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.