L2 flash cards ethics Study Session 2

1. General Fiduciary Standards
Care: The trustee must do their homework by gathering
pertinent information to use in their investment decisions.
This could exclude seeking advice. A higher level of care is
required under the new rule.
Skill: It means that if the trustee does not have the relevant
investment knowledge, he has the duty to seek such advice
Study Session 2, Reading 10

2. General Fiduciary Standards (cont.)
Caution: It states that caution is used to balance the need for
current income with the need to guard against inflation. In addition,
a total return approach to money management should be
employed. In certain cases principal growth is used.
Loyalty: It is required by the trustee to avoid conflicts of interest by
always acting exclusively in the best interest of beneficiaries.
Impartiality: It requires that the trustee act in a fair and reasonable
manner when handling conflicting interests of beneficiaries.
Study Session 2, Reading 10

3. Prudent Man Rule
vs Prudent Investor Rule
Prudent Man Rule: Diversification is expected of portfolio
managers as a method of reducing risk.
Prudent Investor Rule: The duty of the fiduciary to invest and
manage assets in the best interests of another.
Study Session 2, Reading 10

4. Prudent Man Rule
vs Prudent Investor Rule (cont.)
Principles of Prudent Man Rule
Diversification is expected of portfolio managers as a method of
reducing risk.
Trustees must base an investment's appropriateness on its
risk/return profile (how it contributes to the overall risk of the
portfolio).
Excessive trading as well as excessive fees and other transactions
cost that are not warranted by the portfolio risk return objectives
should be avoided.
Study Session 2, Reading 10

5. Prudent Man Rule
vs Prudent Investor Rule (cont.)
Principles of Prudent Man Rule
Current income for the trust must be balanced against the
need for growth.
Trustees are allowed to delegate investment authority. In fact,
this is a duty if the trustee does not have the required level of
expertise.
Study Session 2, Reading 10

6. Prudent Man Rule
vs Prudent Investor Rule (cont.)
Use of Total Return: This rule measures reasonable portfolio
return as total return (Income plus capital growth). It also
emphasizes that the trustee’s duty is to not only preserve the
purchasing power of the trust but in certain cases to realize
principal growth in excess of inflation.
Risk Management: Under the new rule, the trustee has the
obligation to assess the risk and return objectives of the trust
beneficiaries and manage the trust in a prudent manner
consistent with those objectives, rather than to avoid all risk.
Study Session 2, Reading 10

7. Prudent Man Rule
vs Prudent Investor Rule (cont.)
Evaluation in a portfolio context: While the new rule calls for
the avoidance of undue speculation and risk, it also
encourages trustees to view risk in a portfolio context. For
example, stock options are risky when help in isolation but can
actually reduce portfolio risk when held as part of a properly
structured portfolio. Protective put options are an example of
this type of strategy.
Study Session 2, Reading 10

8. Investing and Managing Trust Assets
Factors Considered by the Trustee while Investing and
Managing Trust Assets
Economic Conditions;
Effects of Inflation and deflation;
Impact of investment decisions on the beneficiary’s tax
liability;
How each individual investment contributes to the risk and
return of the overall portfolio;
Study Session 2, Reading 10

9. Investing and Managing Trust Assets (cont.)
Factors Considered by the Trustee while Investing and
Managing Trust Assets
Expected total return for capital appreciation and income;
Other resources of the beneficiary;
The beneficiary liquidity, income and capital preservation
requirements;
Whether any assets have a special relationship to the
requirement of the beneficiary or the trust.
Study Session 2, Reading 10

10. Investing and Managing Trust Assets (cont.)
Factors Considered by the Trustee while Investing and
Managing Trust Assets
Expected total return for capital appreciation and income;
Other resources of the beneficiary;
The beneficiary liquidity, income and capital preservation
requirements;
Whether any assets have a special relationship to the
requirement of the beneficiary or the trust.
Study Session 2, Reading 10