When the creator of a trust is living, they can manage their trust and invest it however they wish. When a named trustee assumes control of a trust, however, they have a number of investment obligations and duties. A trustee’s obligations are set forth in The Uniform Prudent Investor Act (UPIA) and include making prudent investment decisions, diversifying trust assets, keeping administrative costs down, and being impartial with respect to the current income beneficiaries and remaindermen.
A trustee must make prudent investment decisions
Under the UPIA, a trustee is obligated to invest trust assets with the care, skill and caution of a prudent investor, and to design an investment portfolio that optimizes returns and acceptable risks (“Modern Portfolio Theory” or “MPT”). Exceptional investment skills are not required, merely average intelligence and the discretion to make sound investments. To do this, the trustee must consider the following:
- General economic conditions
- The effects of inflation and deflation
- The expected tax consequences of their investment decisions or strategies
- The role of each of their investments and actions within the overall trust portfolio
- The total expected return from income and capital appreciation
- The beneficiaries’ other resources
- The needs for liquidity, regular income, and the preservation or appreciation of capital, and
- Any particular relationship or value of an asset to the trust or to any of the beneficiaries.
There is no specific requirement for a particular investment return, but prudence must be exhibited in the course of the investment process. Under the revised Uniform Principal and Income Act of 1997, a trustee may delegate their investment strategy and individual decisions to qualified financial advisors, and they generally do so. A trustee must, however, carefully select their advisors, and continually evaluate their decisions and overall investment performance.
A trustee must diversify trust assets
The UPIA also states that a trustee must employ an investment strategy that suits the purpose of the trust and which balances risk and return. Part of this requirement is the duty to ensure proper diversification of investments and due diligence in the management of the trust corpus.
Trust investments are viewed as a whole, and a trustee will generally not be liable if a single asset performs poorly. Furthermore, a single speculative investment is unlikely to be an issue if it is small and facilitates the diversification of the trust assets. A prudent trustee should have documentation showing that the investment was part of an overall, successful investment portfolio.
If the trust directs the trustee to retain specific assets, such as a house or a business, the trustee is generally not obligated to seek out more productive investments. However, if circumstances change that may affect the interests of income or remainder beneficiaries, courts in some jurisdictions have held that the trustee should seek out other investments that better meet their fiduciary duty of prudent investing (see Part III).
A trustee must keep costs down
Trustees are obligated to minimize investment expenses and risk, and to keep both administration costs and taxes down. Note that trust companies serving as trustees are usually permitted to combine the assets of different small trusts to facilitate lower costs and diversification of investments – of course, all while keeping track of whose money is whose!
In Part III, we will conclude our series on the Prudent Investment of Trust Assets with a discussion of impartiality to the income beneficiaries and remaindermen.