Risk Management and the Prudent Investor Rule

Trusts & Estates Magazine, November 2020

Northwestern Law & Econ Research Paper No. 20-11

6 Pages Posted: 25 Jan 2021 Last revised: 10 Feb 2021

See all articles by Max M. Schanzenbach

Max M. Schanzenbach

Northwestern University - Pritzker School of Law

Robert H. Sitkoff

Harvard University - Harvard Law School; European Corporate Governance Institute (ECGI)

Date Written: November 1, 2020

Abstract

The prudent investor rule, now enacted in every state, is the centerpiece of trust investment law. In accordance with modern portfolio theory, the rule directs a trustee to implement an overall investment strategy having risk and return objectives reasonably suited to the trust. This article, recently published in Trusts & Estates magazine, summarizes the results of an earlier empirical study of the effect of the rule on asset allocation and management of market risk by bank trustees. We had two main findings. First, enactment of the rule was associated with increased stockholdings by bank trustees, but not among banks with average trust account sizes below the 25th percentile, a result that is consistent with sensitivity in asset allocation to trust risk tolerance. Second, enactment of the rule was associated with increased portfolio rebalancing by bank trustees, a result that is consistent with increased management of market risk. Given these findings, we concluded that reallocation toward additional stockholdings after enactment of the rule was correlated with trust risk tolerance and that the increased market risk exposure from those additional stockholdings was more actively managed.

Keywords: prudent man rule, prudent investor rule, trust investment, fiduciary investment, prudent investor, modern portfolio theory, agency costs, fiduciary, fiduciary duties, risk tolerance, rebalancing, portfolio management

JEL Classification: G11, G28, K11

Suggested Citation

Schanzenbach, Max Matthew and Sitkoff, Robert H., Risk Management and the Prudent Investor Rule (November 1, 2020). Trusts & Estates Magazine, November 2020, Northwestern Law & Econ Research Paper No. 20-11, Available at SSRN: https://ssrn.com/abstract=3744174

Max Matthew Schanzenbach

Northwestern University - Pritzker School of Law ( email )

375 E. Chicago Ave
Chicago, IL 60611
United States

Robert H. Sitkoff (Contact Author)

Harvard University - Harvard Law School ( email )

1563 Massachusetts Avenue
Cambridge, MA 02138
United States

HOME PAGE: http://https://hls.harvard.edu/faculty/directory/10813/Sitkoff

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

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