Collectibles such as fine art, rare classic cars or wine have their own appeal beyond monetary value, but as readers will know, they've become investment topics as well. What "safe haven" value do they have, and regardless of that question, what structures for ownership make sense, and what are the risks?

Attorney and regular columnist, Matthew Erskine, considers the potentially difficult economic picture, what investors should do to prepare, and whether the area of “collectibles” makes sense as a way of sheltering from difficulty. 

As ever, such articles aren’t meant to be the last word but a prompt for debate and conversation. The editors are pleased to share such remarks; the usual disclaimers apply. To comment, email tom.burroughes@wealthbriefing.com and amanda.cheesley@clearviewpublishing.com
 

With the recent inversion of the yield curve and increasing global economic uncertainty, the possibility of a recession in 2025 is gaining attention. Investors, particularly ultra-high net worth individuals, are turning to alternative assets to hedge their portfolios against market volatility.

Among these alternatives, collectibles such as fine art, wine, classic cars, and vintage guidebooks stand out due to their unique blend of financial and emotional appeal. While collectibles can offer diversification benefits and a hedge against inflation, they also carry significant risks. The collectibles market presents a complex landscape, from illiquidity and valuation challenges to high transaction costs. 

Studies such as A Hedonic Index for Collectables and Non-Traditional Alternative Investments, cited below highlight these challenges and emphasize the unique risks inherent in collectible markets. Thoughtful estate and succession planning can mitigate these risks, ensuring that these assets preserve their value and legacy across generations.

Why collectibles are an attractive alternative investment
Collectibles are considered alternative investments because they fall outside traditional categories of stocks, bonds, and cash. They are tangible assets that often carry cultural or historical significance, appealing particularly to UHNW individuals and investors seeking diversification. Recent studies highlight several reasons why collectibles remain attractive:

-- Performance and diversification: Investment-grade collectibles such as fine wine and classic cars have outperformed traditional assets like equities and real estate during certain periods, especially during economic downturns. Research supports these findings, highlighting the unique diversification benefits and historical performance of these assets. For example, fine wine exhibits low correlation with the stock market, making it a valuable diversification tool. Studies referencing the Liv-ex Fine Wine Index have highlighted this low correlation and its benefits in portfolio diversification.

-- Non-pecuniary benefits: Beyond financial returns, collectibles provide emotional value through aesthetic enjoyment, social status, and personal passion, which are particularly appealing to UHNW individuals.

Risks associated with investing in collectibles
Despite their allure, investing in collectibles entails considerable risks that must be carefully managed:

-- Illiquidity: Collectibles often lack liquid markets, making it difficult to sell assets quickly or at fair market value. This issue worsens during economic recessions when demand declines;
-- Valuation challenges: Unlike traditional assets, collectibles have no intrinsic value or cash flow, and their worth is often subjective, relying heavily on trends, provenance, and expert appraisals;
-- Market volatility: The value of collectibles can be highly volatile, driven by shifting tastes, market trends, and speculative bubbles. For instance, specific segments, such as contemporary art, can experience sharp fluctuations in value;
-- Transaction costs: High fees associated with auctions, insurance, storage, and transportation reduce net returns for investors; 
-- Storage and maintenance: Proper storage is critical to preserving the value of collectibles. Items such as fine art and wine require climate-controlled environments, adding significant costs;
-- Fraud and authenticity risks: Counterfeit goods or disputes over provenance can lead to significant financial losses, particularly in high-value markets like fine art and vintage cars; and 
-- Tax and legal implications: Collectibles often attract higher capital gains tax rates. Additionally, inheritance or gift taxes can significantly erode the value passed to heirs.

Estate planning and succession strategies to mitigate risks
To navigate the complexities of collectibles as investments, particularly in the face of a potential recession, comprehensive estate and succession planning is essential. Here are key strategies for mitigating risks:

-- Implement a robust valuation and documentation system: Engage certified appraisers to establish accurate valuations and update them periodically. Maintain detailed records of provenance, authenticity, purchase history, and condition to simplify future transactions or transfers. Research shows that thorough documentation not only preserves value but also protects against disputes and fraud in collectible markets; 
-- Use trust structures: Consider Charitable Remainder Trusts (CRTs) to transfer collectibles, allowing owners to defer capital gains taxes, receive lifetime income, and benefit a charitable organization upon passing. Establish purpose trusts for the long-term management and preservation of valuable collections. Consider using a Grantor Retained Income Trust (GRIT) to make tax-free transfers of future appreciation of the collectibles; 

-- Diversify collectible assets: Spread investments across different categories (e.g., art, wine, cars) to mitigate market-specific risks. Consider fractional ownership through securitized platforms to reduce exposure to a single asset and improve liquidity; 

-- Create a succession plan: Develop a clear plan detailing how collectibles will be divided, sold, or retained by heirs. Provide guidance on handling illiquid assets, such as instructions for auctions or private sales; 

-- Secure insurance and storage: Insure high-value collectibles against risks such as theft, damage, or natural disasters. Invest in professional storage facilities that ensure optimal conditions for preservation; 

-- Leverage tax-efficient strategies: Use gifting strategies during the owner’s lifetime to reduce estate tax liabilities. Take advantage of valuation discounts for lack of marketability or minority interest when transferring collectibles; 

-- Engage professional advisors: Work with estate planners, financial advisors, and auction specialists who understand the nuances of collectible markets. Appoint a trust protector or fiduciary to oversee the management of collectible assets; 

-- Consider philanthropic options: Donate high-value items to museums or educational institutions to receive tax deductions while preserving the legacy of the collection; and 

--  Monitor market trends: Regularly assess the alignment of the collection with market conditions and long-term goals. Utilize indices such as the Hedonic Collectable Index (HCI) to track trends and value changes but be aware of their limitations in predicting the future value of collectibles.

The role of collectibles in estate planning during a recession
In the event of a recession, collectibles can serve as a hedge against inflation and a store of value. However, their performance during downturns varies by category. For example, fine wines and vintage cars tend to retain value better than contemporary art, which is more speculative. Estate planning strategies tailored to collectibles can protect their value and ensure smooth succession. By addressing liquidity challenges, tax burdens, and preservation requirements, investors can safeguard these assets as part of their broader financial legacy. 

At the start of this year, integrating collectibles into investment and estate plans will require careful consideration of economic conditions, market dynamics, and personal goals. Through proactive planning, investors, particularly UHNWIs, can maximize the financial and emotional returns of their collectible portfolios while minimizing risks for future generations.

References:
Dimson, Elroy and Spaenjers, Christophe, The Investment Performance of Art and Other Collectibles (September 2, 2013). Chapter 10 of Anna Dempster (Ed), Risk and Uncertainty in the Art World, Bloomsbury Publishing, 2014, pages 219–238, Available at SSRN: https://ssrn.com/abstract=2319338 or http://dx.doi.org/10.2139/ssrn.2319338

Erdos, Péter, Collectibles as Alternative Investments (November 25, 2010). Available at SSRN: https://ssrn.com/abstract=1715083 or http://dx.doi.org/10.2139/ssrn.1715083

Fisher, Nicolas I and Lee, Alan J. A Hedonic Index for Collectables Arising from Modelling Diamond Prices https://arxiv.org/abs/2312.11496?

Amin Mekachera, Alberto Braccia, Matthieu Nadinib, Mauro Martinoc, Laura Alessandrettid, Luca Maria Aielloe, and Andrea Baronchellia,f,g,* Heterogeneous rarity patterns drive price dynamics in NFT collections https://arxiv.org/abs/2204.10243?utm_source=chatgpt.com