Insight

How should trustees respond to the current market turbulence?

How should trustees respond to the current market turbulence?

The year 2022 may prove to be an inflexion point for global markets. After more than a decade of growth and (relatively) stable performance, average portfolios are down more than 10% year to date. Although not necessarily a new phenomenon, the correlation between equities and bonds has become more worrying, particularly for those portfolios that are supposed to be managed on a cautious mandate. Between ineffective governments, rising inflation and geopolitical instability, there is no end in sight to this turbulence. Trustees must act—or must they?

How should trustees respond to fulfil their obligations to a trust’s beneficiaries by minimising the impact of market downturn?

Trustees aren’t expected to be investment experts. Indeed, while a trustee tends to hold investment power under the terms of a trust, a third party investment manager is also appointed. However, one of the trustee’s fiduciary duties is to monitor and ensure responsible financial stewardship of the trust assets. But in markets like this one, it isn’t always clear what ‘responsible stewardship’ should entail.

Keeping in close communication with beneficiaries is critical at any time. But during periods of market turmoil, it is essential for trustees to reassure their clients that they are actively monitoring, ensuring the investment mandate remains suitable and investment manager performance aligns with expectations.

This article will explore the immediate next steps trustees should take to protect their clients’ investment portfolios over the coming months and years.

First, do no harm

2022 has already been an overwhelming year for many discretionary investment managers. Those who managed to capitalise on the upside of the last decade are likely struggling in the current market downturn, particularly those who favoured growth companies such as Netflix and Meta. Taking a longer-term view, however, we can see that these companies have not performed so poorly over the last five years.

Given rising inflation and growing fears of a global recession, should trustees liquidate portfolios, change managers, adjust their strategy, or do nothing at all? Deciding whether—and how—to act is one of the most challenging tasks for trustees when market performance dips.

The first step should always be to contact your clients (meaning the beneficiaries of the trust) and confirm whether their circumstances have changed. These conversations allow trustees to review the investment mandate and validate clients’ risk appetite.

This conversation should lead to reconfirming or possibly updating the Investment Policy Statement, which includes the time horizon for an investment. If an investor will need to liquidate assets sooner than planned, for example, their overall strategy will require a change of tack. However, if the strategy is more long-term, it is likely that the portfolio will be able to withstand the current volatility in the hope and expectation that growth will return in the medium term.

Confirm the current appetite for risk

If your client’s risk tolerance has changed, that’s your cue to review the investment mandate and possibly adjust the overall strategy to adopt either a more cautious or a more risk-on approach.

Whether trustees decide to take more risk, less risk, or keep the mandate as it is, client communication is key. Manage expectations early and often. When markets are buoyant, it’s easy to say that a 10% dip can be withstood—but when it actually happens, the mood in the room can change quickly.

Confirm that the risk appetite of the trust remains the same. If neither time scale nor life circumstances have changed for the beneficiaries, there is probably no need to change the risk appetite. Most clients can ride out market volatility without liquidating assets. There’s no small amount of research to show that dramatic reactions to short-term market behaviour can have massive consequences on the portfolio over time, and some of the best market days follow volatile periods. A recent Blackrock study shows the dramatic impact of missing just the top five performing market days over a 20-year period.

If funds are sufficient, consideration should be given to taking two different approaches to investments. There are plenty of investment managers out there with different philosophies and ways of investing. Selecting a manager who outperforms in down times is easier said than done, but it is not impossible. However, should the market turn, these “total return” managers are likely to underperform those managers who are more bullish by nature. Put simply: there is no need to put all your eggs into one basket. The search is on for two complementary baskets!

Compare investment manager performance

Many investment managers have had a challenging year so far, but it’s still useful to analyse your manager’s performance relative to their peers and the market at large. Ask investment managers to provide comparison performance for existing and new portfolios. Your comparison should include both benchmark metrics and peer group performance data—but now an additional metric should be added: an inflation + target. A trustee can live with underperformance against benchmark, and to some extent against its peer group, but falling behind inflation is a big problem for trustees and at the very least merits a conversation with the manager.

That said, if a riskier approach was agreed, you can’t criticise the manager for performing slightly worse than markets when times are tough. The key is to compare their risk-adjusted performance to their peers and their benchmark over a longer period.

Comparison to peer groups is not the complete answer, however. Each portfolio will have its own unique characteristics, whether they are tax driven, ethically driven, or otherwise, specific to the portfolio’s circumstances. In addition to this, perhaps largely driven by the correlation between bonds and equities, expert investors with a long-term outlook are increasingly looking at Private Equity and other alternative assets to ensure both diversification and a smoother growth pattern.

Changing managers can come at a high cost and should only be done once all other options have been exhausted. A better first step is to look at the fees an investment manager charges. Performance figures provided by managers should be net of fees—but if not, a portfolio that is down 10% is down at least 11% once fees are accounted for. Therefore, a simple and efficient way to increase net performance is to have a discussion about reducing fees charged by the manager.

Final thoughts

The most critical action for trustees is to keep in close contact with clients to ensure circumstances have not changed and that the risk appetite and strategic asset allocation remains relevant. Trustees also need to communicate with the investment manager to discuss risk adjusted returns against key metrics, including an inflation + target as well as obtaining their thoughts behind increasing diversification in these times of most assets being correlated. Fees can also be discussed, and where possible, a blend of managers is always preferable.

Professional independent trusteeship remains one of IQ-EQ’s core offerings globally. To find out more or discuss any of the insights shared within this article, please feel free to contact me: