State law determines how trustees may invest trust funds, and state law varies from state to state. Unless the trust agreement governing the trust contains language restricting the purchase of certain types of investments, investment guidance to the trustee is from state statutes. Most states have enacted the Uniform Prudent Investor Act (the “Act”), or a modified version of the Act, which guides trustees on the management of trust fund investments.
A trustee holds title of the trust property for the benefit of others and has a duty to manage the property with care and in good faith. This duty extends to the proper investment of trust funds under the Act, and the trustee direction is to invest as a prudent investor accounting for all known trust circumstances. Under the Act, management of the trust fund is a concept known as total return. Under total return, the trustee manages the portfolio as a whole with an overall strategy for investments that provide the best total return to the trust.
Trust Fund Investment Considerations
The trustee takes into account many pieces of information when selecting an investment strategy for the trust that include economic conditions, tax consequences, total return expected and trust income needs. In developing the investment strategy, a trustee must also consider the level of market risk that is appropriate for the trust, and the resources of the trust beneficiaries. For example, an elderly pensioner that needs the trust income to survive will have a much lower risk tolerance than a successful businessman beneficiary with his own wealth and resources.
Diversification and Risk
The Act requires that trustees look at all circumstances known when investing trust funds and, in most trusts, there are two competing types of beneficiaries. There is the current beneficiary who wants the trust invested to provide current income, and the beneficiary who will receive the trust some time in the future that wants the trust invested for growth. Prudent trustees invest to diversify across asset classes in order to provide adequate diversification and lower the inherent risk that comes with investing. This provides a mix of growth and income that is appropriate for the two beneficiary classes and the trust fund as a whole. A trustee does not have any type of requirement to meet or beat market returns and is acting properly as long as there is a standard of care and prudence in selecting the trust fund investments.
Trust Investment Restrictions
Trust law of old contained long lists of restricted assets not allowed for purchase by a trust fund. These types of restrictions did not keep pace with economic times and modern investment theory, particularly the effects of inflation. Even with the ups and downs of the stock market, utilization of a certain amount of growth in trust funds is required in order to keep pace with inflation, even if the inflation rate is minimal. Some states may still have residual laws on their books with trust fund investment restrictions, so it is always sensible to review the state law of the principal place of trust administration for restrictions, and also to see if modification of the Act was enacted by the state legislature.