Investment strategy is key to umbrella trust success

02 August 2007 Richard Krepelka, Fairheads Umbrella Trust Company

The main purpose of an umbrella trust is to provide financial support to the beneficiaries in the form of regular monthly distributions and to utilise the capital to facilitate ad hoc payments in respect of the beneficiaries maintenance, education, medical and general well being. The investment strategy will have as its primary aim the meeting of these objectives.

Each beneficiary's needs are different and must be risk-profiled,taking into account:

* income needs (amount, frequency)
* age
* size of the amount to be invested
* other financial assets
* any known capital requirements such as provision for education and medical expenses that might impact on investable capital

In order to achieve the investment objectives and for the sake of good governance each umbrella trust should have a well-documented investment policy.

The umbrella trust trustees have broad discretionary powers regarding the investments of the trust funds but must exercise the care, diligence and skill reasonably expected of a person who manages the affairs of another. They are responsible for ensuring that the investment strategy adopted for the assets is appropriate given the income and capital requirements of the beneficiaries and taking into account their fiduciary responsibilities. At least annually but more frequently as may be required the investment strategy should be reviewed by the trustees and an independent asset consultant.

The primary risk is that the objectives are not met. Capital loss is a far greater risk than insufficient income being generated to meet any income need, as capital can be used to supplement a shortfall. Such depletion will, of course, reduce the potential for the trust to continue to make payments for as long as may have originally been intended. It is recognised that the management of one type of risk is often only achieved at the expense of another. Such risks include but are not limited to the risk of negative real returns, capital loss and volatility of returns.

Unlike retirement funds that generally have a medium-risk (prudential) mandate, the primary investment objective of an umbrella trust is to provide a return greater than that obtainable on call deposits with major banks, even though many of the amounts would not be able to command such high interest rates on their own. Only where trusts are long term and have capital in excess of that necessary to generate income, can a portion of funds be invested for capital appreciation. The overall investment strategy of an umbrella trust is conservative and requires flexibility to adapt in tandem with beneficiaries changing needs.

Investment vehicles
Given that the average death benefit per beneficiary in trust ranges between R30 000 and R40 000, it is essential to minimise costs and administrative complications. In order to achieve the objectives, at Fairheads Umbrella Trust Company three investment vehicles are used in combination, depending on individual beneficiary needs and based on investment horizon and income requirements. Based on a predetermined asset allocation model, the following vehicles are used:

* a cash portfolio (to provide liquidity);

* an income portfolio (to generate monthly income flows);

* balanced portfolio (to facilitate capital growth).

Other than the cash amounts, which consist of a combination of call and fixed deposits, the funds are invested through approved collective investment schemes (unit trusts), which are tax efficient and transparent on fees and performance.

The remaining risk is "manager risk", where the manager underperforms. The trustees should select the investment managers on the basis of pre-defined objective criteria.

Ongoing monitoring
The umbrella trust trustees and their advisers should monitor the performance of the investments in relation to agreed benchmarks and the performance of similar funds and investment managers. The investment managers will provide quarterly feedback and reporting on such performance, as well as related information such as updates on changes in investment markets, including certain fundamental economic data that might affect the performance of the investments or possibly impact on the investment strategy.

In summary, every umbrella trust should have a well-defined documented investment strategy focusing on beneficiary risk profiling, asset allocation, product and manager selection. This, together with regular monitoring and review, should achieve the beneficiaries needs in allowing them to receive regular income and education which may not have been possible had the funds not been placed into trust. This is not a wealth creation exercise, but rather one of managing relatively small amounts of money to the maximum benefit for beneficiaries.

Richard Krepelka, CEO of Fairheads Umbrella Trust Company

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