A Trustee’s duty to monitor the risk within the trust portfolio

Duty to Establish Risk Expectations:  Section 2(b) of the Uniform Prudent Investor Act directs that “A trustee’s investment and management decisions respecting individual assets must be evaluated not in isolation but in the context of the trust portfolio as a whole and as a part of an overall investment strategy having risk [expectations] reasonably suited to the trust.”

Marketable Securities: There are two types of assets that are held within a trust portfolio. There are assets that have a daily market value, such as stocks, bonds, mutual funds, and ETFs, and assets that do not have daily market data, such as real estate, partnerships, many hedged products, et cetera. This missive will address the trustee’s duty to establish risk expectations related to marketable assets. (The subject of measuring risk associated with assets that do not go to market each day will be addressed in future writings.)

“Moderate” is not good enough: It goes without saying that the investment advisor selected by the trustee probably knows more about the measurement of risk than the trustee does, but this does not absolve the trustee of their duty to make an effort to define their risk expectations. Unfortunately, the investment industrial complex tends to oversimplify the description of risk within the portfolios they manage. It is common to describe the risk of a portfolio in a few short words such as “a moderate risk allocation” or “growth and income objective.” These descriptions may be helpful to the advisor’s marketing materials, but they do not reach the level of specificity required of a trustee. Following are several key performance indicators that the trustee, in collaboration with their selected investment advisor, can use to measure the risk of the marketable assets in the trust corpus. 

Standard Deviation: Without causing unnecessary concern about what you forgot from college, standard deviation is a generally accepted approach to defining the risk in a liquid portfolio. The standard deviation for a particular allocation helps the trustee understand the range of return that can be expected from each portfolio. If, for example, the targeted return for the portfolio is 6%, a standard deviation of 10% would suggest a likely range of returns in any given year is 6% – 10% and 6% + 10%. This range of <4%> to 16% is the return expected of the portfolio. It is very possible that the actual return may fall outside this range on either the high or low side. Nevertheless, this range serves as a fair and reasonable expectation for the trustee’s planning and should be incorporated into the trustee’s compliance library. 

Historical Max Drawdown: A prudent trustee will also seek to identify how the current portfolio allocation would have performed in past periods of heightened market volatility. For example, a prudent trustee would want to know by how much the current allocation of trust assets would have dropped had it been through the burst of the 2000 dot.com bubble or in 2008 during the Great Recession. Nobody knows for sure when a similar dramatic market event will repeat itself, but a prudent trustee will hold a portfolio that anticipates something similar will happen again. 

Other Risks: There are other types of risk the trustee is obligated to measure such as security level concentration (lack of diversification), lack of liquidity, lack of marketability, excessive leverage, et cetera. These are all distinct duties of care that will be addressed in future writings. 

Compliance Library: A prudent trustee will develop a record that demonstrates they have established a return objective for the trust assets. Though this discipline is rarely practiced and trustees too often accept ambiguous objectives defined by the investment industrial complex, it is the law and it needs to be done. (Link to Sample Engagement Letter for the Anodos’ Fiduciary Governance Service).

Give me a call: If you or your clients serve as a trustee and a further discussion would be helpful regarding this duty to monitor risk, I am available for a phone call to discuss the facts. Simply click here to book a 20-minute consultation.

Onward,

Josh Yager, Esq., CFP®, ChFC®
805-899-1245
jyager@anodosadvisors.com

 

Anodos helps trustees (ERISA, individual, and endowment) save time, reduce their personal risk, and fulfill their fiduciary duties.  We do this by helping the trustee conduct audits of the money managers to whom investment duties have been delegated.  Fiduciaries have an affirmative duty to provide ongoing and independent oversight of the money managers.  What makes us unique is that we do not manage money or sell insurance.  Doing fiduciary audits, benchmarking studies, and performance attribution is all we do. 

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Anodos develops and maintains an investment governance process for trustees so that their fiduciary duties are fulfilled.