When it comes to alternative investments, a couple that come to mind include hedge funds and real estate. Essentially anything that isn't considered a stock, bond or cash.

However, there is another alternative investment that flies under the radar: art. The right sculpture or painting can have significant returns for the savvy investor, and many clients - especially the high-net worth ones - are asking their advisors about the blossoming art-investment market.

Art can be worth the investment
The value in art can be a bit hard to spot. It hasn't been a long time since buying art meant collecting art - and buyers made their purchases based off of personal preferences, not just return on investment.

"High returns attract more art investors."

That has changed recently, and investing in art has gained ground as a viable wealth management strategy. Now, it is much more than a hobby. Recently, The Wall Street Journal spoke to several art-investment experts, including Philip Hoffman, chief executive of London's Fine Art Fund Group, and Kathryn Graddy, an economics professor at Brandeis University.

When it comes to returns, Hoffman highlighted several options. Buying direct from sellers, for example, can net returns of as much as 20 percent long-term. Going through auctions, on the other hand, can yield lower figures.

"A number of economists have estimated the returns to art over a very long period," added Graddy. "Overall, estimates range from about 1 percent to about 5 percent real returns. Clearly, there is not a lot of consensus on long-run returns to holding art, other than that long-run real returns are less than investing in stocks."

Understand your clients' preferences
Knowing the potential in art is different than actually investing in it. How your clients view art - and how they want to invest in art - can differ depending on the person.

To get a grasp on the right investment strategy for each person, you should focus on the personal aspect of art. For example, many clients have deep emotional attachments to their collections. The pieces could have sentimental value, or they could have an extensive collection that you may not know about.

Ask a few questions of your clients to get started, including:

• How passionate are you about art? - Learning their love for art can help you come up with a strategy. A person who is passionate may have a hard time buying and selling quickly - they could want to hold on to their pieces instead.
• What will eventually happen to your art? - Art is also a major player during succession planning. Ask your clients who gets the art when they are gone. Is it family, friends or someone else?
• Is your art insured? - Many investors underestimate the importance of art insurance, especially if they intend to hold on to the pieces for years before selling again. Art insurance is also a specialized type of coverage that brings its own set of rules.

Before you move forward with an investment strategy, you need to learn about your client's relationship to art. This will help determine whether or not this option is right for them.

Manage the risks to reduce volatility
Even with the potential returns, there is no avoiding the volatility of the art market. There are several key issues that can make investing a dangerous proposition:

• High art values
• Lack of general knowledge
• Risk of theft or forgery

Art is a type of investment that truly takes money to make money. Clients who want the best returns have to be willing to spend upward of $1 million per painting, or else the taxes, auction fees and other costs erode profit. The problem is that today's art is bringing extremely high prices. For example, Hoffman told The Wall Street Journal that one painting bought in 2005 for $1.1 million sold just a year later for $2.3 million. What's more, the news is full of stories of paintings or sculptures going for over $100 million.

This attracts clients who may have the money, but not the art expertise. The end result is more risk. This is compounded by the fact that the art market is full of enterprising thieves and skilled forgeries.

Perform your due diligence
Investing in art requires the same due diligence as investing in a standard financial market, Laura Patten, senior intelligence analyst in the Federal Bureau of Investigation's art crimes division, told Wealth Management.

If your clients are focused on art, then they'll need to understand the risks. The way for advisors and their clients to stay safe is to never get complacent, have the right insurance in place and evaluate each and every transaction.

Patten shared a few red flags to watch out for:

• Deceased owners
• Print, not painting
• Famous artists like Picasso or Dali
• Lack of or questionable paperwork
• Sellers with criminal backgrounds

Even ownership disputes that aren't criminal in nature can complicate art investment. In some cases, the true owner - the one who is authorized to sell - is debatable. There could be problems with an estate, collateralization of art or family disputes. Your clients must do their due diligence to ensure the transaction is free of concern.

When art is a safer bet
Investing in art isn't right for everyone. Given the high value of art today, many of your clients may be asking if you can work art into their portfolios.

For the client on the low end of the asset spectrum, the answer should often be no. Buying and selling art through auction houses can be time-consuming and costly at low values, and the volatility of the market makes it hard for low-net worth clients to withstand the ups and downs - or front the money to buy direct from seller.

On the other hand, high-net worth clients can benefit from investing in art. They can spend more - often above $1 million per purchase - and have the cash flow to turn art into a long-term play. They can also afford auction fees and related costs that so often make art a poor investment for other clients. With that said, high-net worth clients with a sound art education and the right due diligence can turn art into a smart investment strategy.

To learn more on this topic, register for our Investment Management courses.

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