Title: Understanding Non-Securities — What They Are, How They’re Valued, and Practical Steps to Invest and Manage Them
What is a non-security?
– A non-security (sometimes called a “real asset” or alternative asset) is an investment that is not issued and traded on public securities exchanges like stocks, bonds, or mutual funds. Examples include physical assets such as art, antiques, rare coins, precious metals (gold, silver), gems, fine wine, collectibles, and certain personal financial contracts such as traditional life insurance or many annuities.
– Unlike securities, these assets generally do not have standardized, continuously quoted market prices and are traded in specialized or private markets (auctions, dealer networks, private sales).
Key characteristics
– Illiquidity: No centralized exchange; buying and selling can be slow, infrequent, and often expensive.
– Heterogeneity: Each item is unique (one painting differs from another), so valuation depends on condition, provenance, rarity, and demand.
– Transaction complexity: Sales often require authentication, appraisal, negotiation, and specialized intermediaries (auction houses, dealers, brokers).
– Storage and custody needs: Physical protection, climate control, secure storage, and insurance matter.
– Indirect public exposure: Non-securities can be packaged into securities (e.g., ETFs or funds that hold physical gold), allowing public-market access to a non-security’s return characteristics.
Common examples
– Tangible collectibles: Fine art, antiques, rare coins, stamps, vintage watches.
– Commodities in physical form: Bullion (gold, silver), diamonds.
– Real property: Direct real estate ownership (managed differently from REITs).
– Personal financial contracts: Many life insurance policies and annuities are contractual assets rather than tradable securities.
– Niche assets: Classic cars, bottles of rare wine, sports memorabilia.
Valuation of non-securities
– Appraisal-based: Professional appraisers, auction records, and expert opinions are primary valuation inputs.
– Comparable sales: Where available, recent sales of similar items provide benchmarks, but comparables may be sparse.
– Condition & provenance: Grades, restoration history, authenticity certificates, and ownership history materially affect value.
– Market sentiment & rarity: Trends in taste and the scarcity of a given item drive demand and price volatility.
– Formal appraisal frequency: For portfolios, periodic re-appraisals (every 1–3 years, or with significant market changes) are common practice.
Liquidity and markets
– Trading venues: Auctions (Sotheby’s/Christie’s), specialized dealers, private sales, online marketplaces for collectibles, and consignment.
– Time horizon: Expect longer timelines to sell and higher transaction costs (commissions, buyer’s/seller’s premiums, authentication fees).
– Indirect liquidity: ETFs and funds that hold non-securities (e.g., gold ETFs) can provide liquid exposure without holding the physical asset.
Practical steps to invest in and manage non-securities
1. Define your objectives and allocation
– Decide whether the asset is for passion (collecting), diversification (low correlation), inflation hedge, or speculative upside.
– Limit portfolio allocation to non-securities to a size you can tolerate being illiquid (common advice: a modest percentage of investable assets).
2. Educate yourself and specialize
– Learn the specific market dynamics for the asset class (artists, grading scales, historical price drivers).
– Follow auction house results, dealer price guides, and specialist publications.
3. Authenticate and appraise before purchase
– Obtain expert authentication and a written appraisal. For high-value purchases, use multiple independent experts.
– Check provenance and documentation (certificates, past auction records, repair/restoration history).
4. Use reputable channels
– Buy through established auction houses, well-rated dealers, or verified platforms. Avoid unverified private sellers without provenance.
– For life insurance/annuities, deal with established insurers and review contract terms thoroughly.
5. Plan for custody and insurance
– Arrange secure storage (bank safe deposit boxes, professional vaults, specialized climate-controlled storage).
– Insure the asset with policies that cover valuation changes, transit, and display if applicable.
6. Manage costs and taxes
– Factor in transaction fees (auction premiums, dealer margins), storage, insurance, authentication, and shipping.
– Consult a tax professional about capital gains treatment, collectibles tax rates, estate implications, and any state taxes.
7. Maintain documentation and provenance
– Keep detailed records: purchase invoices, appraisals, certificates of authenticity, restoration records, and insurance papers.
8. Consider liquid alternatives if liquidity matters
– Use ETFs, mutual funds, or futures (where available) to gain exposure—examples include gold ETFs that hold bullion.
– For exposure to real assets with professional management, consider commodity funds or real-asset ETFs.
Due diligence checklist before buying a non-security
– Provenance established? (Ownership history, title)
– Authenticity verified? (Certificates, expert verification)
– Condition documented? (High-quality photos, condition reports)
– Current appraisal available? (Written, from reputable appraiser)
– Total costs understood? (Acquisition + ongoing storage/insurance + expected selling costs)
– Exit strategy clear? (Likely buyers, expected time-to-sale)
– Tax and legal implications reviewed? (Capital gains rate, inheritance/estate treatment)
Selling and exit strategies
– Auction vs. private sale: Auctions can surface competitive bidding but charge premiums; private sales may net a higher price for unique buyers.
– Consignment: Use trusted houses that reach target collectors, but verify commission rates and marketing plans.
– Staged marketing: Build provenance and presentation (cataloguing, professional photos) to attract buyers.
– Timing: Monitor market cycles and specialist auction calendars for peak demand windows.
Tax, legal and estate planning considerations
– Tax rates: In some jurisdictions (e.g., the U.S.), collectibles are subject to different capital gains tax rates—check current rules.
– Estate planning: Non-securities can complicate inheritance; maintain clear documentation and consider liquidity for heirs to pay estate taxes.
– Consumer protections: Smaller secondary markets may have fewer legal protections; contracts and title verification are key.
Pros and cons at a glance
– Pros: Potential for diversification, inflation hedge, aesthetic/enjoyment value, scarcity-driven upside.
– Cons: Illiquidity, high transaction costs, valuation subjectivity, need for specialized knowledge and custody.
When to use professional help
– If the asset is high value, esoteric, or if you lack market expertise: hire appraisers, legal advisers, tax professionals, or specialized asset managers.
– For life insurance and annuity purchases: use a licensed insurance advisor and review the insurer’s financial strength ratings.
Conclusion
Non-securities can play a useful role for investors seeking diversification, inflation protection, or personal satisfaction. However, their illiquid, heterogeneous nature requires careful research, rigorous documentation, trusted custody arrangements, and clear plans for valuation and exit. Many investors gain similar exposure with improved liquidity and lower operational burdens by using professionally managed funds or ETFs that hold real assets.
Sources
– Investopedia. “Non-Security.” https://www.investopedia.com/terms/n/non-security.asp (accessed June 16, 2021).
– State Street Global Advisors. “Welcome to SPDR Gold Shares.” (information on gold ETF structure).