Trust investments can’t be too risky or too conservative
All about Trusts:
By Phia van der Spuy
The Trustees of a trust are required to be more careful and prudent with the affairs of the trust than they would be with their own affairs.
In performing their duties, trustees fulfil a fiduciary position. A fiduciary duty is the onerous, legal obligation of someone who manages the affairs of another to act in the best interest of that person - in the case of a trust, the trustees should act in the best interest of the beneficiaries. When there has been a breach of fiduciary duty by a trustee, the beneficiary may claim the trustee’s gain out of a transaction, or may hold the trustee liable for breach of trust, even if the trustee did not financially benefit.
Trustees are not permitted to play an inactive role in administering the trust. They cannot exempt themselves from their fiduciary duties as are often found in trust instruments.
Whereas an individual can take personal risks in managing his or her own investments and affairs, a trustee must take great care when dealing with trust assets, and avoid any business risk as far as possible (Sackville West v Nourse case of 1925). In Estate Richards v Nichol (1999), it was established that a person in a fiduciary position, such as a trustee, is obliged to adopt the standard of a “prudent and careful person”.
Although trustees are required to invest prudently, they are also required to ensure that a reasonable return is obtained on the trust capital. Trustees may therefore be found negligent, not only if they invested in risky investments, but also if they invested too conservatively, resulting in the capital not growing sufficiently. In the Sackville West v Nourse case, the beneficiary succeeded in claiming damages from a trustee who had made an unwise investment.
Section 9(1) of the Trust Property Control Act states that trustees shall, in the performance of their duties and in the exercise of their powers, act with the care, diligence and skill that can reasonably be expected of a person who manages the affairs of another person.
It is important to note that “skill” encompasses more than simply acting in good faith. Trustees could therefore find themselves personally liable for losses suffered by the trust if it can be proved that they did not act with the necessary care, diligence and skill.
In the Gross v Pentz case of 1996 (also refer to Estate Bazley v Estate Arnott of 1931) the court held that, in order to sustain an action against a trustee, a disgruntled beneficiary must have a vested interest in the trust and not, as in the case of a beneficiary in a discretionary trust, merely a contingent-right interest in the future income and/or capital of the trust. However, based on any beneficiary’s right to proper administration of a trust, some legal experts believe that even discretionary beneficiaries have recourse against a misbehaving trustee. Trustees, therefore, have to perform a delicate balancing act between seeking out safe investments and avoiding risk, versus investing trust assets productively while considering beneficiary needs. An element of risk-taking seems unavoidable, and therefore trustees should be careful to record and document their reasons in arriving at investment decisions.
Trustees should preferably develop an investment strategy that should be documented in an investment policy, taking into account the purpose and duration of the trust, and after considering the interests, needs and expectations of all beneficiaries. Such a policy should be constantly reviewed and updated as circumstances change.
When capital and income beneficiaries are different people, extra care should be taken to ensure that all beneficiaries are considered. Capital beneficiaries may prefer capital growth and capital preservation, whereas income beneficiaries may favour maximising income, even if it is at the cost of capital growth or capital preservation.
If the income and capital beneficiaries are different, it is good practice to provide in the trust instrument that, if income is insufficient for the maintenance of an income beneficiary, then capital can be used to make good any such shortfall. This will assist the trustees to optimise the trust’s investment returns, while taking into account the needs of all beneficiaries.
Focusing at all cost on the short-term income production in a trust may have a detrimental effect on the long-term position and value of the trust’s assets, which in the long run may negatively impact both the income and capital beneficiaries.
Although trustees are ultimately responsible for the trust’s investments, they can obtain investment advice. It can never be expected of them to know it all, but in discharging their fiduciary duty, they have to demonstrate that they have obtained suitable input from experts in areas where they consider their knowledge to be deficient or lacking.
Phia van der Spuy is a registered Fiduciary Practitioner of South Africa, a Master Tax Practitioner, a Trust and Estate Practitioner and the founder of Trusteeze, a professional trust practitioner.