Practical analysis for investment professionals
29 January 2014

Issues Confronting Fiduciaries Today: Solving a “Three-Variable Problem”

Acting as a fiduciary is, by definition, a role centered on trust (the word itself is derived from the Latin fiducia meaning “trust” and fidere meaning “to trust”). And nowhere is trust tested more acutely than when it comes to managing money — other people’s money. These days, the role of a fiduciary is also fraught with challenges and potential pitfalls, ranging from investing in challenging market conditions to ensuring all beneficiaries are treated fairly.

As Paul S. Lee, a national managing director at Bernstein Global Wealth Management, put it recently, acting as a fiduciary requires a person to, at the very least, “solve a three-variable problem . . . determining an investment policy, a distribution policy, and a taxation policy.”

Lee addressed some of the issues confronting fiduciaries today during a webinar hosted by Family Office Exchange (FOX). Here are two of the six questions he discussed in his presentation — “Aligning Investment and Trust Distribution Policy: Meeting Fiduciary Duty in a Total Return World” — along with tips on best practices.

How Do You Safely Boost Income Today from an Investment Standpoint?

“If you are talking about purely from an investment standpoint and you’re distributing only traditional income, the easiest thing to do is just take into account that we have this unusual market today with a taxable yield basically the same as the muni yield, which means if you are taking into account the taxes, and your beneficiaries might be in the highest income tax bracket, simply moving from taxable [bonds] to municipals will give you a 2% premium on an after-tax basis,” Lee said. “So if you are a taxable trust, or have taxable bonds, just simply go to munis today and constantly monitor how this relationship may change over time.”

But, he noted, the question that most fiduciaries are asking is: Why don’t we simply go to higher yielding investments, such as REITs, preferred stocks, LLPs, and high-yield bonds, and other investments where the yields are significantly higher than municipal bonds and stocks?

“That may be part of the answer, but it can’t be the answer for everything,” Lee said. “You have to remember that during the bear market, these same asset classes that had these wonderful yields were actually the worst-performing assets during the bear market.” The take-away? “There is no free lunch from an investment standpoint.”

How Do You Choose an Investment Policy That Is “Fair and Reasonable” for All Beneficiaries?

From the standpoint of the Uniform Prudent Investor Act, Lee said, a fiduciary needs to have the right balance between risk and return. What that effectively means is: What is the right asset allocation? In the most simplistic sense, this means what is the correct percentage of stocks and bonds. Is it 60/40? 80/20? 20/80?

“It’s very difficult to determine the appropriate asset allocation for an individual, it’s even more difficult when you are dealing with two individuals and those two individuals have very different ideas of what they would like their own asset allocation to be,” Lee said.

Consider this scenario: You have a current beneficiary who wants 20% stocks and 80% bonds, and you have a remainder beneficiary who wants 80% stocks and 20% bonds, and you, as the fiduciary, need to make a decision between those two. What do you do?

“The vast majority of beneficiaries would actually say, ‘Let’s go 50/50. We should be Solomon-like and just go in between,'” Lee said. “From an investment standpoint, this is a rather linear relationship — you satisfy or dissatisfy both of the beneficiaries. From an investment standpoint, this makes absolutely no sense. Total return from an investment standpoint means you are trying to get as much return as you can get and trying to be equitable to both of the beneficiaries.”

Is there a way to determine what the asset allocation should be?

“In a total return world, asset allocation determines how the portfolio will take on risk and return,” Lee said. “But that does not determine who shares the risk and return — distribution policy actually determines that. So in a total return world, you need to determine these two things simultaneously.”

Other Related Questions to Consider:

  • How do you provide an “equal” or “equitable” sharing of wealth, and how do you determine that?
  • Does a unitrust distribution solve the low-yield problem?
  • What distribution and investment policy will ensure inflation-adjusted values in the future?
  • Do I have a duty to distribute income to the current beneficiaries with the new tax laws?

Best Practices

  • The Prudent Investor Act and general fiduciary duty do not require success, or that you have inflation-adjusted value down the line, or that all of the beneficiaries are happy, Lee said. What it does require, however, is that you have the process in place for whatever decisions you make. “The results are much less important than showing that you at least considered all of the things you were supposed to consider, and you made a reasonable distribution at that time.”
  • Documentation is critical. “From a fiduciary standpoint, because many of the claims of failure to meet fiduciary duty come many years down the line, documentation is critical. Clearly setting out the investment, distribution, and tax policies is critical.”
  • Communication is key especially in a world where fiduciary litigation claims have gone up dramatically. “Set expectations with beneficiaries and share the rationale for your decisions.”
  • Monitor and adapt your asset allocation, distribution, and tax policies. “You can’t simply choose policies and let them run forever — markets change, tax laws change, and the needs of the beneficiaries change.”

To listen to a replay of the webinar, click here (registration required).

For more on the topic of fiduciary duty, see:


Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.

Photo credit: ©iStockphoto.com/ARTQU

About the Author(s)
Lauren Foster

Lauren Foster is a content director on the professional learning team at CFA Institute and host of the Take 15 Podcast. She is the former managing editor of Enterprising Investor and co-lead of CFA Institute’s Women in Investment Management initiative. Lauren spent nearly a decade on staff at the Financial Times as a reporter and editor based in the New York bureau, followed by freelance writing for Barron’s and the FT. Lauren holds a BA in political science from the University of Cape Town, and an MS in journalism from Columbia University.

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