Achieving a Fine Balance

Thomas E. Junkin and Giles D. Marshall tackle the realities of investing trust monies and the ripple effects of decisions trust creators make.


Achieving a Fine Balance

As you know, Fiduciary Trust Canada is a specialized firm with the seamless ability to structure and manage trusts plus invest money held in trust. It’s equally unusual to have a trust specialist and portfolio manager—with over 60 years of combined professional expertise—talking about the market and human dynamics involved in managing trust funds. That’s what team members Thomas Junkin, Senior Vice President, Personal Trust Services, and Giles Marshall, Vice President and Portfolio Manager, did recently for Perspective. Take advantage of their insights and knowledge. 

Q: What are your general thoughts on the nuances of investing trust funds?

Thomas Junkin: The parameters have certainly evolved over the last few decades. Historically, trustees had to invest in accordance with an approved list of investments (unless the will or trust deed authorized unrestricted investing). This so-called “legal list” was enshrined in provincial statutes and regulations and was badly out of step with modern portfolio theory (MPT). It got to the point where following the legal list of investments and not employing an MPT-driven total portfolio approach could actually be seen as imprudent, since no knowledgeable investor would follow the legal list.

Provinces have since updated their statutes, enabling trustees to invest according to the “prudent investor rule” that says: When making investment decisions, a trustee must adhere to the same standard that a prudent business person, familiar with investing, would adhere to when making investments on behalf of another person to whom they owe a fiduciary standard of care.

As a result, trustees take a broader portfolio view of risk and return, use diversification to improve return expectations while reducing risk, and seek an optimal total return from investments instead of focusing narrowly on investment income or capital gain expectations.

Giles Marshall: As discretionary investment managers, we’re already held to a fiduciary standard which, among other things, necessitates a prudent approach to investment decision making, so there’s nothing new in that regard. However, the even-handedness rule, specific to managing trust property, adds a layer of complexity in designing a portfolio’s strategic asset mix. Being even-handed means we need to ensure the needs of beneficiaries who currently rely on trust income, and those who expect to eventually inherit capital, are both met. In addition, the Investment Policy Statement (IPS)—outlining the constraints within which the trust’s property will be managed—needs to be approved by the trustees.

Beyond those items, managing a living or testamentary trust is similar to managing other long-term portfolios such as an RRSP.

Q: Given the realities of investing over years, what key things should one keep in mind when structuring a trust?

Thomas Junkin: I’ll tackle that answer from the view of the person creating the trust (the settlor). Choose a trustee who is knowledgeable now and committed to keeping pace with change over decades, who will listen and take advice, and above all, will put beneficiaries’ interests above their own. Take time to consider the amount of discretion your trustee should have and the investment, as well as distribution strategy, which will result from your decision.

Traditional trusts, for instance, separated investment returns into two buckets, income and capital. A common example would be a spousal trust created by the husband for his wife that states: “Pay all trust income to my spouse during her lifetime. Once she has passed, pay the capital to my children.” In this scenario, the wife wants maximum income and the children want maximum capital gain. From the outset, there’s a built-in conflict, especially if a second marriage is involved.

In contrast to this traditional model, we frequently recommend a fully discretionary distribution model that allows the trustee to make income and/or capital distribution decisions based on current circumstances, shaped by beneficiaries’ needs, not the return source. Here are a few reasons why.

First, there are market realities. This prolonged low-yield environment has demonstrated that a narrow focus on generating traditional income (interest and dividends) may frustrate income beneficiaries. Consider creating trust terms that allow the trustee to seek the optimal balance of risk and return, based on total investment return, not separate buckets of income and capital gain.

Second, there are family relationship realities. The traditional model may incent competing beneficiaries to focus too narrowly on specific investment outcomes, such as maximizing dividend income. The fully discretionary model aligns beneficiaries’ interests in seeking the optimum total investment return, consistent with their risk tolerance. The trustee can focus on meeting beneficiary needs instead of refereeing disputes over investment strategy.

We also believe tax planning and working with a tax advisor should be a priority for the settlor, trustee and beneficiaries. 

Q: Is there a type of portfolio construction/asset allocation generally associated with investing trust monies? 

Giles Marshall: Once we understand beneficiaries’ needs, there’s nothing especially unusual about managing a trust portfolio. We’ve developed a counselling and an investment decision-making process that’s effective in identifying a suitable strategic asset mix for clients at the outset. We then make tactical adjustments to that strategic positioning, as well as ongoing changes at the portfolio construction level (i.e., holdings in individual securities and/or pooled funds).

Q: How is the low-interest environment influencing trust fund investment decisions?

Giles Marshall:  Given low bond yields, satisfying the needs of income and capital beneficiaries is a key issue. With the overall FTSE Canada Universe Bond Index—a broad measure of the opportunity set in Canadian bonds—yielding a meagre 2.12%,[1] meeting the needs of income beneficiaries necessitates a higher weighting in dividend-paying common stock than has historically been the case. This obviously has ramifications for the overall level of volatility, one widely used measure of portfolio risk. In short, we’re seeing a trend whereby the equity component of a trust portfolio is significantly higher than 10 or 20 years ago.

Q:  What do you think is key when structuring a trust intended to span generations?

Giles Marshall: For multigenerational trusts, inflation protection will be an especially important consideration to preserve both income and capital in real terms. Since equities offer better inflation protection than bonds, a skew towards dividend growth companies may well be appropriate.

Also, keep in mind that, although some of the tax benefits of trusts have been clawed back over the years, trusts remain effective investment structures where the settlor and beneficiaries can be assured their objectives and best interests will be honoured. 

Thomas Junkin: Looking ahead, I wonder how current investment realities will affect the evolution of what’s considered “prudent.” If, for instance, global diversification were to become less effective, it will be interesting to see whether trustees have to look beyond the wisdom of modern portfolio theory in search of other ways to balance risk and return. What do the next evolutionary steps look like for a structure that, for centuries, has been helping families shape their future?


1.FTSE Russell Debt Market Indices as at November 30, 2019.


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