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B Trust Basics - Part II
 What started out as a simple idea has become a bit more challenging.
Hopefully you read Friday's Rant covering the basics of B
Trusts and the Uniform Prudent Investor Act. If not, click here for the archive. Today we delve into Modern Portfolio Theory (MPT). Why? MPT provides quite a bit of guidance for constructing trust
portfolios. Many of the provisions found
in the Uniform Prudent Investor Act (UPIA) we discussed last week are grounded
in MPT, and as a result, give a clear indication of the role of life insurance
as a trust asset.
Fortunately, any discussion of MPT is beyond the scope of
this forum (Click here for a brief discussion on MPT and the Efficient
Frontier. Reading this will make the
rest of The Rant make a bit more sense!). There is, however, one aspect that warrants further investigation - How
does life insurance integrate with MPT in a trust portfolio? The most important thing to understand is
that life insurance has a unique risk/return profile. Specifically, it is a completely uncorrelated
asset, and has a zero standard deviation (a statistical measure of risk. Zero means no risk). OK, great!
What does that mean?
It means a couple things: Owning life insurance in a trust portfolio allows for investing in other
asset classes with higher standard deviations without increasing the overall
portfolio standard deviation. More
importantly, the result of being able to invest in these other asset classes
drives the potential return of the overall portfolio up at the same time. Read that again, higher potential return, the
same standard deviation (level of risk).
Who would not want that?
Of course, there are some additional considerations. The first is obvious - you need to be dead to
realize the investment return on life insurance. Remember, however, the dual nature of these
trusts. The insured in this scenario is
the surviving spouse, and the ultimate trust beneficiaries are the next
generation. Seems like this was built
for life insurance!? Sure, the insurance
premiums may impact the income available to the spouse, but again, this is a
balancing act between the two purposes, so that certainly seems appropriate as
well. Maybe even prudent?
That's all for Part II, and next week in Part III we go back
to kindergarten to learn how to play nice with others!
Special thanks this week to Brad Owen at Donnelly Wealth
Advisors for his insight on MPT.
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