LEGAL CONSTRAINTS TO TOTAL RETURN INVESTMENT BY TRUSTEES
| Published date | 01 December 2020 |
| Author | TAN Yock Lin BSc (London), BA BCL Dip Econ Devt (Oxford); Professor, Faculty of Law, National University of Singapore. |
| Date | 01 December 2020 |
| Citation | (2020) 32 SAcLJ 249 |
Two alternative methods with potential to obtain higher incomes for income beneficiaries in a low-income environment are considered. The conferment of trustee powers to readjust capital and income by way of enlargement of the duty of impartiality is first discussed. The most difficult aspect of this method is that it overlooks the duty to maintain capital integrity as an aspect of the duty of preservation of trust capital. The article argues that reform proposals which do not overcome its strictures are flawed. The total return trust or unitrust, which is the second method, is conceptually sounder. But its economic or business foundations, this article argues, must be approved by the settlor when setting up the trust or otherwise by consent of all trust beneficiaries.
1 Business experts and financial economists seem convinced that investment markets have undergone a sea change. In a word, the days of high passive investment income are over. Various reasons have been given for saying that investors should no longer expect to earn high passive income. Some point out that people are living longer as a result of medical and nutritional advances and therefore saving more. A higher savings rate lowers the interest payable on savings and in turn the returns that business must pay to attract funds. At the same time, the pace of technological improvements has slowed, reducing the ability of businesses to pay high dividends to investors. These accounts may be somewhat simplistic.1 They are predictive and conditioned upon premises which may be highly variable. Counter-predictions of higher productivity gains through new scientific breakthroughs cannot always be dismissed.2 What, however, cannot be denied completely is that in the preceding ten or even 15 years, trustees making passive investments have
2 For trustees who must pay income at rates fixed by the settlor in times of high investment income, there are three prospects: (a) selling assets to make up the deficiency in income; (b) raising income by turning to risky investments; or (c) investing for capital gains and turning gains into income to meet income shortfalls. The option of invading the corpus, however, may not be open under the trust. The option of placing more trust funds in risky instruments may open up questions of breach of the duty of care when making investments. The option of investing for gains may only be theoretical if there are formidable legal constraints on converting gains into income. Trustees who, being charged to preserve the trust corpus, are mandated to take a medium- or long-term view of investments are particularly affected by the changes highlighted. These include trustees who hold investments for successive interests for any significant duration or must distinguish income and capital, as well as charity trustees who hold permanent endowments or are restricted in the use of their funds to income earned on capital.
3 To such trustees, it has been urged that total return investment as opposed to total income investment is efficacious to sustain income distributions or charitable activities at a level matching previous income payouts or deployments in low-income environments. This article discusses the legal obstacles to the recommended course of action with reference to private law trustees. It does not evaluate the case for total return investment by charities, where special considerations are governing. It will explain why many law reform agencies which have considered the problem of falling incomes in relation to private trusts recommend legislative enactments which will validate and implement total return investment.5 Without exception, the recommended solution is two-fold and either cumulative (partially or wholly) or disjunctive: (a) conferment of trustee discretion to adjust between income and capital; and/or (b) allowing trustees to adopt or convert to total return trusts.6 This article argues that such solutions are flawed if they ignore
4 A simple but important starting observation is that rigid rules of investment will not be appropriate for trustees, apparently at any time. History bears ample record to this. For a long time, the concept of authorised investment imposed by trust law held sway. Trustees not otherwise unconstrained by the terms of the trust were admonished and permitted to invest only in investments listed or considered by judges as authorised or permissible. No lesson is clearer today than that this was a mistaken and wrong turn which the law took very early on in 1719.7 Whereas this first attempt to permit investment in the South Sea Company was on hindsight ill-conceived, what followed was at the other extreme. The courts in the wake of the collapse of the South Sea Company (which caused untold loss to investing trust funds) devised a court-approved list which initially included only 3% consolidated annuities, later extended to long-term government and corporate bonds and well-secured first mortgages.8 From the 19th century onwards, several statutes then perpetuated the notion of intrinsically safe legislatively-approved (read as authorised) trust investments by gradually expanding the list of permissible investments.9 These ad hoc and incremental additions culminated in 1961 in UK legislative approval of investment of not more than half of the trust fund in equities generally.10 The law's intervention to separate intrinsically safe from unsafe trust investments was barely tolerable so long as investment markets remained characterised by stable business cycles, low inflation, and inefficient processing and disseminating of market information. The premises, however, became
5 To be fair, even in the US where the prudent investor norm has been in existence since 1830, it took many more years before the present enlightened understanding was reached.12 Along the way, the courts there supposed that they could generalise types or classes of speculative investments that trustees must avoid.13 In an ironical sense, the prudent investor norm is now apparently so firmly established that it is a wonder that it was not the norm all along.14 Conceived in the broadest manner, the modern prudent investor norm is an objective and dynamic requirement to consider and follow the evolving institutional best standards and practices of the investment market (presently committed to Markowitz's modern portfolio theory which emphasises risk diversification).15 This means that prudent trustees will adhere to investment practices considered efficient by the market. They do no wrong when they do so. They are not required nor expected to do more. They need to neither outguess nor out-perform the market. They are bound by no governing formula but only a method, a process to obtain the requisite propositional contents for investment decision-making from the market. Trustees therefore must seek advice where the market practice so warrants. Similarly, they should employ a strategy if the market practice recognises there are merits in this or act on
6 Investment strategies are a significant aspect of the prudent investor norm for several reasons. Trustees manage funds on a premeditated and execute-as-planned basis, not so as to satisfy some statistical ratio, but thematically having regard to the objectives set by the terms of the trust. In the present market practice, without adopting a strategic or goal-based portfolio management suitable for the trust, they will hardly justify their claims as thematic prudent investors. Reinforcing this, the 2004 changes to the Singapore Trustees Act,17 aimed at underscoring the importance of diversification of risks, in no uncertain terms make investment strategy for trustees imperative.18 In the absence of a personalised strategy, trustees will fail to have formulated that prudent balance of risk and return which is a first principle, as shall be seen. To relieve them (especially lay trustees) of the onerous duties of keeping abreast of investment market developments and fluctuations, they are permitted to delegate their investment functions to authorised fund managers.19 The trade-off is that they must formulate a statement of investment policy which will advance trust objectives and establish an ex ante yardstick of appraisal.20 That statement of policy is an essential investment strategy which demonstrates fitness over time and market performance, having regard to the range of intended benefits which the trust may or must provide.
7 For the sake of simplicity of exposition, this article will only consider two broad competing and alternate strategies; namely total income and total return investment.21 There are intermediate or gradated strategies, of course, since market innovations easily combine features
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