The rules may change when a valuable collection is involved.
Asset allocation has served Natalie Michalek and her
clients well over the years, providing a firm planning foundation
through both good times and bad. Yet Michalek did run into a rare
instance recently where asset allocation provided very little help.
The reason? About 20% of one of her client's $10 million net worth is comprised of a world-class duck decoy collection. It's an assembly of works he values dearly and refuses to sell or even put into a trust.
"He really doesn't want to give up ownership," says Michalek, account manager at the Ayco financial planning firm in Dallas. "He calls them his flock-his duck family."
Without any options to generate cash flow out of the collection, Michalek is instead focusing on ensuring that the client's estate plan properly transfers the decoys to his wife after his death. Beyond that, there is also the question of how the wife's estate plan will deal with the items.
Other issues yet to be addressed are getting the collection properly insured, establishing a cost basis and deciding if something beyond a will and an attached personal memorandum are needed to get them smoothly transferred. "We need to figure out specific directions for what he wants to happen to them," she says.
Although dealing with a collection of duck decoys may be a rare circumstance, advisors say providing planning for clients with sizable collections of art, antiques, collectibles and other tangible assets is not. In fact, some say the amount of items tied up in such items may be on the rise.
Some go a step further and say that there seems to be a rising number of art collections arising in the financial services marketplace that are owned by collectors who view arts and collectibles as an investment-a way to diversify and appreciate the value of their assets in an arena completely untied to the equity and fixed-income markets.
Underscoring the point is the recent appearance of mutual funds that invest in fine art. These would include Fernwood Art Investments LLC, which was founded in 2003 as a research and investment company focused exclusively on fine art.
Art as an investment, some say, is certainly not a raging trend. But observers with contacts in both the artistic and financial services realms say there are certainly signs of rising interest in the financial, as well as intellectual, rewards of collecting valuable items.
This, observers say, is on top of the fact that the art and collectible fields are booming-fueled by Internet technologies that allow people to sift through auctions and catalogs of items throughout the globe. "Collecting has really flourished," says Larry Zale, president and founder of Laurence C. Zale Associates, a consulting firm on matters dealing with the purchase, sale and donation of fine art and other tangible assets. "I think the Antiques Road Show and the whole area of collecting has exploded, through eBay and other portals."
Zale has also noticed a rising interest in art for investment purposes and is worried that-similar to the way investors embraced dot.coms during the late 1990s-people are leaping in without realizing that valuations of art and collectibles can be just as volatile as stocks and bonds. "To suggest to collectors that if they have X, Y and Z, they can get a return equal to or better than the stock market, I think can be perilous business," he says. "I'm a little troubled with this movement."
Advisors also recommend caution when dealing with artwork. "The idea of comparing a piece of art or a grouping of art to an index of some sort is a bad idea in that the two are not comparable," says Kyle Pitts, of Hitchinson/Ifrah Financial Services. "The metrics applied to the S&P 500, for example, are not the same" as those for appraising artwork.
Michael Mendelsohn, president of BRIDDGE Strategies for Art, Heirs & Philanthropy, a consulting firm that focuses on inheritance planning for art, collectibles and other valuables, agrees that collecting art purely as an investment is dangerous-partly because there isn't always an available market for what the client is trying to sell. "It's a tough thing," he says. "You need a buyer at the other end."
But Mendelsohn says from an estate planning perspective, the arts and collectibles world should be fertile ground for advisors. He notes studies that show about 40% of affluent families collect valuables of some kind.
Mendelsohn also says that many collectors don't include their collections in estate plans, and often prefer to quietly pass them on to friends and relatives informally. Briddge, however, advises collectors to include valuable items in estate plans as soon as possible to take advantage of philanthropic vehicles that can reduce the tax hit once collections do come under the gaze of the IRS.
"I think it's incumbent upon the advisors to really talk about this with their clients," Mendelsohn says.
Beyond just investing, some clients are seeking ways to extract cash flow out of their collections without having to give them up. One such way is to use them as collateral for loans.
Doris Straus, worldwide specialty fine art manager for Chubb Insurance, says she's seen an increase over the past two years in the number of policyholders who are using their artwork as loan collateral. As one of the nation's top insurers of fine art, Chubb gets informed of such loans when a mortgager is added to art insurance policies.
"In the past, usage for art as collateral was kind of limited to just a few people and handled mostly by private banks and was done sort of hush-hush," Straus says.
Not anymore. Now Straus says she's seeing one or two such loans each week. It's mostly still done through private banks, for longtime customers, but she says there has been an uptick in activity.
The increase in loans has run parallel with rising values in contemporary art, but Straus feels there is more behind the search for cash flow than rising art prices. "I think one direct correlation is there are a lot more people investing in art who are in the financial industry," she says. "People have gotten into the art market who are not just traditional collectors. You've seen an infusion into the art market by collectors who are hedge fund managers or investment bankers."
But she adds that the loans are not just being given out to people narrowly focused on cash flow. Longtime collectors, who collect for the appreciation of art, are also cashing in on the value of their pieces, she says. "People are taking an asset that has been quiet and nonproducing other than through its aesthetic value, and saying, 'We can have all that and also utilize it by taking some of its principal out and reinvesting in something else,'" she says.
Advisor Lewis Altfest, president of L.J. Altfest, an advisory firm in New York City, says art can be a way to diversify assets, but it must be done carefully. A collector himself, Altfest says he is investigating the possibility of starting an art mutual fund that would be only open to his firm's clients.
Of investors who are thinking of pouring assets into art, he says, "I think it's a little exotic and they better know the characteristics of the market before they do anything in it. It should only be for a modest portion of their monies."
Unless the art is a work of an established master, Altfest says the prices can fluctuate wildly. And unlike stocks and bonds, which were built to generate income, art is dependent solely on supply and demand for its value. "It can be a volatile ride," he says.
Rather than manipulate art as an investment, observers say advisors could better serve their clients by establishing what they have in terms of collections, the value of the items and, if possible, the cost basis. Given that these assets are subject to a 28% capital gains tax, as opposed to the 15% maximum for liquid investments, advisors should view the art as a potential charitable donation that could free up assets for liquid investments.
Getting an early start on including valuable items into an estate plan can also save families from much misery if the planning is put off until the last moment, says Mendelsohn. "Take the collection and do the best financially and philanthropically for it," he says. "Some of the things we want to prevent is a family war."
Among the options for passing from an estate includes gifts to charitable organizations, donor advised funds and gift annuities, or to gift the tangible asset at the time of death, says Zale.
What route to take depends on a client's financial situation. If cash flow is needed, a plan possibly could be worked out to sell a portion of the collection, advisors say.
A sale is also advisable if a collection comprises too large a percentage of a client's assets, says Andy Berg of Homrich & Berg advisors in Atlanta. "When it gets to be too large of an asset class given their overall asset condition, then we've got to help out on the brakes," he says.
Advisors also need to keep their eyes open in recognizing exactly what the client has as a tangible asset. Diane Pearson, director of financial planning with Legend Financial Advisors, says she recently had one client who had an early 20th Century home that had a kitchen made completely of cherry. An inspection of the kitchen eventually led to a higher appraisal for the home, she says.
In many cases, however, the owners of significant collections don't have an immediate need for cash flow, advisors say.
"If cash flow is not an issue, then gifting is really the preferred method of planning with art work," says Phillips Ruben, president of Vision Financial Planning in Boston. He adds that for many collectors, the idea of gifting before, rather than after, death is an appealing planning option. "I think there is an awful lot of satisfaction in making the charitable donation and seeing where the artwork is going and how it's appreciated by the public," Ruben says.