Geoffrey Schindler considers how trustees should react to market turbulence

If this article were being written in 1909 instead of 2009 its content would have been totally different. For many years, the wealth of England and Wales was tied up in land, and trusts began as a method of ensuring that land ownership was protected by passing through the generations.

There was a very unfortunate incident around 1720 when large numbers of people lost large amounts of money in what is now known as the South Sea Bubble, a form of ramping up of the price of shares not exactly unknown today. To ensure that trustees could not be caught up in this kind of scandal again, Parliament enacted a rule giving power to the Court of Chancery to restrict the investment powers of trustees, permitting investment only in “three per cent consoles” (i.e. government stock).

Behind the curve
With the development of alternative sources of wealth in the era of the Industrial Revolution, there was a growing appetite for investing in shares in companies, especially when incorporation became more frequent and easier following reform of the law in 1844.

Effectively, for much of the late 19th century and the early part of the 20th century, trustee investment was either in land or from a list of securities prescribed by statute. The tide only began to turn in 1961 with the passing of the Trustee Investments Act. This allowed trustees to split their trust fund into two halves and effectively to invest one half in equities, provided they were ‘blue chip’.

Again, society overtook the trustee in the latter part of the 20th century, as it became more and more frequent for trust deeds to contain wide powers of investment so that by the end of the century almost every new trust deed contained a power for trustees to invest as if they were beneficial owners. The Trustee Act 2000 enshrined that principle into law.

Duty of care
Although trustees now have an almost unlimited power of investment, there is an overriding duty for them to remember that they are not investing their own funds but investing funds for the benefit of other people. A degree of prudence is expected, so that the tolerable level of risk when investing as a trustee is much lower than the level of risk an individual might take when investing his own money.

For trust law purposes, investment requires an income return, so a power to invest without producing income was needed before trustees could invest safely in, for example, the insurance bond market. This, too, became a common feature of trustee investment powers.

Reacting to events
Two cataclysmic events have happened recently. The decline in capital values and, for those with bank shares (including many trustees) and cash deposits, the near disappearance of income returns.

We live in worrying times, and when trustees read valuations of their investment portfolios, whether they be invested in property or equities, they will, no doubt, have to re-examine their investment strategies.

The classic investment portfolio for trustees of, say, 55 per cent in equities, 30 per cent in fixed interest (bonds) and 15 per cent in cash may no longer be appropriate. Likewise, there can be problems for trustees who have invested in property – declining values and rentals and an even greater illiquidity in the market place.
And recently trustees will have started using hedge funds and derivatives, not always with a satisfactory outcome.

More than ever, trustees need to have the needs of their beneficiaries uppermost in their minds when making investment decisions.