Prudent Investor Rule and Asset Allocation

Max Schanzenbach (Professor of Law, Northwestern University School of Law) and Robert H. Sitkoff (Professor of Law, New York University School of Law) have recently posted their article entitled Did Reform of Prudent Trust Investment Laws Change Trust Portfolio Allocation? on SSRN.

Here is the abstract of their article:

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 through 1997, we find that after adoption of the new prudent investor rule, institutional trustees held about 1.5 to 4.5 percentage points more stock at the expense of safe investments.

Our findings explain roughly 15 to 30 percent of the overall increase in stock holdings in the period studied. We attribute most of the remaining increase 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.