WE HAVE REVAMPED OUR SERVICE OFFERINGS TO MEET THE REQUESTS OF LAWYERS AND HOMEOWNERS. This is not an offer for legal representation.
Our services consist mainly of the following:
30 minute Consult — expert for lay people, legal for attorneys
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THE FOLLOWING ARTICLE IS NOT A LEGAL OPINION UPON WHICH YOU CAN RELY IN ANY INDIVIDUAL CASE. HIRE A LAWYER.
The 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. Most investment managers are required to produce performance data that is SEC-compliant. However, defining whether the return experienced was appropriate, given the level of risk that was taken, is more complicated.
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)).
To fulfill this duty to monitor the risk and return of the trust assets a prudent trustee, acting in good faith, will make the following inquiries:
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 of 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%).
Strategic Benchmark: The manager’s actual performance will be tested to determine whether any strategic value has been added by the manager. This test answers the specific question, “Have the manager’s strategic investment choices produced a better outcome than a simple investment in a few major asset classes?” This is done by comparing the actual performance and risk to that of a simple “vanilla” Strategic Benchmark that is historically consistent with the trustee’s stated Target Return (see above). The Strategic Benchmark is a combination of Russell 3000 (US Stock), MSCI ACWI ex-US (Int’l stock including Emerging Markets), and Barclays 1-10 Yr Muni (Bonds). For tax-deferred/free accounts, the bond component will be the BOFAML US Corp/Govt 1-10 Yr.
- The stock-to-bond ratio used is a mix of stocks and bonds which historically matched the client’s Target Return over the last 50 years.
- The Russell 3000 and MSCI ACWI ex-US are intended to represent the entire stock universe. For example, the Russell 3000 includes US Small Cap stocks, US Value stocks, etc., and the MSCI ACWI ex-US includes Emerging Market stocks.
- The US-to-Int’l ratio is fixed at 70/30 to represent the “home bias” that investors of any given country typically exhibit and to recognize that the client usually spends US Dollars.
- For example, if the client’s Target Return is 7.0% (or Inflation + 4.0%), the Strategic Benchmark will be 40% Barclays 1-10 Yr Muni, 42% Russell 3000 and 18% MSCI ACWI ex-US.
Risk: In addition to measuring the manager’s performance against these two 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
- 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
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.