Trust Portfolio Allocation

Two professors from the Northwestern University School of Law, Robert H. Sitkoff and Max M. Schanzenbach, have recently released an article entitled Did Reform of Prudent Trust Investment Laws Change Trust Portfolio Allocation?

Here is the abstract of their article as reported on SSRN:

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 such as government bonds and disfavored “speculation” in stock. The new prudent investor rule, now widely adopted, relies on modern portfolio theory, freeing the trustee to invest based on risk and return objectives reasonably suited to the trust and in light of the composition of the trust portfolio as a whole.

Using state- and institution-level panel data from 1986-1997, we find that after a state’s adoption of the new prudent investor rule, trust institutions held about 1.5 to 4.5 percentage points more stock at the expense of “safe” investments. Accordingly, we conclude that trustees are sensitive to changes in trust fiduciary law. Even though trust investment laws are nominally default rules, such rules matter in the presence of agency costs and unreliable judicial enforcement of opt outs.