A trustee’s duties may be summarized as follows: take possession of the trust assets, distribute the trust assets 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 and their advisors may have to consider whether they are appropriate, or even permissible, 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 be contributing 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?

An individual client is free to devote some or all of her portfolio to SRIs. If the client is 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 the 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.

For instance, Ontario’s governing legislation is the Trustee Act, which establishes the standard of care a trustee must meet to be that of “a prudent investor (or a “prudent person” depending on the province).” This broad standard is further refined by the addition of mandatory criteria, plus a duty to diversify to an “extent that is appropriate to the requirements of the trust and general economic and investment market conditions” (ss27.(7)). Subsection 27.(5) sets out the criteria a trustee must consider in planning the investment of the trust property. The factors include:

  • the expected tax consequences of investment decisions or strategies;
  • needs for liquidity, regularity of income, and preservation or appreciation of capital; and
  • the expected total return from income, and the preservation or appreciation of capital.

The legislation includes only one factor—an asset’s special relationship or special value, if any, to the purposes of the trust or to one or more of the beneficiaries—is not purely financial in nature. As a result, SRIs can be included in a trust portfolio only if it makes financial sense.

Current trust law says moral, ethical, social and environmental attributes are irrelevant.

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 and 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 companies that are ousted with 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 says that negative screening is allowed, this strategy is generally inappropriate for trust investments.

In contrast, positive screening ranks 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 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?

SRI is 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.

by Elaine Blades, director of Fiduciary Services, Scotia Private Client Group and Paul Fensom, director of Business Development, Scotia Private Client Group.