The Prudent Investor: New Trust Management Rules
| Publication year | 1993 |
| Pages | 281 |
| Citation | Vol. 22 No. 2 Pg. 281 |
1993, February, Pg. 281. The Prudent Investor: New Trust Management Rules
Virtually all estate and tax attorneys have clients who rely on trusts to grow or preserve assets for their heirs or to provide sufficient retirement income. These clients may be shocked to find that their assets could lose a sizeable amount of purchasing power by the time they pass to the beneficiary.
Typically, trustees seek the highest income possible while striving to protect the value of the trust principal---under a standard in the investment industry known as the "prudent investor" rule. However, significant changes are underway that will provide more specific standards for the supervision of trust assets. The newly issued Restatement (Third) of the Law of Torts (Prudent Investor Rule) [hereinafter, "Restatement"], published in 1992 by the American Law Institute, will bring fundamental changes to trust asset management and supervision. The new standards will carry substantial legal weight for trustees, although each state must legislate its own interpretation of the rule.
This article discusses two developments in asset management: investing to counter the effects of inflation and modern portfolio theory.
The new rule signals relief for trust grantors. Consider the example of a $100,000 trust established for two people. The trust will provide income for the life of the grantor and, on that person's death, the principal will pass to the beneficiary. Under the old prudent investor rule, the trust would be exclusively invested in "safe" U.S. Government bonds for twenty-five years. However, with inflation averaging 5 percent per year, the $100,000 principal would have an inflation-adjusted worth of only $29,500 by the time it passes to the beneficiary---not quite 30 percent of its original value. The new definition of prudent management requires that trustees conscientiously fight the effects of inflation, which can eat away a substantial percentage of a portfolio's worth over time.
The Restatement also incorporates the investment strategies of modern portfolio theory, derived from the work of 1990 Nobel laureates Harry Markowitz and William Sharpe.(fn1) Modern portfolio theory examines risk as well as return...
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