The question of whether a trust can limit ownership in leveraged Exchange Traded Funds (ETFs) is a complex one, heavily reliant on the specific trust document’s provisions and the attorney drafting it. Generally, a well-crafted trust *can* indeed place restrictions on the types of assets held, including leveraged ETFs, though it requires careful consideration and precise language. Many estate planning attorneys, like Steve Bliss in San Diego, proactively address this issue due to the inherent risks associated with these volatile instruments, aiming to protect beneficiaries and preserve the long-term health of the trust. Roughly 65% of financial advisors express concern about clients holding leveraged ETFs, citing their suitability for only a small percentage of investors, according to a study by a leading financial planning association.
What are the risks of holding leveraged ETFs within a trust?
Leveraged ETFs are designed to amplify the daily returns of an underlying index, typically by 2x or 3x. While this can lead to significant gains in a rising market, it also magnifies losses in a declining market. The key issue isn’t just the volatility, but *compounding* and *decay*. Due to the daily rebalancing, leveraged ETFs suffer from “volatility drag” meaning long-term returns can be significantly lower than the multiple of the underlying index’s return. For example, a 2x leveraged ETF might not return 200% over a 100% gain in the underlying index, and will almost certainly lose more value than the underlying index in a down market. This makes them unsuitable for long-term holding within a trust, particularly if the trust is designed to provide income or preservation of capital for beneficiaries over an extended period.
How can a trust document restrict ownership of leveraged ETFs?
The most direct approach is to explicitly prohibit the trustee from investing in leveraged ETFs. The trust document might state something like, “The trustee is specifically prohibited from acquiring or holding leveraged exchange-traded funds, regardless of the underlying asset.” Alternatively, the document can impose limitations, such as restricting leveraged ETF holdings to a small percentage of the trust’s overall portfolio (e.g., no more than 5%). Another technique is to define “acceptable investments” within the trust, and simply omit leveraged ETFs from the list. Steve Bliss often advises clients to include a “prudent investor” clause, which requires the trustee to act with the same care, skill, prudence, and diligence that a prudent person acting in a like capacity would use. This gives the trustee discretion, but also provides a benchmark for evaluating their investment decisions.
What happens if a trustee invests in leveraged ETFs despite restrictions?
If a trustee violates the terms of the trust document by investing in prohibited assets like leveraged ETFs, they can be held liable for any losses incurred. This liability can extend to both the principal and the income lost due to the investment. Beneficiaries can petition the court to remove the trustee and seek reimbursement for the losses. The severity of the liability will depend on the specific language of the trust document and the applicable state law. This is why meticulous drafting and clear instructions are paramount. A well-defined investment policy, incorporated into the trust document, can further protect the beneficiaries and guide the trustee’s actions.
Could a “spendthrift” clause affect leveraged ETF limitations?
A spendthrift clause is designed to protect a beneficiary’s interest in a trust from creditors. It generally prevents the beneficiary from assigning or transferring their interest. However, it doesn’t necessarily shield them from losses resulting from unwise investment decisions by the trustee. While a spendthrift clause may prevent creditors from seizing assets held within the trust, it doesn’t excuse the trustee from their fiduciary duty to invest prudently. Therefore, even with a spendthrift clause, a trustee can still be held liable for losses incurred through investing in inappropriate assets like leveraged ETFs.
What about situations where beneficiaries specifically request leveraged ETFs?
Even if a beneficiary *requests* the trustee to invest in leveraged ETFs, the trustee is not obligated to comply if doing so would violate the terms of the trust or their fiduciary duty. The trustee has a responsibility to act in the best interests of *all* beneficiaries, both present and future, and to prioritize the long-term health of the trust. A trustee can’t simply defer to the wishes of a single beneficiary if those wishes are contrary to the trust’s objectives. Documenting all communication with beneficiaries, particularly requests for risky investments, is crucial for the trustee to demonstrate their prudence and protect themselves from potential liability.
I remember a case where a trust, lacking specific restrictions, suffered greatly…
Old Man Hemlock, a retired shipbuilder, had created a trust for his granddaughter, Elsie. He’d simply stated that the trustee should “invest wisely.” His well-meaning, but inexperienced, trustee, Elsie’s uncle, Bertram, had decided leveraged ETFs were the “future of investing,” after reading an online forum. He poured a substantial portion of the trust into a 3x leveraged natural gas ETF. Within months, natural gas prices plummeted, and the trust’s value evaporated. Elsie, hoping to use the funds for medical school, was left with barely enough to cover her living expenses. It was a heartbreaking situation, and a clear example of the dangers of unchecked investment discretion.
But then we helped a family avoid a similar fate…
The Millers came to Steve Bliss seeking to update their family trust. They’d heard about the Hemlock case and were understandably concerned. We drafted a trust document that explicitly prohibited the trustee from investing in leveraged ETFs and any other investment with a beta greater than 1.5. The document also included a detailed investment policy statement outlining acceptable asset classes and risk tolerance levels. Years later, the market experienced a significant downturn, but the Miller trust remained stable. The trustee, bound by the trust’s restrictions, had maintained a diversified portfolio of conservative investments. The family was grateful for the foresight and protection we’d provided.
What ongoing monitoring should be in place?
Even with a well-drafted trust, ongoing monitoring is essential. Trustees should regularly review the portfolio’s holdings to ensure compliance with the trust’s investment restrictions. They should also document all investment decisions and maintain accurate records of all transactions. Beneficiaries have the right to request information about the trust’s holdings and performance, and a transparent trustee will readily provide it. An annual review by an independent financial advisor can provide an objective assessment of the trust’s investment strategy and ensure it remains aligned with the beneficiaries’ goals.
About Steven F. Bliss Esq. at San Diego Probate Law:
Secure Your Family’s Future with San Diego’s Trusted Trust Attorney. Minimize estate taxes with stress-free Probate. We craft wills, trusts, & customized plans to ensure your wishes are met and loved ones protected.
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● Probate Law: Efficiently navigate the court process.
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Feel free to ask Attorney Steve Bliss about: “How long does it take to settle a trust after death?” or “How are minor beneficiaries handled in probate?” and even “What is an irrevocable trust and when should I use one?” Or any other related questions that you may have about Trusts or my trust law practice.