When a client first said four years ago that he planned to invest in Hawaiian koa wood trees, Gary Hutto was skeptical. Hutto, a financial advisor in Orange, Calif., didn't argue because the amount was relatively small, less than $10,000.
The next year, when the client said he planned to multiply that amount by five times, Hutto balked. He decided to investigate. Since then, he's invested more than 20% of his own retirement assets in the trees.
Disillusionment with returns on traditional financial investments is driving more high-net-worth clients toward niche alternatives. Former presidential candidate Mitt Romney's extensive IRA holdings, for example, include a variety of private, nontraded entities.
Other options gaining favor among wealthier investors include rare coins, wine, art, real estate and musical instruments. (Or baseball cards: See "Let Me Help You With That," on page 67, for a story of an advisor who helped a client find a highly collectible Honus Wagner card.) In some cases, like the koa wood offering, investors of more moderate wealth are placing their investment bets far beyond the securities markets.
Hawaiian Legacy Hardwoods, the asset in which Hutto and his client invested, sells koa trees that the company planted on the big island of Hawaii.
Koa is an exotic wood prized for furniture and musical instruments, such as guitars. It's also scarce. That's typical: Limited supply and built-in demand are two factors that make niche assets - whether they are wood, rare coins or wine - attractive.
Mike Wilson, director of sales for Hawaiian Legacy Hardwoods, says the company projects that a single lot of 100 trees, purchased for a bit more than $9,000 at current prices, will appreciate over the 25-year fixed term of the investment, when all the trees have been harvested - for a payout of $285,000.
That's if the trees survive, of course. Koa trees are vulnerable to fungus and to insects. Wilson says the elevation at which they're planted minimizes these risks. Still, there's no guarantee that an investor's trees will live to be harvested and sold.
While the firm can't eliminate all risks, Hawaiian Legacy has addressed one drawback of exotic investments by creating an "investable format." That's something Thomas Healey, a retired Goldman Sachs partner in New Jersey, says is lacking in most niche investments. He defines them as investments that attract little or no institutional interest.
'A TENTH OF A PICTURE'
"There are no funds," Healy notes, "which would be a typical way of organizing an investment that multiple smaller clients can invest in. If you're an investment manager, it's hard to obtain a tenth of a picture or to create a diversified portfolio of paintings."
As interest in exotics has grown, however, specialized vehicles have multiplied. Art funds have been created as closed-end models that raise money. After the fund closes, the money is used to buy art. Investors receive their returns when the art is sold in 10 years.
An open-end model is being used by the Artist Rare Instrument Fund, which invests in rare stringed instruments. Investors must commit funds for five years. The fund's managers will call in the money as needed when a desired musical instrument comes available.
There are fewer than 600 rare Stradivarius violins in existence, for example. Fund partner Ed Papier says investors are assured that they will get their money back because of the fixed scarcity.
The Stradivarius cello owned by the late performer Bernard Greenhouse recently sold for more than the previous record price of $6 million - although an exact sale price is not known.
Average annual returns of exotic investments may not necessarily outstrip those more traditional asset classes over the long term. Between 1900 and 2000, the S&P 500 rose at an annualized 11%, according to Healey; between 1980 and 2005, he says returns on investments in fine violins rose 10%.
Of course, exotics are by nature non-liquid assets, meaning clients who need to cash out in a hurry could have trouble doing so. This is true even when the non-liquid assets in question are highly desired bottles of wine.
The best vintages in French wines remain a hedge against inflation and currency fluctuations. Sotheby's sales figures for fine wines in the Hong Kong/Asia market grew 213% between 2009 to 2011 during the global market rebound.
Yet risks remain for investors. Auction houses like Sotheby's don't give investment advice, says Robert Sleigh, head of wine for Sotheby's Asia. "We only can advise how wine has performed in the past," he says.
Serious wine investors commonly sell at least some bottles purchased in advance on the futures market once the wine is delivered, Sleigh says. But pricing can fall short of expectations. Wine investors are at the mercy of weather and vine-eating pests, as well as changes in taste among wine connoisseurs.
Besides these mundane risks, they may also find that wine by its nature has more than one way of going to their heads. Sleigh tells a story that underscores this risk.
One man was so seduced by his own wine collection that he decided to display bottles in his kitchen to impress party guests. At the end of one fateful night of festivities, all the bottles were empty.
For planners who work on commission, there is probably little incentive to research niche investments for clients, except for the sake of creating goodwill. However, fee-based planners can and do include such services.
RARE COIN BETS
Marc Henn, founder of Harvest Financial Advisors of West Chester, Ohio, a multifamily wealth management firm, learned about rare coin investing from his father.
He stresses that coins, like other exotic investments, are not for everyone. And, as with all exotics, clients intrigued by rare coins need specialized guidance.
Yet the market for rare coins can be more stable than that for other exotics, Henn says. The value of coins can be firmly established, due to grading services that the market accepts.
After grading, the coin is put in a plastic case that cannot be reassembled if it's broken. "That's the insurance," Henn says, "of a quality coin that's not fake, that has not been altered."
Because the market for rare coins is fairly established and deep, values of coins are generally a lot more predictable than for, say, paintings, Henn says. "We know the approximate value of the coins,'' Henn says, "whereas with an artwork, you're guessing until it goes to auction, unless you can find a private market."
Planners and clients should consider carefully before wading into this market nonetheless, Henn says. Rare coins are "something you want to have for a long time."
As an investment, a rare coin is "more appropriate for families or individuals with higher amounts of wealth." A 2007 study found that from 1979 through 2006, the average return for a coin mix graded as "mint" was 13.3%.
Henn, who works on a fee basis, has helped some clients enter rare coin investing. Other planners or advisors who may not be experts themselves can negotiate fees for helping clients find appropriate consultants or dealers.
When a successful niche investment like a portfolio of rare coins is cashed out and reinvested in traditional assets, a planner can benefit from an increase in assets under management, Henn says.
Much of the growing interest in non-financial assets comes from investors seeking to diversify retirement portfolios. Yet a whole new layer of complexity is added when high-net-worth investors include the assets in self-directed IRAs.
Such IRAs can include many types of non-financial assets, such as real estate, some rare coins, even racehorses and bowling alleys, as long as the asset is not for personal use. Real estate, for instance, must be for rental only.
Art and most collectibles, however, are prohibited. If prohibited assets are included in an self-directed IRA, the whole account becomes taxable.
Alternative-asset IRA providers ensure that IRS and Department of Labor rules are followed, although the firms don't act as financial planners.
REAL ESTATE BOOM
Kelly Rodriques, CEO and president of Pensco Trust in Denver, one of the largest alternative-asset custodians in the country, says the company's assets now stand at $11 billion and have been doubling roughly every four years. Some of the biggest gains have been in real estate.
"What we're seeing is the perfect storm," Rodriques says. "We're seeing boomers near retirement age at the same time as the 10-year look back at their retirement investments has not returned anything, and we're seeing the regulatory environment shift toward more independent IRAs offering more flexibility in a wider range of assets."
A self-directed IRA investor may, of course, seek the advice of a financial planner. Pensco has a network of nearly 7,000 independent advisors with which the company works.
When it comes to exotics, independent advice is certainly in order. As niche investing draws more interest, the dangers are also rife.
Custodial fees for self-directed IRAs can be high. Violating tax rules can jeopardize all the money in a tax-deferred qualified fund. Given the risk profile and illiquidity of exotic investments, most remain suitable only for high-net-worth individuals.
Both planners and clients should watch for any sign that many less-wealthy investors are jumping into exotic assets, Hutto says.
"The consensus is very often wrong," he says. "Once the consumer starts investing in alternatives on a wide scale, look out. That's probably the time to be in traditional investments."
Elena Mannes, an independent television documentary director, writer and producer in New York, has contributed to ABC News and CBS News.