(Article by Chris Smith, Partner of Visis Private Wealth, first published in Equity Dec, 2017)
For as long as the opportunity has presented, people have been investing in such material objects as Art, Wine and Vehicles. Investment to such assets is often outside conventional contemplation but this in no way limits the potential for consideration.
Like all investment decisions, significant matters must be considered and weighed prior to action. Considerations arise from such fundamental questions as:
- What level of return do I need of my assets to achieve my current and long term wealth objectives?
- What are my long term wealth objectives and how does this investment fit?
- Do I need income or capital growth from my assets or a combination of the two?
- Should I diversify my investment in specific assets and asset classes?
- How much capital loss risk and price volatility am I willing to take on for the potential of capital growth over time?
- What is the potential return on the asset considered?
- What will drive the appreciation in value of the asset in question?
- How liquid is the asset? Can I sell into a transparent market with a good number of buyers at a price point on short notice?
- What is the current price of the asset and does it represent reasonable value at this moment in time?
- How do I value the asset I am considering?
- At what price do I choose to acquire the asset?
- How shall I fund the purchase? Am I buying with cash or do I need to consider borrowing? Is it an appropriate asset to acquire with borrowed monies? Will it be positively, neutrally or negatively geared and is that appropriate to my wider circumstances? How will I fund the interest expense on that borrowing?
- Should I acquire the asset in my own name, a trust, a company or my Self-Managed Superannuation Fund in order to maximise my potential net of tax return upon sale and which best fits my circumstances and requirements now and in the future?
- Do I wish to gain personal use and benefit from the asset now and/or in the future and when?
- When do I choose to sell the asset and what would trigger that decision?
Each of these questions is relevant prior to making any investment decision but arguably more so for assets such as wine, vehicles and at. To this end let us consider the key pros and cons of investment to ‘Collectables’ relative to more familiar assets.
- It is widely recognised that a fortunate and/or well-chosen asset has the potential for extraordinary profit. Often such profits result from limited supply and hyper interest in the particular asset.
- Appreciable aesthetic beauty (though often found to be in the eye of the beholder).
- Often felt to be a reflection of social status and thereby providing the owner personal utility value.
- Identifying the value of a particular collectable requires a very specific skill set, expertise and experience in the particular asset class generally and often the asset specifically.
- Return profiles are very specific to the individual asset in question.
- Valuation methodologies are based less so on discounted future cash flow and more so on specific supply and demand for the piece at that future time. This amongst other matters results in a higher degree of valuation and therefore return ambiguity.
- Values are highly correlated to economic conditions.
- Markets for trading these assets are less liquid.
- Like unlisted property, collectables are generally non divisible assets with partial realisation of value in an asset problematic.
- Lack of market and pricing transparency.
- Of themselves these assets are rarely income producing. This has the relative effect of increasing holding cost over time and presents challenges when income return is required to fund cash flow requirements. For example, where such SMSF owned assets support retirement pension accounts required to make minimum annual payments.
- Given the often high value of such items single asset risk can be high. In the majority of cases, up to a level of indicated exposure, a portfolio that is represented by a greater number of individual assets and assets classes will have a higher risk-adjusted return than a portfolio that was composed entirely of one asset.
- Such assets carry specific risks such as theft or fire.
- The availability and cost of insurances can be a challenge.
- Often the market for the assets are shallow with fewer buyers at a given price point.
- Time to facilitate sale without discounting price can be a challenge. This may or may not be significant but will be dependent upon the occurrence of an unpredictable event.
- Such assets have the potential for extraordinary losses.
When considering the pros and cons of investment in collectables it is important not to get caught up in marketable stories of immense wealth generated from a single asset. For every Ferrari 250 GTO (available for around US$18,000 in 1962 and yours if you can seek out the unnamed buyer of chassis number 5111GT who acquired his/hers for US$52,000,000 in October 2013 – a gross annualised return of 16.9%) there are 100 Leyland P76’s. Further, wine in particular is a challenging investment both in terms of selection and maintenance with very specific storage conditions required to preserve quality and subsequent value.
It is extraordinarily difficult to quantify both the probability of, and the time frame required, to realise an appropriate return in such assets due to many of the cons outlined above. In practical terms when we choose to sell an asset is dependent upon many considerations but central to that decision is that the price achievable in a given market is greater than the value of the asset as perceived by the seller. Less transparent markets, pricing specific to the unique asset in question, limited ability to apply cash flow based valuation methodology, sensitivity to future trends and high correlation to wider economic conditions at a future point in time makes the ability to forecast return over time within a reliable indicated range of probability much more difficult than for conventional assets.
The field of choosing artists work of future note and wine of exceptional quality is beyond the scope of this article and the remit of the writer. However, having made the decision to acquire such an asset if you are considering whether to buy that asset within your Self-Managed Superannuation Fund (SMSF) there are some matters to be aware of and I trust the following assists.
A Self-Managed Superannuation Fund (SMSF) can invest on behalf of members in what are labelled as ‘Collectables and Personal Use Assets’ where certain conditions are met and rules understood.
Section 62A of the Superannuation Industry (Supervision) Act 1993 (SISA) and 13.18AA of the Superannuation Industry (Supervision) Regulations (SISR) define these assets to include:
- Antiques, Artefacts,
- Coins, medallions or bank notes,
- Postage stamps or first day covers,
- Rare folios, manuscripts or books,
- Wine or spirits,
- Motor vehicles,
- Recreational boats.
Handed to Government in 2010 the Cooper Review had originally recommended that SMSF’s be forbidden from investing in ‘Collectibles and Personal Use Assets’. Following significant discussion and policy debate ultimately the federal government confirmed collectable assets were legally available investments for SMSF’s to acquire on behalf of members. However, stricter storage and insurance conditions were enacted and since 1 July 2016 all SMSF’s have had to comply with those new requirements.
The new requirements have contributed to SMSF’s investing less to this class of assets with the ATO Statistics reflecting investment to Collectables and Personal Use Assets in June 2011 of $713 Million (0.18% of total SMSF assets) while in June 2016 the value reflected for this same asset class had reduced to $375 Million (0.06% of total SMSF assets). Nevertheless, trustees on behalf of members retain the ability to invest in this class of asset.
The SIS Act and the SIS Regulations prescribe the rules under which assets can be owned by a SMSF. A summary of these rules as they relate to SMSF acquisition and holding of ‘Collectable and Personal Use Assets’ follow:
- Must not be used by a member or a related party - collectables and personal use assets cannot be owned in order to provide a present day benefit and instead are required to be held for the sole purpose of providing future retirement benefit for members. In this way the assets cannot be used by members or related parties of the members.
- Display and Storage - must not be stored in the private residence of any related party. You can store (but not display) collectables and personal use assets in premises owned by a related party, provided it is not their private residence. They can't be displayed because this means they are being used by the related party. By extension the ATO shares that where a SMSF invests and owns an artwork the piece cannot be hung in the business premises of a related party where it is visible to clients and employees.
- Documented Decision Making – The decision on storage of the asset must be documented. Further, the SMSF must document an Investment Strategy that allows for the acquisition of that asset on behalf of the members.
- Insurance - collectables and personal use assets purchased by the fund must be insured in the name of the fund within seven days of purchase. As part of the decision to invest in collectables and personal use assets, the trustee needs to consider the availability and cost of insurance. In all cases the insurance must be owned in the name of the SMSF.
- Leasing – You can only lease the assets to an unrelated party and the lease must be on arm’s length commercial terms. The ATO provides the example where a SMSF can lease artwork to an art gallery provided the gallery is not owned by a related party and the lease is on arm's length terms. The asset must not be leased to a related party.
- Selling – the asset can be sold to a related party provided the sale is at market price as determined by a qualified, independent valuer. A qualified valuer is taken to be one who either holds formal valuation qualifications or by being considered to have specific knowledge, experience and judgment by their particular professional community. A valuer is taken to be independent if they are independent of the interests of the fund. This means the valuer should not be a member of the fund or a related party of the fund.
For the purposes of the above a ‘related party’ of an SMSF is defined by the SISA to include each member of the fund, a Standard Employer-Sponsor of the fund and a ‘Part 8 Associate’. A ‘Part 8 Associate’ includes:
- A relative of the member - parent, grandparent, brother, sister, uncle, aunt, nephew, niece, linear descendant or adopted child of the member or their spouse or a spouse of the aforementioned,
- Other members of the SMSF and other trustees/directors of a corporate trustee of the fund,
- A partner of the member and their spouses and children,
- The trustee of a trust the member controls, and,
- A company sufficiently influenced by, or in which majority voting interest is held by the member and their Part 8 associates either individually or together.
Many consider superannuation for investment to collectables given the mandatory (for most of us) capital accrued over time and the timeframe to retirement before monies can be accessed. However, equally the period it takes to accrue enough wealth within superannuation to acquire such an asset and then the investment period likely before a return can be realised can present challenges.
Having outlined the abovementioned considerations, rules and regulations the question arises as to why I would choose to buy my next ‘collectable’ within the somewhat legally and administratively complex superannuation vehicle. The inevitable answer is that, amongst other benefits, superannuation remains a very tax effective wealth accumulation vehicle and the only structure allowing for tax free earnings on assets and income stream payments to an individual in retirement. In this way superannuation ownership has the ability to increase the net return on any profitable investment by reducing tax impost and by extension provides greater potential for longevity of the capital supporting future retirement income needs.