Setting a prudent asset mix policy for an aboriginal trust
February 13, 2019
Over the last few years we have seen numerous First Nations’ settlements with the government. The amounts of these settlements are typically large and can, if prudently invested, greatly enrich the quality of life for both current and future community members. With that in mind, let’s explore some of the key considerations in determining a prudent asset mix for an aboriginal trust.
An aboriginal trust is set up to hold the assets from a claim settlement from a government to compensate for a historic damage, such as land appropriations. Established to hold the settlement, it is used to fund benefits for current and future members and is governed by a trust document, outlining the uses of its assets. Trustees, who are appointed to oversee the investment and distribution, are held to a “prudent investor” standard, requiring them to exercise the same care as they would investing their own money and avoid imprudent investments or risks.
Generally, the initial investment in the trust is the settlement amount, which is fixed. This settlement, plus future investment income, will fund future benefits. The higher the investment returns earned by the trust, the greater the future benefits payable to the community.
However, this relationship does not necessarily support an extremely aggressive asset mix policy. Much like a pension fund or foundation, the asset mix policy should be tied to the liability structure or expected use of the trust.
In certain cases, the trust document may restrict benefit spending to income from the trust, restricting the access to principal and capital gains. Only the trust income may be used to fund regular programs, such as paying annual salaries for teachers. These ongoing program obligations can be thought of in a similar manner to pension payment obligations from a pension fund. They will require a regular income stream from investments and some growth to account for wage inflation or future cost escalation. They would likely benefit from a higher allocation to interest-bearing bonds or stable dividend stocks, to generate regular income to fund the obligations.
In the current low and rising interest rate environment, investors should consider finding investments that increase portfolio yields, such as a higher allocation to dividend stocks, corporate bonds or mortgages. Given the long-term nature of these obligations, consideration could also be given to an allocation to less liquid and higher yielding alternative asset classes, such as real estate and infrastructure.
In other cases, the benefit obligation could involve building a community centre, school or hospital, expenditure requiring a fixed lump-sum payment or a series of lump-sum payments over a construction period. Similarly, the trust documents may permit per capita distribution to community members out of the initial settlement. In these cases, a significant equity investment would introduce too much volatility. For example, in 2018, the Canadian equity market lost nine per cent. If the building payment was due at the end of 2018, this would result in a crystallization of those losses, which would impair the future benefits from the trust. Given the short-term nature of this commitment, a prudent investment policy might involve a shorter duration bond portfolio, with a similar duration to that of the project. If the payments schedule is known, a laddered bond strategy might provide the combination of the certainty and a competitive yield on the investment.
The trustees must also consider the need to fund potential future program requirements. Meeting this objective requires a reserve to fund future benefit needs. Future program obligations can be thought of in a similar manner to pension surpluses. The goal for these assets is to generate significant growth to maximize future benefit spending — since the time horizon will normally be quite long, these assets can bear a high allocation to equities and may benefit from a well diversified (by geography and capitalization) portfolio of equities.
So, when looking to determine an investment policy for an aboriginal trust- looking at the liabilities and intended use is a good place to start- instead of just focusing on maximizing returns. As each trust will have a different risk tolerance and different liquidity needs, based on the benefit obligations outlined in the trust documents, a better understanding on the part of trustees of the nature of the obligations will help them to tailor prudent long-term investment policies that will best support these obligations.