Did Reform of Prudent Trust Investment Laws Change Trust Portfolio Allocation?

Abstract

This paper investigates the effect of changes in state prudent trust investment laws on asset allocation in noncommercial trusts. The old prudent-man rule favored "safe" investments and disfavored "speculation" in stock. The new prudent-investor rule directs trustees to craft an investment portfolio that fits the risk tolerance of the beneficiaries and the purpose of the trust. Using state- and institution-level panel data from 1986-97, we find that after adoption of the new prudent-investor rule, institutional trustees held about 1.5-4.5 percentage points more stock at the expense of "safe" investments. Our findings explain roughly 10-30 percent of the overall increase in stock holdings in the period studied. The rest of the increase appears to be attributable to stock market appreciation. We conclude that, even though trust fiduciary laws are nominally default rules, institutional trustees are nonetheless sensitive to changes in those rules.

Keywords: prudence, trust investment law, modern portfolio theory, investment, prudent investor rule, prudent man rule, agency costs, fiduciary

JEL Classification: C23, G11, G21, G23, K11