What is it, and why does it matter to investors, trustors, trustees, and beneficiaries?
In the 1990s, the Uniform Prudent Investor Act (UPIA) established primary legal and financial responsibilities for trustees, based on principles of judiciousness, trustworthiness, and objectivity. Any trustee should be prepared to be held to its standards.1
The roots of the UPIA go back to 1830. In that year, the Massachusetts Supreme Judicial Court handed down a decision in the case of Harvard College v. Amory. That decision inspired what came to be known as the “prudent investor” principle.1
In this case, beneficiaries took trustees to court because of the way they invested. These trustees (the brother and cousin of the late trustor) had directed trust assets into stocks instead of risk-averse investments that might have produced steadier income. The trustor’s will had instructed the trustees to invest this way, so the trustees were not judged disobedient – but the court noted that a trustee should “observe how men of prudence, discretion, and intelligence manage their own affairs,” with an eye toward “the probable safety of the capital” as well as the potential for trust income.1
The “prudent investor” principle urged trustees to manage trust assets as if the assets were their own. It guided trustees to ask themselves a question: given the information and financial knowledge available at the time of an investment decision, is the investment decision a prudent one?2
The UPIA gave legal structure to the prudent investor principle. The UPIA is not a federal law; rather, it is a legal doctrine that was developed in 1994 by the National Conference of Commissioners on Uniform State Laws. Forty-three states and the District of Columbia have so far enacted the UPIA, sometimes with modifications.1,3
A trustee “shall invest and manage trust assets as a prudent investor would, by considering the purposes, terms, distribution requirements, and other circumstances of the trust,” the UPIA states. “In satisfying this standard, the trustee shall exercise reasonable care, skill, and caution.”1
The UPIA weds the “prudent investor” principle to Modern Portfolio Theory. What does that mean? It means that the standard of prudence now applies to the entirety of a trust’s assets. Investment risks and investment decisions need to be seen in the context of their impact on the whole portfolio.1,4
In the view of the UPIA, prudence requires thorough diversification of invested assets. Should a trustee want to strongly overweight or concentrate assets in one investment class, he or she must show compelling reason for that portfolio management decision and be prepared to legally defend that choice, if challenged. He or she must also recognize the duty to manage assets on behalf of assorted parties linked to the trust: not just the trustor and beneficiaries, but also charities or non-profit organizations that may eventually receive some of the assets.1
In applying the standard of prudence in a broader context, the UPIA also states other expectations for trustees. It notes their duty to avoid unreasonably high investment and account fees; they should seek to minimize them. It guides them to invest with twin goals of income production and capital appreciation in mind. It directs trustees to act with loyalty and impartiality in keeping with their role as fiduciaries. Lastly, it allows them to delegate authority prudently.3
Prudent trust management is a legal duty in almost all U.S. states. Irresponsible trust management may lead to legal trouble for a trustee. Fortunately, capable financial professionals are ready to provide guidance and insight to families, charities, and colleges, to help prevent the mismanagement of trust assets and abide by the principles codified in the UPIA.
In Summary: UPIA states that the fiduciary’s role is to manage risk and expected return by developing and monitoring the trust portfolios. Modern Portfolio Theory is the idea that you should diversify, measure risk, and account for all costs. Not only are these your primary responsibilities as a fiduciary, but the great news is that there is an academic and scientific method, if applied appropriately, that can give you very good solutions and prudent reasons for making an investment decision.
This is one of the areas that makes us unique, we follow the UPIA.
1 Eugene F. Fama, “Random Walks in Stock Market Prices,94 Financial Analysts Journal, September/October 1965
2 Past performance is not indicative of future results. Indices are unmanaged baskets of securities in which investors cannot directly invest. Assumes reinvestment of income and no transaction costs or taxes. US large-cap stocks are represented by the CRSP Deciles 1-5 Index, US small-cap stocks by the CRSP Deciles 6-10 Index, US large growth stocks by the Fama-French US large growth index, US large value stocks by the Fama-French US large value index. Full descriptions of indices used above are available upon request. 37 year performance figures taken from Dimensional Fund Advisors, Inc. Returns software 12/09. Some data provided to DFA by the Center for Research & Security Pricing, University of Chicago. January 1, 1973 – December 31, 2009
This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. All economic and performance data is historical and not indicative of future results. Market indices discussed are unmanaged. Investors cannot invest in unmanaged indices. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This material was prepared by MarketingLibrary.Net Inc., for Mark Lund, Mark is known as a Wealth Advisor, The 401k Advisor, Investor Coach, The Financial Advisor, The Financial Planner and author of The Effective Investor. Mark offers investment advisory services through Stonecreek Wealth Advisors, Inc. an independent, fee-only, Registered Investment Advisor firm providing investment and retirement planning for individuals and 401k consulting for small businesses. Stonecreek is located in Park City, Salt Lake City, Murray City, West Jordan City, Sandy City, Draper City, South Jordan City, Provo City, Orem City, Lehi City, Highland City, Alpine City, and American Fork City in Utah.