s performance and understand what the managers are doing, how they are mitigating the worst falls and how they are preparing portfolios for some inevitable bumpy rides ahead.
In terms of monitoring performance, it is important to compare the portfolio with a sensible benchmark that has been selected by the manager not the trustee, as well as comparing performance against the investment manager’s peer group. Armed with this information, the trustee can ask the manager why the portfolio has under- or outperformed against the agreed strategy (or benchmark) and also whether the manager has under- or outperformed against their competitors. With this data, they should be able to have a constructive conversation with the beneficiaries.
It is equally important for trustees to revisit and perhaps update the portfolio’s Risk Profile Questionnaire to ensure that the risk appetite of the trust and, crucially, the liquidity requirements of the beneficiaries, have not changed. It might be that circumstances in the family have altered, meaning that beneficiaries have additional and unforeseen cash requirements. When it comes to private equity, hedge funds and other investments in portfolios that are illiquid in nature, a change in cash requirements means trustees need to alert investment managers so that they are prepared and can liquidate other parts of the portfolio as and when required.
Trustees should also look to ensure that their Investment Policy Statement is up to date and that time horizons (and tax considerations) have not altered since the statement was last looked at. Trustees should discuss with beneficiaries the time horizon of the investment portfolios and ensure they understand that investment portfolios can “go up as well as down”. Indeed, time horizon is a key consideration; although recent falls have been disturbing, if the investment horizon is longer term then it may be best to avoid hasty decisions.
That being said, if an investment manager is unable to satisfactorily explain poor performance, it may be necessary for the trustee to consider replacing them. The year 2019 was one in which most portfolios performed well (indeed the ARC Balanced PCI was up nearly 12% last year). If a manager did not perform well during 2019 when markets rose and yet still performed badly in 2020 when markets fell, it may be time to consider more drastic action. Such decisions should not be taken lightly, of course, as this may well crystallise losses and possibly mean that the portfolio misses out on a market recovery.
Generally speaking, the construction and ongoing makeup of investment portfolios should be part of a wider strategy and risk profile, including due consideration as to whether a portfolio is sufficiently diversified in that context. Although again trustees are not investment professionals, there should be regular discussions with investment managers on the makeup of the portfolio(s) and trustees should understand the rationale of the strategy and how and why they are positioned as they are. COVID-19 has heightened the importance of this communication and understanding, and necessitated greater frequency of such discussions.
Taking a step back and considering asset allocation, unless trustees employ specialised expertise they should not make asset allocation decisions (i.e. what percentage of the portfolio should be allocated to bonds, equities, alternatives and cash) – let alone which specific companies should be invested in. But not being an investment expert is very different from not understanding how and why portfolios are positioned.
Taking this proactive and involved approach, implementing all of the measures outlined above and ensuring proper reporting, will serve to reassure beneficiaries, minimise disruption, allow for tactical shifts and fulfil fiduciary duties, even in times of crisis.