Acting as a Trustee: Understanding What You Can and Cannot Do

by Tom Allen and Mark Hebner - Friday, 07 August, 2015

Most of us, either through personal experience or someone we know, understand what it means to be a trustee. There may even be some of us out there who don’t know that we are a trustee (anyone own a business with a 401(k) retirement plan?). Regardless, it is important to understand the legislation that dictates how we can perform our duties as trustee. From an investment standpoint, for anything outside of retirement plans, which are governed by federal law (ERISA), we must rely on what our particular State has outlined for us. And not all States have adopted or written, although they should, a universal set of laws.

We are going to speak specifically about the laws governed around regular trusts versus trusts that are set up for the endowments of universities or for foundations since they have their own set they must follow. Most States have adopted all or parts of the Uniform Prudent Investor Act (UPIA), which was established in 1992 by the American Law Association. It has set forth certain tenents based on research in the field of financial economics over the last 50 years. It allows fiduciaries to apply a total return concept when making investment decisions and must utilize the framework of Modern Portfolio Theory, which is a body of academic literature established by Nobel Laureates like Harry Markowitz and William Sharpe, individuals that Index Fund Advisors has idolized since their theories helped establish the basis of our own investment philosophy.

Before the establishment of UPIA, most individuals were constrained to choosing only the safest investment options for trust assets. This was usually a combination of long-term U.S. Treasury Bonds and other fixed income vehicles. While the idea was to protect as much of the principal as possible, real threats such as inflation inflicted the most harm. In today’s market environment, relying on U.S Treasuries is likely to result in more harm to the overall portfolio (in terms of protecting real purchasing power), than taking on certain risk factors within the market. Just to give a real quick example, if someone had decided to invest solely in U.S. Treasuries over the last 5 years, they could have earned 1.57% (yield on 5 Year U.S. Treasury Note as of August 5, 2010). Inflation over the same period averaged almost 2% per year. In real terms, an investor would have lost money.

Now this of course does not mean that all of a sudden a trustee can go out and start buying penny stocks or private placements. They must always act with prudence when making any investment decision. Key things to consider when making a prudent decision in the world of investing include:

  • Current Economic Conditions
  • Taxes
  • Inflation or Deflation
  • Fees
  • Expected Risk and Return
  • Special Circumstances of the Beneficiaries of the Trust

From our standpoint, acting with prudence goes hand-in-hand with acting based on facts, not stories. For example, it wouldn’t be considered prudent to invest trust assets in a hedge fund. There is almost no empirical evidence that hedge funds provide substantial benefit for investors. We know, this may sound insane since the growth in the hedge fund world has been tremendous and it may sound like a fun conversation you have over a round of 18-holes, but it is in fact growth based on salesmanship rather than empirical evidence.

The total return approach prescribed under UPIA is very important. Understanding that not all assets are going to appreciate at the same time does not mean that we abandon them when they lose money. Diversification is essential to mitigating risks that have been proven to not reward investors over the long-term. But there are periods when there may be substantial losses in a particular area of the market. The essential idea is that making portfolio decisions should be based on what we can expect to reward investors, which is backed-up by many years of supporting data (not just 5-year periods, which is the standard in our industry). For example, small-cap stocks have been shown to provide higher rates of return compared to large-cap stocks over the long-term based on data that goes back almost 90 years. Although small-cap stocks have lagged large-cap stocks year-to-date, we shouldn’t just abandon small-cap stocks altogether.

UPIA also allows trustees to delegate their responsibilities if they feel like they do not possess the skills necessary to perform the required duties. Because most people do not have a qualified background in the field of investments, we highly recommend that trustees work with an independent registered investment advisor to assist with guiding the trust assets. Even if a trustee works in the field of investment management, they should still probably go to an independent advisor since the advisor can bring scale in terms of costs to manage the investments.

While UPIA is in no way the end all be all (in fact, a trust can waive UPIA in their trust agreement), we highly recommend that trustees stick with the tenents that UPIA has outlined.

For more information of how Index Fund Advisors can assist with your trust services, contact us at 888-643-3133 or online, here.