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Trust Law/Level VIII · Trusts of the world/8.3 Running a trust/Lesson 2

Investing under the prudent investor rule

How the US Uniform Prudent Investor Act and the Trustee Act 2000 in England and Wales shape trust investing, and where ESG investing fits within the duty of loyalty.

Education, not legal advice. Trust law changes from country to country and state to state, and the right structure depends on your situation. Anything you sign should be drafted or reviewed by a qualified lawyer where you live.

The lean path

The cheapest, lowest-tax, simplest and most private route the law allows, best first. Each step names the rule it rests on and the condition that keeps it lawful.

  1. Low-cost diversified funds usually meet the core duties: UPIA §3 requires diversification and §7 allows only appropriate and reasonable costs. Catch: prudence is judged at the time of each decision (§8), so record the strategy and reasons when choosing.
  2. Delegate investment management to a qualified agent, and the trustee is not liable for the agent’s decisions if selection, scope and monitoring were reasonable (UPIA §9). Catch: periodic review of the agent’s performance and compliance is part of the duty.
  3. Keeping a low-basis holding or family business can be prudent where special circumstances, such as the tax cost of selling, make not diversifying better (UPIA §3). Catch: the trustee must reasonably determine that, unless the trust terms authorise concentration (§1).
  4. England and Wales: lay trustees meet a lower standard than professionals (Trustee Act 2000 s.1) and may skip advice they reasonably conclude is unnecessary (s.5). Catch: they must still consider suitability and diversification and review investments from time to time (s.4).
  5. ESG investing is safest when chosen for risk and return; sacrificing return for a social cause breaches the sole-interest rule absent authority (UPIA §5 comment). Catch: a settlor who wants values-based investing should authorise it expressly in the instrument.

MaterialsThe Uniform Prudent Investor Act (1994) with official comments, free from the Uniform Law Commission, or a state enactment such as Maine Revised Statutes title 18-B, chapter 9Trustee Act 2000, sections 1 and 3 to 5 (England and Wales), free on legislation.gov.ukMax M. Schanzenbach and Robert H. Sitkoff, ‘Reconciling Fiduciary Duty and Social Conscience: The Law and Economics of ESG Investing by a Trustee’, 72 Stanford Law Review 381 (2020)

Wonder

  1. Can one risky asset be prudent if the portfolio as a whole is sound?
  2. Can a trustee consider environmental or social factors without breaching the duty of loyalty?
  3. Is a trustee liable for the decisions of an investment manager it hired?

Explore

  1. The prudence standard for US trust investing traces to Harvard College v. Amory (Massachusetts, 1830). The older ‘prudent man’ rule tended to judge each investment on its own. The Restatement (Third) of Trusts: Prudent Investor Rule (1992) and the Uniform Prudent Investor Act (UPIA, 1994), adopted in most states, changed that. Under UPIA §2, a trustee must invest as a prudent investor would, considering the trust’s purposes, terms and distribution requirements, and decisions about individual assets are evaluated in the context of the whole portfolio, as part of an overall strategy with risk and return objectives reasonably suited to the trust. A trustee may invest in any kind of property consistent with the Act, and the official comment says no particular type of investment is inherently imprudent. Under §1 the rule is a default that the trust terms can expand, restrict or eliminate. This lesson describes the rules and recommends no investment.
  2. UPIA §2 lists circumstances a trustee must consider where relevant, including general economic conditions, inflation, tax consequences, each investment’s role in the portfolio, expected total return from income and capital growth, the beneficiaries’ other resources, and needs for liquidity, regular income and preservation or growth of capital. Under §3, a trustee must diversify unless the trustee reasonably determines that, because of special circumstances, the trust’s purposes are better served without diversifying. The official comment gives examples: the tax cost of selling a low-basis holding, or a wish to retain a family business. Under §8, compliance is judged by the facts and circumstances at the time of the decision, not by hindsight. The Act sets no percentage limit on concentration.
  3. UPIA §9 lets a trustee delegate investment and management functions that a prudent trustee of comparable skills could properly delegate. The trustee must use reasonable care, skill and caution in selecting the agent, setting the scope and terms of the delegation consistent with the trust, and periodically reviewing the agent’s performance and compliance. The agent owes the trust a duty of reasonable care, and a trustee who meets these requirements is not liable to the beneficiaries or the trust for the agent’s decisions or actions. Under §7, a trustee may incur only costs that are appropriate and reasonable in relation to the assets, the trust’s purposes and the trustee’s skills. Under §6, a trustee of a trust with two or more beneficiaries must act impartially, taking account of their differing interests, such as those of income and remainder beneficiaries (lesson 8.3.3).
  4. In England and Wales, the Trustee Act 2000 gives trustees a general power of investment (s.3), subject to the trust instrument. Under s.4, in exercising any power of investment trustees must have regard to the ‘standard investment criteria’: the suitability to the trust of investments of the kind proposed and of the particular investment, and the need for diversification so far as appropriate to the trust’s circumstances. They must also review the investments from time to time and consider whether to vary them. Under s.5, before investing and when reviewing, trustees must obtain and consider ‘proper advice’, from someone they reasonably believe to be qualified by ability and practical experience, unless they reasonably conclude that in all the circumstances it is unnecessary or inappropriate. The s.1 duty of care applies, with a higher standard for professionals (lesson 8.1.2).
  5. Uniform Trust Code §802 requires a trustee to administer the trust solely in the interests of the beneficiaries, and UPIA §5 applies the same ‘sole interest’ rule to investing. The official comment to UPIA §5 says no form of ‘social investing’ is consistent with loyalty if it sacrifices beneficiaries’ interests, for example by accepting below-market returns, for a social cause. As environmental, social and governance (ESG) investing grew in the 2010s, its place in trust law was debated. In a 2020 Stanford Law Review article, Max Schanzenbach and Robert Sitkoff distinguished ‘collateral benefits’ ESG, pursued for ethical reasons or to benefit third parties, which they argue generally conflicts with the sole interest rule absent authorization, from ‘risk-return’ ESG, used because it is expected to improve risk-adjusted return, which they argue can be permissible. Trust terms can authorize other approaches. The law continues to develop.
  6. Both systems judge investment conduct largely by process. US law asks whether decisions fit a portfolio strategy with suitable risk and return objectives, whether the portfolio is diversified or a special circumstance justifies not diversifying, whether costs are reasonable, and whether any delegation was properly made and monitored. English law asks whether trustees had regard to suitability and diversification, reviewed the investments, and took proper advice or reasonably concluded it was unnecessary. In both, the trust instrument can change the default rules, for example by permitting a concentrated holding, and under UPIA §1 a trustee is not liable to the extent of reasonable reliance on the trust’s provisions. Because prudence is judged as at the time of a decision, records made then show what was considered.

Key facts

  • Under UPIA §2, decisions about individual assets are evaluated in the context of the whole portfolio and an overall strategy with suitable risk and return objectives.
  • UPIA §3 requires diversification unless the trustee reasonably determines that, because of special circumstances, the trust’s purposes are better served without it.
  • Under UPIA §9, a trustee who uses reasonable care in selecting, instructing and monitoring an agent is not liable for the agent’s decisions or actions.
  • UPIA §7 permits only investment costs that are appropriate and reasonable; §6 requires impartiality among beneficiaries; under §8, prudence is not judged by hindsight.
  • Trustee Act 2000 s.4 requires regard to suitability and diversification and periodic review; s.5 requires proper advice unless the trustee reasonably concludes it is unnecessary or inappropriate.
  • The comment to UPIA §5 says social investing that sacrifices beneficiaries’ interests breaches loyalty; Schanzenbach and Sitkoff distinguish ‘collateral benefits’ ESG from ‘risk-return’ ESG.

Exercise nine, six, three, one

9CollectList up to 9 investment decisions described in this lesson or in a hypothetical trust portfolio (some sources give fewer), such as holding a large block of one company’s stock, hiring an investment manager, choosing between funds on cost or applying an ESG screen.
6ClusterSort them into 6 categories: portfolio strategy, diversification, delegation, costs, impartiality, and loyalty and ESG.
3DistillReduce the 6 categories to 3 groups: decisions about what to hold, decisions about who manages and at what cost, and decisions about whose interests are served.
1CrystallizeWrite 1 sentence explaining, in your own words, why the UPIA judges prudence across the whole portfolio and at the time of the decision, rather than one asset at a time with hindsight.

Fact check

Dates, figures and claims checked against the published sources listed below.

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