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Opportunity Costs: Prudence versus Returns

There is, unfortunately, a trade-off between the soundness of investment decisions made by a family and the speed with which those decisions must be made to be effective.² All too often, in other words, there is a conflict between a family's desire to be prudent in its decision making and the family's desire to achieve competitive returns.

In the fiduciary world, over the course of several hundred years, standards of fiduciary prudence have become ever more process oriented and ever less outcome oriented. The main reason for this is that, under traditional trust doctrine, a trustee was absolutely liable for almost any loss of principal: “Traditional trust doctrine caused ultimate liability for losses to the trust to sit like a devil on the shoulder of every trustee.”³ As a result, trustees typically invested only in gold-plated investments, such as gilts (debt securities issued by the Bank of England).

The traditional rule was very much outcome-oriented: Allow the capital to decline in value and you will be held liable. Interestingly, this situation began to change when trustees in the United States found that there was no domestic counterpart to gilts: Bonds issued by the new United States were too risky! This circumstance “encouraged the majority of American fiduciaries to direct their investments toward promoting nascent industrial enterprises”⁴ in the United States, and this in turn caused American courts to revisit the absolute liability ...