Intro
For a number of years, investors seeking alternative investments to diversify their portfolios have increasingly been turning away from traditional markets to ‘passion assets’. Passion assets are typically collectable, tangible assets such as vintage cars, artwork, jewellery and watches, whisky and wine.
The growth in this market is perhaps unsurprising; often, as opposed to intangible investments in the stock market, investment in passion assets can offer the additional attraction to investors of aligning their investments with their values, developing social capital and preserving cultural heritage. In short, passion assets afford investors the opportunity to have an emotional connection with their investments. Coupled with that emotive benefit, recent reports indicate that passion asset investments are financially outperforming traditional markets over the medium to long-term.
However, while passion asset investments can be financially and emotionally rewarding, they also carry unavoidable risks. Those risks will differ with each asset class. We have previously published articles on investments in wine and whisky. We focus here on some of the wider risks that apply generally to passion asset investments and how to mitigate those risks.
Provenance and authenticity
Provenance and authenticity are fundamental to passion asset investing and can mean the difference between an ‘ordinary’ asset and one worth many hundreds or thousands more.
As readers will know, provenance refers to the chain of ownership and the authenticity of an item. For art, this would mean tracing the item back to the original artist. For wine, this would mean its authenticity, the bottle's origin, proof of ownership, and storage conditions.
However, whilst any good seller will keep extensive records to demonstrate provenance, in the event of a dispute the burden to establish provenance is typically on the investor. Whilst the importance of establishing provenance for some asset classes – for example, artistic works – is well known, it is not uncommon for emerging asset classes to have a degree of mystique and therefore limited information regarding their authenticity. Coupled with a lack of regulation of a number of passion asset markets, the risk of fraudsters seeking to exploit would-be investors is obvious.
An investor should seek as much information about the assets as possible. Where possible, a physical inspection of the assets should be carried out by the investor and an independent expert selected by them. If there is any doubt about provenance or authenticity, instruct an independent advisor such as a lawyer to conduct due diligence. Scepticism is key.
Value and illiquidity
Passion assets are more subjective in value than traditional investments and subject to market fluctuations. As with any investments, there is an unavoidable risk that the value of the asset may depreciate or fluctuate over time. Passion assets may suffer from greater volatility due to factors such as trends and global demand.
Investors should research available sales history of comparable assets to inform their decision about fair value for their investment. An independent expert appointed by the investor can also advise on value.
Unlike traditional investments such as stocks, an investor typically cannot sell passion assets at market value overnight. Illiquidity, particularly for more niche asset classes, is an important consideration.
Solvency and the key parties
Whilst perhaps obvious, due diligence should also be conducted into the seller.
If the seller becomes insolvent, the investor may lose the price paid for the passion asset as well as the right to the passion asset itself and risks ranking as an unsecured creditor in any insolvency process. We have covered some of the risks and mitigation that can be taken in relation to potential insolvency of key parties in our recent article on investment in wine.
For some passion asset classes, there are trade associations; art, wine and historic vehicles being among the more well known. Where possible, investors should select sellers that are members of such associations as they will likely be subject to codes of conduct and may have additional safeguards in place to protect the investor.
You may not be an expert - Using a broker or agent
If something is too good to be true, it often is… but not always. But regardless, it is an unavoidable fact that emotion can cloud judgment. Consideration should therefore be given to using a broker or an agent. There are many potential advantages to appointing a broker to advise on a passion asset investment. The right professional may be instrumental in identifying opportunities and giving bespoke advice on risk management and market trends. However, brokers and agents should be carefully selected.
Most importantly, ensure that there is a written contract with any intermediaries instructed. Such contracts should specify the duties that they owe the investor and require the intermediary to disclose the detail of any commissions potentially earnable by them in connection with the investment. Legal advice should always be sought.
The less familiar the investor is with the passion asset market, the more important it will be that they carefully select any such intermediary and that they instruct a solicitor to review the terms of the contract to ensure they are adequately protected.
Novel assets
Extra caution should be taken in respect of novel assets. Many of the risks associated with passion asset investments are heightened in novel asset markets.
Novel asset markets are likely to be unregulated, highly volatile, and investors typically will not benefit from the availability of independent experts.
For these reasons, novel asset markets are also at higher risk of being targeted by fraudsters.
Taking NFTs as an example, which were initially pitched as a novel investment asset in 2017, reports suggest that within a period of around 5 years of their introduction 95% of NFTs, held by an estimated 23 million people, had zero monetary value. The market was said to be worth US$17 billion in 2021. A cautionary tale.
Passion assets can bring both emotional and financial reward. But like any investment, investors would be well advised to approach with caution, consider the potential risks, and the downside costs and losses that could arise. Take time to understand the issues and always consider seeking advice to ensure you are making informed decisions.
