In 2002, the Province of Alberta modernized its Trustee Act, replacing the traditional legal list legislation with the "prudent investor rule". Described as the legal application of modern portfolio theory1, the prudent investor rule provides trustees with sophisticated investment guidelines and a new standard for determining liability. These critical changes apply to trustees–both professional and layperson–who are in a position of exercising investment powers for family trusts, pension plans, endowments, charities and the like.
The Trustee Act says a trustee “…is not liable for a loss in connection with the investment of trust funds that arises from a decision or course of action that a trustee exercising reasonable skill and prudence … could reasonably have made or adopted.”
Conversely, when quantifying the liability of an imprudent trustee, the Trustee Act says, “A court assessing the damages payable by a trustee for a loss to the trust arising from the investment of trust property may take into account the overall performance of the investments.”
This raises key questions such as, “Are some investment approaches more prudent than others?” If so, “what are the higher standards to guide trustees?” “Does a prudent approach include protecting the portfolio against underperformance?” “Is it prudent to attempt to beat the market return with a trust portfolio?”
A recent Canadian court case and the CFA Institute both offer clear guidance to trustees to establish the higher standards of prudent trust portfolio management. Knowing the difference between active and passive portfolio management, and which approach protects the trustee from liability, is critical.
There are six steps to implement "prudent–investor–rule–compliant" (PIRC) portfolios and help trustees avoid liability. Each step should be documented:
Six steps to your PIRC trust portfolio:
- The Index House will work with trustees and their board to discover and analyze the purpose, guidelines and constraints of the trust portfolio.
- We will develop an appropriate asset mix recommendation.
- Each board will be presented with an investment policy statement that documents Steps 1 and 2 and describes how the portfolio is to be managed.
- Following a modern approach, we will safely and efficiently implement the asset mix by researching and choosing the appropriate index fund for each asset class.
- The Index House is responsible for managing this portfolio. Periodically, holdings are rebalanced in order to maintain the customized asset mix.
- We will send a quarterly update to each board, which outlines current holdings, their market and book values, the unique asset mix, their rates of return (after fees are deducted), and fees. Monthly statements are available from the custodian, which also provides online access 24/7/365.
- Harry Markowitz, "Portfolio Selection", The Journal of Finance, Vol. 7, No. 1 (New Jersey: Wiley-Blackwell, 1952), pp. 77-91, at http://www.jstor.org/discover/10.2307/2975974?uid=3739392&uid=2&uid=3737720&uid=4&sid=21101411859767
- Province of Alberta, Trustee Act, Revised Statutes of Alberta 2000, Chapter T-8, current as of February 1, 2012. (Edmonton: Alberta Queen's Printer, 2012).