If you’re a trustee, your job is to take possession of the trust assets, distribute the trust asset as per the terms of the trust indenture, and manage and invest the trust assets pending their distribution.
While the hallmark of trust investing — managing the assets in the best interests of the beneficiaries — has remained constant, what constitutes an acceptable trust investment has changed over time. Assets once deemed unacceptable, including equities and mutual funds, now appear prominently in many trust portfolios. As new investment options or styles emerge, trustees may have to consider whether they are appropriate in a trust portfolio.
A look at SRIs
One category currently garnering attention is that of Socially Responsible Investments (SRIs), which are investments that are considered to contribute to the greater good because of the nature of the business. One example of an SRI is a company that focuses on environmental sustainability through alternative energy.
Here are some common questions and answers regarding SRIs.
Can a trustee adopt an SRI investment mandate?
A trustee can devote some or all of the portfolio to SRIs. If you’re a trustee charged with investing funds on behalf of others, the acceptability, even permissibility of this asset class is less certain.
Where does a trustee get authority to establish an investment policy?
A trustee’s power to invest trust assets derives from common law and has evolved through statute and case law. These statutory powers may be broadened or curtailed by the terms of the governing trust indenture. So, a trustee must look at both the legislation and trust indenture to gain a full understanding of his powers, duties and restrictions in trust investing. If the trust indenture doesn’t mention the trustee’s investment powers, the trustee is limited to the powers bestowed by statute.
Fortunately, most trust indentures include comprehensive investment powers granting considerable latitude to the trustee. Occasionally, the document will provide direction in respect of the sale or retention of a particular asset, or set restrictions limiting the scope of investments available to the trustee. If the settlor (or testator) does not explicitly direct her trustee to invest in an ethical or socially responsible manner, the test then becomes whether it would be prudent, as defined by the governing legislation, for a trustee to include socially responsible investments in the trust portfolio.
What SRI options are available for trusts?
An investment may be considered socially responsible because it avoids investing in companies engaged in producing potentially harmful products/services, or because it seeks out companies with strong environmental, social governance, ethical or other attributes deemed beneficial to society. The former approach is called negative screening. Common examples of companies that are ousted under this approach include tobacco and alcohol producers. When certain industries are excluded from an investment mandate, diversification is weakened and, as a result, investment performance could be limited. So unless the governing trust indenture specifically references negative screening, this strategy is generally inappropriate for trust investments.
In contrast, positive screening makes use of a scoring system to rank the best of class within a particular industry. Factors such as a company’s environmental footprint, hiring practices and board governance are considered when assigning a score. Since this type of investment mandate does not necessarily exclude any specific industries from the list of possible investments, it may be viable for trusts granted unrestricted investment powers.
In either investment style, a prudent trustee will consider the investment performance against common benchmarks, such as the TSX or the S&P500. If an SRI mandate is deemed appropriate, SRI-specific indices can assist in asset allocation. For example, the MSCI Global Environmental Index includes companies that derive the majority of their revenues from environmentally beneficial products and services. The MSCI KLD 400 U.S. securities that provide exposure to companies with outstanding environmental, social and governance ratings and excludes companies whose products are deemed to have negative social or environmental impact.
Where does that leave us?
SRIs are a relatively new, albeit fast-growing style of investment management. Since most current testamentary trusts are governed by wills drafted many years ago, a specific direction to invest in SRIs is unlikely. Moreover, while what constitutes an acceptable trust investment has evolved from a restricted list of low-risk assets to the more expansive standard of prudence, key criteria and benchmarks for measuring success must remain financial in nature.
This means that as long as the governing trust indenture contains broad, unrestricted investment powers, SRIs may be acceptable if they are evaluated through the same financial lens as all other investments.