Q#1 What is a ‘Cash Trust’?
‘Cash Trust’ as commonly promoted by some companies (other names are also used) is very different from the private trusts that trust companies normally provide as a service.
The normal private trust is a trust set up by a person named a “settlor” while alive, for an estate planning purpose, such as to provide for his own medical care on incapacity or to provide for children’s future education.
In private trusts, the settlor transfers to the trustee a trust asset or assets in the form of cash, investments and/or property. If it is cash for investment, it may be referred to as a cash trust.
In the case of the widely promoted Cash Trust, the agents of the trust companies will present to clients from an investment viewpoint. Typically, such products offer high yields and capital protection. The investor signs with the trust company a trust deed that allows the trust company to invest in anything it likes without liability for failure.
The focus when selling Unregulated Cash Trusts explains why some trust companies experience a surge in revenue and profit, far higher than trust companies selling normal trust services.
Q#2 What are the differences between normal and high yield Cash Trust?
|Characteristics||Normal trust||Cash Trust|
|Objective||Meeting estate planning needs||Higher yielding “Unfrozen FD”|
|Role of trustee||Custodian||Directs how monies are invested|
|Return||No return promised or indicated||High return promised or indicated|
|Capital protection||Not available||Presented as guaranteed or protected|
|Creditor protection||Available if irrevocable||None if can withdraw prematurely|
|Upfront fee||Fixed fee||4 – 5% of capital invested|
|Withdrawal penalty||None||10 to 25% of capital|
|Fund management||Given to licensed fund managers||Given to fund managers who claimed to be licensed|
|Ownership transfer||After event (death or incapacity)||After death only|
|Taxation||Return taxable unless from dividend||Return is presented as tax free|
|Accountability||Account & tax certification provided||Undisclosed|
Q#3 Where do monies in an Unregulated Cash Trust go?
This is a mystery. There is no disclosure on where the money goes or who the fund manager is.
FD rates range from 1 – 4%, REITs 5 – 6%, equities have widely fluctuating returns but generally is negative or poor because of poor market conditions this year, while yield on corporate bonds ranges from 6 to 8%.
Trust companies promoting Unregulated Cash Trusts charge around 4 – 5% annual fee. Assuming all funds are invested in corporate bonds, these would have to earn at least 11% to cover trustee fee and the promised return. Such bonds would not be investment grade but would be like high risk junk bonds. We could be wrong. But we simply don’t know anyone who can produce that kind of return, especially in the short term of 1-3 years, and yet able repeat the performance for an extended period like more than a decade. When someone can do that, they will be very famous and highly sought-after in the investment community. For example, billionaire Warren Buffett is someone with this calibre.
So the question to ask is where exactly are Cash Trust monies invested, who manages them and what expertise do they have.
Q#4 Are such schemes regulated?
I am not sure as I am not a legal expert. Promoters quote the Trustee Act 1949 and other legislations governing Cash Trust and that they are supervised by MOF, SSM, SC or BNM.
From my limited knowledge and understanding, there is no direct supervision on trust companies on any retail trust services other than for compliance with anti-money laundering activities. Legislation and supervisory agencies do not specifically cover Unregulated Cash Trusts and even if covered in future, such rules will not guarantee that players comply.
Unregulated Cash Trusts could fall under a legal loophole.
In the case of deposit taking or insurance sales, industry participants must follow stringent rules of BNM. The same goes for SC rules in the case of unit trusts and fund management.
There are no rules established for those who sell Cash Trusts. The promotion of such investment products is through agents who may not be regulated by the SC. The Cash Trust funds are managed privately, not under the supervision of the SC.
This is all I speculate. Take it with a pinch of salt.
Q#5 How is a trust company regulated?
As Nadeswaran, a respected investigative journalist, said recently, to get a trust company licence is a lot easier than to get a licence for fiduciary bodies such as banks, which require millions in capital and satisfactory personal probity checks for people to qualify as board members and senior management.
In the case of trust companies, licensing is from SSM which is under the Ministry of Domestic Trade and Cost of Living, not under the Ministry of Finance. The capital required is low and there is minimal supervision, if at all. SSM’s jurisdiction relates to the Companies Act and does not cover sale of investment products, acceptance of public deposits or fund management.
Q#6 What are ‘authorised investments’?
Authorised investments are defined in S4 of the 1949 Trustee Act. This section gives a trustee general powers to invest for beneficiaries into specific classes of investments, such as government securities, companies with a 5-year continuous dividend record, and property.
This section is meant to safeguard the interest of beneficiaries in the absence of specific powers under a trust deed, by limiting investments to less adventurous ones.
However, in the case of Cash Trusts, the trust deed that customers sign invariably allows the trust company to invest in ‘authorised investment’. If you entrust a trust company to decide on your investments, why not ask your preferred trust company on “what exactly are the authorised investments?’’
Please proof me wrong if you can identify the clause in the Trust Deed that says otherwise.
In most of the cases, the monies are directed to RPS, Promissory Notes, shares in a private company or property, which are illiquid assets.
Q#7 What is a ‘RPS’?
RPS stands for a Redeemable Preference Share. This is a form of preference share.
Preference shares may be issued by a company in addition to ordinary shares. The advantage of doing this is that the company raises funds without diluting voting rights of ordinary shareholders.
Typically, preference shareholders do not have voting rights and get dividends up to a fixed rate, only if there is a profit. They rank before ordinary shareholders in distribution for dividend or when the company is wound up.
Depending on what is provided in the constitution of the company, a preference share can be in various forms.
A preference share can be cumulative or non-cumulative. In the case of cumulative, any dividend unpaid (because of lack of profit) is accumulated as a debt. Such debt is paid when the company is able to, before any further dividend can be paid. In the case of non-cumulative, non-payment of dividend because of lack of profit is not carried forward as a debt.
A preference share can be redeemable or non-redeemable. A redeemable preference share (RPS in short) can be redeemable at the option of the company or at the option of the preference shareholder. A non-redeemable preference share is repaid only upon a stated maturity date.
A preference share can also be convertible to ordinary shares within a stated time frame, or non-convertible.
Bear in mind that a preference share is an investment signifying a share of ownership. It is not a liability of the company. If the company does not make profit, the preference shareholder does not get any return. If the company fails, its assets are sold and distributed to the creditors before preference shareholders, who may get nothing. Unlike in the case of a liability, the company has to pay the debt, whether it makes profit or not.
Q#8 What is a promissory note?
A promissory note is a promise in writing from the borrower to pay the lender a certain sum of money, either on demand or on a stated future date. It can either be negotiable (transferable to another) or non-negotiable.
A bank note is in effect a negotiable promissory note, payable on demand.
Q#9 What is the difference between investing in a share such as a RPS and a promissory note?
The main difference is that the RPS is equity not a liability, i.e. the company has no obligation to pay except when able. You cannot sue the company except when it breaches the terms of the issue.
The promissory note represents a legal debt which the company is obliged to pay when due, whether it is able or not.
Q#10 What is the ‘return’ paid out to customers of Unregulated Cash Trust?
This is supposed to be income from dividends or other forms of income such as gains arising from investment of Cash Trust funds. Such returns that are paid to investors should not come from capital but from income. Otherwise the capital gets less and less.
What is highly unusual about the Unregulated Cash Trust is the payment of ‘return’ to investors consistently at the promised rate. Compare this with EPF and Amanah Saham that provide stable income for decades, Cash Trust’s promised return is very outstanding indeed.
So the question is – how does the fund manager of the Cash Trust manage to achieve such returns year after year, after year, after year…?
Q#11 Are such returns taxable?
Such returns are taxable unless they are from distribution of unit trusts or from company dividends.
For tax free payments, there should always be a tax certification provided to the investor.
Q#12 High yield Cash Trust are compared with bank deposits? What is the difference?
The two are very far apart in terms of risk.
A bank deposit is what the bank owes you as a liability. Which means if the bank fails to pay you on maturity, you can sue the bank.
An Unregulated Cash Trust is an investment not a liability. If the investment fails, you will not be able to sue the trust company, except if fraud, gross negligence, misrepresentation or misconduct was involved.
Q#13 What are the risks involved in investing in Unregulated Cash Trusts?
It is possible for any investment to fail given the risk of illiquidity or business failure.
But the risks are much higher than normal if you do not know where your money goes or who manages the money.
Here are some of the important possible risks you should be aware of before investing:
- When you do not know who is managing the money
- Potential conflict of interest – when the trustee and the fund manager are not independent, the trustee will be conflicted in his duty to the investor. For example, he may not take action against a bad fund manager who is related to him. Or if he invests in a related party on terms that are unfavourable to the investor, such as investing in preference shares that are redeemable not at the shareholder’s option but at the issuer’s option, or perpetual loan notes where the capital is never returned.
- Licensing – the fund manager may not comply with the law, if not supervised by any authority.
- Experiences – Funds may be managed by an inexperienced fund manager resulting in loss caused by poor judgement.
- Negligence or lack of care – Funds may be managed by a person who does not exercise sufficient care or worse, who does not feel any need to be responsible to look after the interest of investors. For example, he may fail to insure assets against catastrophes.
- Co-mingling – under the law, a trust company must keep each client account separate, not pooled or co-mingled. Otherwise, one client’s investment loss can affect another client. There is also the danger of the trust company co-mingling the clients’ funds with its own, in which case, it is possible for gains to be kept by the trust company while losses are spread among clients.
- Lending to related parties – lending by a trustee to a related party gives rise to conflict of interest. The trustee may give the related party indulgence when he is unable to repay. Until it is too late.
- Abscondment – the trustee may disappear with the funds entrusted to him.
- When you do not know where the money goes, it could go to fund problematic projects, defaulting debtors or illegal activities or diverted for personal benefit.
Disclosure is very important. Otherwise, how are you going to assess your risks? Supposing you were to board a plane and the plane has some faulty parts that have a 50% chance of causing a crash. You would board the plane if you were unaware of this risk and if you were made aware, you would surely not board the plane. You need disclosure before you part with your money.
The higher the risk, the higher the reward should be. Let us say risks are assessed on a scale going from lowest 1 to highest 10, and the reward is lowest 1 to highest 10. If you have an investment with a risk of 6, you should expect a reward of 6 or better. However, if the promised reward is only 6 but the risk is 10, then obviously this would be a poor investment and not worth doing.
If that risk level is not disclosed to you, you would be investing blind, which is one of the biggest financial traps that I advocate readers to avoid. That is why they will be evasive about disclosing who handles your money or where it goes.
Q#14 The reason given for non-disclosure on investments is “confidential information” or “trade secrets”. Is that a good reason?
Not for me. If you invest in bank deposits, you know where your money goes and you get a statement. When you deal with a licensed fund manager, he will show you his track record, check your risk appetite and give you a regular statement on the composition of your portfolio and its performance. Same when you invest in a unit trust fund. Even when you invest in a company, it will provide annual audited financial statements.
There is no reason why the fund manager should not be able to tell you in general terms (without revealing any trade secrets or confidential information) where he intends to invest and regularly report to you how the monies have been invested and his performance.
Q#15 Are the yields offered by Unregulated Cash Trusts achievable?
It is possible but chances are very high that such high yields will not be achieved consistently.
Consistent pay-outs can only happen from a profitable source. If the investment is not profitable, then the pay-outs can only come from borrowing sources or new funds sold, which makes it a Ponzi.
In terms of yield, it is not unusual for unit trusts that are regulated under SC to achieve 10 to 20% p.a. or even beyond. So why go for uncertain and unregulated schemes when there are alternatives that offer as good a yield if not better, and that are properly supervised.
Since the underlying assets are ‘a mystery’, how would you know if they could / couldn’t achieve those returns?
That would be like you giving money to a stranger to invest when he has an unknown track record and no one checks on his performance.
Also, it begs the question – who sweats to make a high investment return and then give you, a passive investor, a big share?
Q#16 The Unregulated Cash Trust has also been compared to the one offered by AmanahRaya Trustees Berhad. Are the two comparable?
The two are not comparable. The one referred to for comparison is a normal cash trust in which trust funds comprising cash go to investments in unit trust or to licensed fund managers to handle the fund management.
Such products do not promise high returns, are not restricted to short term periods, have no heavy withdrawal penalties and there is full disclosure as to who manages the funds and to where the funds go.
And by the way, AmanahRaya Trustees Berhad is not governed under the Trust Companies Act but under Public Trust Corporation Act 1995 after corporatisation. Meaning it has its own special set of rules that are different from that of other trust companies.
Q#17 A senior representative of SSM said that the trust company acts only as a custodian, and hands the fund management to a fund manager regulated by SC. What are your comments?
He is entitled to his opinions and findings. My speculation is that someone might have been misled and was referring to normal trust products for which the trust company acts only as custodian and hands over funds for investment to licensed fund managers.
But those who operate Unregulated Cash Trusts do not act merely as custodian. They receive the funds and either manage such funds themselves or through subsidiaries or related parties, none of whom are licensed. Had these fund managers been licensed, performance reports would have been made available.
The above article is intended to be shared for public awareness. Please share it to people who are interested in cash trust or related products for educational purposes.
Disclaimer: No warranty (whether expressed or implied) is made with respect to the accuracy, adequacy, reliability, suitability, applicability or completeness of the information contained herein, and both the author and the publisher specifically disclaim any responsibility or liability for any damages, lost profits, losses or risks, whether personal or otherwise, which are incurred as a consequence, whether directly or indirectly, of the use and application of any contents of this book.
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