Well-Performing Portfolios and
Well-Disguised Insolvency
Patrick J. Collins, Steven M. Fast & Laura A. Schuyler
The Secret to Life
According to Charles Dickens:
“Annual income 20 pounds, annual
expenditure 19 pounds, 19 and 6,
result happiness. Annual income 20
pounds, annual expenditure 20 pounds
ought and 6, result misery.”
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The Secret to a
Successful Trust Portfolio
Trust Assets > Trust Liabilities . . .
Result = Happiness 
Trust Assets < Trust Liabilities . . .
Result = Misery 
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Trust Liabilities:
 Distributions to Current Beneficiaries
 Capital Preservation/Growth for Remainder
Beneficiaries
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Key Duties of a Trustee:
Monitor the trust portfolio and inform the
beneficiaries in a meaningful way.
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Key Duties of a Trustee:
Monitor the trust portfolio and inform the
beneficiaries in a meaningful way.
 How is the trust portfolio doing relative to its
liabilities?
NOT how the trust portfolio is doing in
relation to the S&P
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Key Duties of a Trustee:
Monitor the trust portfolio and inform the
beneficiaries in a meaningful way.
 How is the trust portfolio doing relative to its
liabilities?
 Are there enough assets to distribute amounts to
the current beneficiary and preserve capital for
the remainder beneficiaries?
 Sequence Risk
 Feeding the Bear
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1. Use Risk Models
Judiciously.
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Simple, 2-Asset Class Portfolio
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Diversified Portfolio
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Diversified Portfolio
+ Fees
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Diversified Portfolio
+ Fees + Longevity
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Diversified Portfolio
+ Fees + Longevity + Taxes
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Summary
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Summary: Model Risk
 Results range from an 8% risk of bankruptcy to a
53% risk of bankruptcy.
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Summary: Model Risk
 Results range from an 8% risk of bankruptcy to a
53% risk of bankruptcy.
 The “NH” model (simple Monte Carlo model)
produces the most optimistic results in each
case, perhaps underestimating risk.
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Summary: Model Risk
 Results range from an 8% risk of bankruptcy to a
53% risk of bankruptcy.
 The “NH” model (simple Monte Carlo model)
produces the most optimistic results in each
case, perhaps underestimating risk.
 The “Bear” model (regime-switching model,
assuming initial bear market) produces the most
pessimistic results in each case, perhaps
overstating risk.
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2. Locate the
Free Boundary.
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The Free Boundary
Free Boundary Line
Unfeasible
$0
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Wealth Deficit
Feasible Region
Wealth Surplus
The Free Boundary
Present Value of Trust Assets ≥
[Stochastic Present Value of Distributions to
the Current Beneficiary
+ Stochastic Present Value of Capital
Preserved for Remainder Beneficiaries
+ Stochastic Present Value of Fees and
Investment Expenses.]
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The Free Boundary
Present Value of Trust Assets ≥
[Cost of an Annuity for the Current
Beneficiary
+ Stochastic Present Value of Capital
Preserved for Remainder Beneficiaries
+ Stochastic Present Value of Fees and
Investment Expenses.]
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The Free Boundary
Wealth to Annuity Cost Ratio (WACR) =
The Ratio of the Trust’s Value to the Cost of
Purchasing an Annuity for the Current
Beneficiary and Returning Capital to the
Remainder Beneficiaries
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Example 1: Bob & Joanna
Assumptions:
 Bob’s Goal: Provide for his wife Joanna for her
lifetime.
 Initial Trust Value = $1 million
 Joanna is 70 years old.
 Joanna needs distributions of $61,800 per year.
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Example 1: Bob & Joanna
Is Bob’s goal feasible?
Current Beneficiary Age 70
Evolution of Portfolio Value and WACR
(WACR) Weath to
Annuity Cost Ratio
3
Portfolio Value
$1,200,000
$1,000,000
2
$800,000
$600,000
1
$400,000
$200,000
0
$0
0
2
4
6
8
50th Percentile WACR
50th Percentile
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10
12
14
Years
16
18
30th Percentile WACR
30th Percentile
20
22
24
26
28
5th Percentile WACR
5th Percentile
Example 1: Bob & Joanna
Is Bob’s goal feasible?
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Example 1: Bob & Joanna
5 Years Later . . . Is Bob’s goal feasible?
Current Beneficiary Age 75
Evolution of Portfolio Value and WACR
(WACR) Weath to
Annuity Cost Ratio
Portfolio Value
2
$700,000
$600,000
$500,000
$400,000
1
$300,000
$200,000
$100,000
0
$0
0
2
4
6
50th Percentile WACR
50th Percentile
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8
10
Years
12
14
16
30th Percentile WACR
30th Percentile
18
20
22
5th Percentile WACR
5th Percentile
Example 2: Bob, Joanna & Children
Assumptions:
 Bob’s Goals: (1) Provide for his wife Joanna for
her lifetime and (2) preserve the original
principal (as adjusted for inflation) for his
children.
 Initial Trust Value = $1 million
 Joanna is 50 years old.
 Joanna needs distributions of $42,000 per year.
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Example 2: Bob, Joanna & Children
Are Bob’s goals feasible?
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Example 2: Bob, Joanna & Children
20 Years Later . . . Are Bob’s goals feasible?
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Free Boundary: Summary
 If the only goal is to provide for the current
beneficiary, the free boundary is located at a
WACR of 1.
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Free Boundary: Summary
 If the only goal is to provide for the current
beneficiary, the free boundary is located at a
WACR of 1.
 If there are dual goals of providing for the
current beneficiary and preserving capital for the
remainder beneficiaries, a higher WACR is
necessary because the portfolio must grow to
sustain the remainder beneficiaries’ interest on a
constant dollar basis.
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What Are My Options?
Based on your analysis of the risk models and the
location of the free boundary, you know you’re in
trouble.
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What Are My Options?
Based on your analysis of the risk models and the
location of the free boundary, you know you’re in
trouble.
1. Stay the course?
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What Are My Options?
Based on your analysis of the risk models and the
location of the free boundary, you know you’re in
trouble.
1. Stay the course?
2. Change the asset allocation?
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What Are My Options?
Based on your analysis of the risk models and the
location of the free boundary, you know you’re in
trouble.
1. Stay the course?
2. Change the asset allocation?
3. Reduce distributions to the current beneficiary?
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What Are My Options?
Based on your analysis of the risk models and the
location of the free boundary, you know you’re in
trouble.
1. Stay the course?
2. Change the asset allocation?
3. Reduce distributions to the current beneficiary?
4. Divide the portfolio into two funds?
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What Are My Options?
Based on your analysis of the risk models and the
location of the free boundary, you know you’re in
trouble.
1. Stay the course?
2. Change the asset allocation?
3. Reduce distributions to the current beneficiary?
4. Divide the portfolio into two funds?
5. Buy an annuity and invest the balance?
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Summary
Monitor the trust portfolio and inform the
beneficiaries in a meaningful way.
 Use Risk Models Judiciously.
 Locate the Free Boundary.
 Review Options.
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