UPIA §2(b) re Duty to Balance Risk and Return

UPIA §2(b) re Duty to Balance Risk and Return

Duty to Balance Risk and ReturnThe preamble to the Uniform Prudent Investor Act notes, “The tradeoff in all investing between risk and return is identified as the fiduciary’s central consideration.” For most trustees determining the return that was produced by the assets held in trust is a fairly straightforward exercise. But measuring risk can be more problematic.

What’s the Risk?

The Bogert treatise states, “The trustee cannot assume that if investments are legal and proper for retention at the beginning of the trust, or when purchased, they will remain so indefinitely. Rather, the trustee must systematically consider all the investments of the trust at regular intervals to ensure that they are appropriate” (A. Hess, G. Bogert, & G. Bogert, Law of Trusts and Trustees §684, pp.145–146 (3d ed. 2009)). Where investment management duties have been delegated to an outside investment manager, key performance indicators and benchmarks are the tools used to meet the trustee’s duty to measure and balance the risk that is accepted in the pursuit of return.

Target Return

The manager’s actual performance will initially be compared to the trustee’s stated return objective. This begs the question whether the trustee has taken steps to define a targeted rate of return for the assets over which they are responsible. If they have not, they are encouraged to do so. The Target Return is stated as an absolute number (e.g., 7.0%) or as a real, inflation-adjusted number (e.g., Inflation+4.0%). Once identified, this is the long-term objective is communicated to the investment manager to whom investment duties have been delegated.


There are a variety of benchmark types that can be useful in gauging whether a manager’s activities have added to or detracted value from the trust, which shows up in the return and risk levels. No single benchmark can tell a whole story. Rather we suggest using multiple benchmarking methods, each with its own purpose and advantage. Following are a few benchmark constructions:

  1. The trustee could blend a few simple stock and bond indexes in the same proportion as the current investments of the trust portfolio. The index components of this “vanilla” benchmark might consist of Russell 3000 for US stock, MSCI ACWI ex-US for int’l stock and Barclays Aggregate Bond or BofAML 1-10 Yr Muni for bonds.
  2. The trustee could also create a benchmark using those same index components, but instead determining what specific blend historically produced a return equal to the trust’s Target Return.
  3. Further, the trustee could use more detailed sub-asset class indexes (or better yet, index-based securities) in the same allocation as the investments when the manager first began. Any difference in performance between the actual portfolio and this benchmark could then be said to be attributable to the manager’s tactical decisions, whether in security selection, market timing, or departure from market cap weightings.

One important consideration is that most benchmarks assume no manager or product level fees, perpetual cost-free rebalancing and no cash holdings. Even still, much can be learned from a consistently applied set of benchmarks as to how the manager’s decisions are affecting the trust portfolio.


In addition to measuring the manager’s performance against the Target Return and fairly established benchmarks, there must be an evaluation of the risk that has been accepted by each manager. Some forms of risk are quantitative and can be discovered through statistical analysis. Other types of risk cannot be deduced from statistical inquiry and require a more subjective analysis.

Quantitative Risk Measures

  • Standard Deviation / Downside Deviation
  • Value-at-Risk
  • Beta
  • Max Drawdown
  • High Month Return / Low Month Return
  • Sharpe Ratio (risk-adjusted return)
  • M-Squared (risk-adjusted return)
  • Information Ratio (risk-adjusted return)

Qualitative Risks

  • Lack of Liquidity: The % of the trust that cannot be liquidated within 5 business days
  • Concentration: The % of the trust held in the single largest security
  • Leverage: The % of leverage used by the trust as reflected in a debt-to-equity ratio
  • Lack of Valuation: The % of the trust assets that do not have daily valuation

Collaborating with the Trustee’s Investment Manager

Most investment managers, if provided with this overview, can help the trustee create a record that these factors have been considered and documented. If the investment manager is unable to help the trustee develop such a record, a prudent trustee will take steps to independently evaluate these factors or find an investment manager that is willing and able to do so.

Free Ebook: The CPA and Attorney’s Introduction to Serving as a Trustee

UPIA §9 re Prudent Delegation of Investment Duties

UPIA §9 re Prudent Delegation of Investment Duties

prudent delegation of investment duties

Many trustees implicitly trust the investment manager to whom investment duties have been delegated. They trust that the manager’s strategy is reasonable. They trust that the return the manager produced was appropriate given the level of risk that was taken. They trust that the manager’s representation of being “above average” is supported by facts. This kind of trust may be good enough for some, but for a trustee it is not.

The Duty to Prudently Delegate

The Prudent Investor Act directs, “A trustee may delegate investment and management functions… The trustee shall exercise reasonable care, skill, and caution in: (1) selecting an agent; (2) establishing the scope and terms of the delegation…; and (3) periodically reviewing the agent’s actions in order to monitor the agent’s performance and compliance with the terms of the delegation.”

How Do You Know?

Few trustees have any evidence – other than what their manager says – that the trust assets are reasonably invested. Trustees are obligated to make their investment decisions based on something more than trust. They are obligated to find the facts and record the basis for the confidence they put in the money managers they have decided to use.

An Investment Policy Statement Is Not Enough

Many trustees think that by accepting an Investment Policy Statement drafted by their investment manager, they have fulfilled their duty to prudently delegate. They have not. The IPS is evidence of the investment manager’s understanding of the parameters of the relationship, but it does not stand as a substitute for the trustee’s clear delegation to the investment manager.

Checklist for a Prudent Delegation

Following are several suggestions, depending on the nature of the trust, for how a trustee might create an evidentiary record that a prudent delegation has been made.


  • A prudent delegation will have a written plan that includes the purposes, terms, and distribution requirements of the trust.
  • A prudent delegation will establish a fair benchmark for comparison that appropriately balances the risk and return of the trust.
  • A prudent delegation will carefully consider the cost of the investment services purchased to determine if they are in line with industry norms and appropriate for the assets being managed and the purposes of the trust.
  • A prudent delegation will include a background check of the party to whom investment duties have been delegated on the FINRA website to determine if any complaints, judgments, felonies, or regulatory issues have been filed (see http://brokercheck.finra.org/).
  • A prudent delegation is NOT simply sticking with the manager that the decedent/grantor initially used. What was good for the gander may not necessarily be good for the goose.

Free Ebook: The CPA and Attorney’s Introduction to Serving as a Trustee

UPIA §7 re Duty to Pay Only Fair Fees

UPIA §7 re Duty to Pay Only Fair Fees

Duty to Pay Only Fair Fees“Wasting beneficiaries’ money is imprudent. In devising and implementing strategies for the investment and management of trust assets, trustees are obliged to minimize costs” (National Conference of Commissioners on Uniform State Laws).

Duty to Pay Only Fair Fees

Section 7 of the Uniform Prudent Investor Act states, “In investing and managing trust assets, a trustee may only incur costs that are appropriate and reasonable in relation to the assets, the purposes of the trust, and the skills of the trustee.”

Types of Fees

To put it in the simplest terms, there are only two types of distributions that are made from a trust: those made to directly support the beneficiary and those made for other purposes. The latter class of distribution, those that do not directly meet the trust purposes, are “costs” or “fees” associated with the administration of the trust. These fees can be organized into two classes: those paid to the trustee for the services they provide as they occupy the office and those paid to third parties to whom management and administrative functions have been delegated.

Delegate Fees

In deciding how or what functions to delegate, the trustee must take costs into account. The role most frequently delegated by a trustee is the day-to-day management of the trust assets. At the time of the delegation and periodically throughout the relationship, a trustee is obligated to confirm that the fees being paid to the investment manager are reasonable and consistent with industry norms. This can be done by periodically gathering the fee schedules of other investment managers who provide a competing offering to the manager the trustee is currently using. A thorough fee analysis would include not only the fees the trust pays to the manager, but also the fees the trust incurs for the products or sub-managers among which the trust capital has been deployed.

Trustee Compensation

A conflict arises when the trust document is silent, as most are, about how much the trustee is to be paid. The matter is further complicated when the trustee is a professional (like a CPA, attorney, or investment manager) who not only is appropriately compensated for their role in administering the trust, but also provides professional services to the trust. The Uniform Trust Code, adopted by most states, gives specific guidance for fee disclosures that trustees are to make to the trust beneficiaries when the trustee wears multiple hats as the chief fiduciary and as a service provider to the trust. Developing a record of what the trustee decides to pay themselves and a rational basis for that fee amount is a critical risk mitigation discipline.

Procedural Prudence

A prudent trustee acting in good faith will create a record of who is being paid what and by whom. In many cases a simple “fee study” will suffice to create this record that the trustee both (1) recognizes this duty to incur only reasonable costs and (2) has taken proactive steps to fulfill this duty.

Now you know what you should know. Go and do likewise.

Free Ebook: The CPA and Attorney’s Introduction to Serving as a Trustee