How the UPIA Has Changed Fiduciary Responsibility
By definition, the world of finance and investments contains risk. It can be scary for clients, especially when they’re not familiar with or haven’t had much experience in portfolio management.
As a Fiduciary, you can help.
In times when the market is volatile, or even when it’s steady, Fiduciaries have one primary goal – try to achieve the best risk-adjusted rate of return for their clients or beneficiaries. You want them to feel safe and confident in both their investments and in their trust in you.
The Uniform Prudent Investor Act (UPIA) transforms this goal into much more, as it actually mandates that it is a Fiduciary’s responsibility to manage overall financial risk while maximizing potential financial reward.
So how can you do this?
Managing investment risk could be something you take on yourself, or maybe you delegate to a qualified investment professional. Either way, when you’re working with clients and beneficiaries, you want them to feel safe, and what could be more reassuring than being able to trust that anyone managing their financial portfolio is guided by principles, regulations, and rules? The Uniform Prudent Investor Act (UPIA) does just that.
What is the Uniform Prudent Investor Act (UPIA)?
The UPIA was written to generate much-needed change to standard investment laws. An update to the Prudent Man Rule, the UPIA was designed to help Fiduciaries reduce clients’ risk by establishing five major, fundamental changes to how investments are managed.
The Prudent Man Rule dates back to the early 1800s and originally directed trustees to invest trust assets as a “prudent man” would do so, taking into account things like the needs of the beneficiaries and the need to preserve the estate or trust, as well as keeping in mind amount and regularity of income.
This is exactly the principles UPIA demands.
Encouraging Diversification in Investing
The act parallels much of Harry Markowitz’s Modern Portfolio Theory (MPT), an investment theory hypothesis made popular in the early 1950s.
Markowitz’s theory coined the very idea that to invest wisely is not to merely just choose stocks, but rather, it is to intentionally diversify investments by selecting the right combination of stocks to vary a portfolio – and to do this, we must look at consolidated portfolios as a whole. In essence, Markowitz really promoted the idea of diversification in investing.
Think about that old adage about all your eggs in one basket. If your portfolio lacks proper, intentional diversification, you risk losing everything in one fell swoop. It makes sense then that focusing on prudent investing by spreading out strategy can protect assets better in the long run.
Markowitz’s MPT embraces the idea that even investors averse to or nervous about risk can maintain an optimized portfolio. Further, they can even harbor a reasonable expectation of seeing a return based on a given level of market risk.
It’s true that more risk can mean more reward, but by looking at multiple investments as a whole (rather than just one stock purchase on its own), a risky investment can be offset so that an overall portfolio is generally more stable and investors can hope to achieve a better risk-adjusted rate of return.
Utilizing the total portfolio approach, the UPIA allows Fiduciaries to assess entire portfolios as one entity, thereby fostering diversification.
How Has the UPIA Changed Fiduciary Responsibility?
The UPIA made five changes to address and update the process of prudent investing and the Prudent Investor Act standard.
The financial industry had changed greatly, and so how Fiduciaries advise clients needed to change as well. The five additions the UPIA adds address issues that the original rule simply did not cover. Ultimately, and perhaps most importantly, the UPIA mandates that Fiduciaries act in the best interest of their clients.
New Changes to the Prudent Investor Rule
The changes that the UPIA implements require both suitability as well as an overarching understanding that, as a Fiduciary, you agree to think of and treat your clients’ money as if it were your own money.
The five major changes the UPIA makes update trust investment law are as follows:
- Rather than just looking at individual investments, a Fiduciary’s standard of prudence must be applied to any investment as part of a total portfolio. A portfolio encompasses all the assets in a trust. No longer can Fiduciaries act in terms of solo investments.
- A Fiduciary’s primary – hence, central – consideration and concern is now a tradeoff in all investing between a client’s risk and return.
- All categoric restrictions on types of investments were lifted as a result of the act. This fundamental change results in allowing trustees to invest in anything playing “an appropriate role” that could help achieve the risk/return objectives of the trust, providing the investment also meets other requirements of prudent investing.
- While it’s long been a requirement, the UPIA goes a step further in defining prudent investing by actually integrating a stipulation that Fiduciaries diversify investments and whole portfolios.
- The previous (and widely criticized) rule that forbade a trustee to delegate investment and management functions was reversed. Now, delegation is permitted, though it’s important to keep in mind it is still subject to safeguards.
Diversification is the Name of the (Protected Assets) Game
The easiest, most basic way to think of the UPIA is to simply regard it as an act that requires you to treat clients’ money and investments as if they were your own and to act in the best interest of clients and their funds.
So, how do you accomplish this?
We’ve already mentioned diversification, and it follows that before you can take this step, you must first examine a portfolio as a whole.
The Portfolio Standard section of the UPIA addresses the whole-portfolio tactic to investing. It stresses the idea that a stand-alone investment may not be popular, or prudent, if it has shown poor or decreasing performance in recent years. Yet when combined with other trust assets, this new, combined mix of assets may in fact be quite prudent.
The basic idea is really not all that complicated. In essence, first and foremost, a portfolio should be consolidated to better assess and evaluate all investment decisions.
So, once the entire portfolio is assessed, then what?
Step two is to ensure you’re encompassing diverse options and investments. Choosing investments that are low cost, yet highly liquid, is one way to protect assets – and it goes without saying that tax efficiency is a high priority for most investment portfolios.
The ultimate goal of this strategy: to protect assets, allowing risk to spread out over the entire portfolio, versus just one main investment that isn’t working in conjunction with the rest of a portfolio.
When you’re diversified, certain investments may see an upswing at the same time others are going down – so you can see how there is inherently less risk now. A well-diversified portfolio can result in less risk to clients’ overall wealth.
In times of uncertainty or swinging markets – even in terms of just “normal” market fluctuations – a diversified portfolio reduces a client’s risk of losing all his or her assets. In the event of a strong or unpredictable change occurring in the market, clients will be better-protected when their portfolio is focused on prudent investing and they are diversified, and the UPIA helps foster this diversification.
Do you have questions about the UPIA or about your Fiduciary responsibilities to your clients? Court Investment Services is here to help you. Reach out today.
