The trappings of wealth such as beautiful art, fine wine, classic cars, forestry and old watches may have an aesthetic value, but are they good investments? This blog evaluates whether you should invest in collectibles or stay mainstream.
The allure of the exotic
Vanilla, grey and beige (or magnolia paint for that matter) are deemed sad and boring. Few people want to line up in their defence.
There is the strange and exciting allure of the exotic. The ‘dare to be different’ approach. There are over seven billion people on earth, and some people want to stand out.
This allure applies to investments, savings and pensions. The mainstream is for ‘them’ and you want the path less trodden. Don’t worry, the media is on your side.
Everyone has heard the stories about vast profits made on collectibles, from classic cars to bottles of vintage ‘first growth’ Bordeaux wines. Take Jon Hunt, the founder of Foxton’s Estate Agency, who sold the company at the height of the pre-credit crisis housing boom, and bought a Ferrari GTO 250 for an eye watering £15.7 million.
He sold it three years later for £20.2 million. Not a bad return for a normally depreciating asset sitting in a garage.
Substitute the GTO for a Penny Black, Van Gogh, Patek Philippe watch, or a Stradivarius and the stories are much the same. Headline-grabbing profits have increased investor focus and appetite for real, collectible assets, such as fine wine, coins, musical instruments, art, watches and classic cars to name a few.
With this interest comes a spate of new investment products cashing in on the trend. The question you need to ask yourself is whether, in practice, these collectibles represent a real and accessible (liquid) investment opportunity that complements a traditional investment portfolio, or not.
Sensible investment criteria
If you are considering collectibles, as opposed to mainstream traditional investments (company shares, government bonds and commercial property), it will help if you can benchmark your choice against key criteria.
There are six fundamental questions that you need to ask and answer to your satisfaction before an allocation can be made to a collectible:
- Source of returns: where do the returns of the asset class come from? How robust are they likely to be in the future?
- Data quality: can the data be trusted? Is the data long enough to provide useful insight?
- Portfolio role: what contribution would the asset make to your portfolio?
- Rewards: are the risks compensated for by the expected returns on offer?
- Product structure: do products exist that can capture the asset class return?
- Risk management: can the risks be monitored and managed over time?
Peeking behind the headlines
It is easy to understand the superficial appeal of investing in collectibles, either directly or through pooled investment funds or ETFs. You need to get behind the headlines of the money pages of the Sunday papers and kick the tyres.
The first step is looking at broader ‘industry’ data sets rather than the anecdotal stories of success. Each of the major collectibles now has its own set of indices, tracking repeat transactions.
Statistics from these indices in articles in the press suggest that collectibles have delivered strong returns uncorrelated to bonds and company shares.
What is driving the returns?
Traditional investment assets are valued by discounting back future cash flows into a present value. Companies deliver earnings (and in most cases dividends) into the future. Bonds deliver coupon payments and return of principal. Investment property delivers rental income over time.
These assets can be valued using their cash flows yet collectibles have no positive cash flows. In most cases they deliver negative cash flows due to insurance and storage costs. That makes them hard to value by traditional methods.
In practice, price movements are a simple case of supply and demand. Collectibles tend to be illiquid, rare, and privately owned for financial and aesthetic reasons. This means their supply is limited. Prices are demand driven. It is evident that a few collectible items – often well-known pieces e.g. a Picasso, or a Rolex – draw the attention of the wealthy.
Take the example of the one surviving 1856 one-cent Magenta stamp from British Guiana. It was sold at auction by Sotheby’s in New York for $9.5 million, beating the previous world record for a stamp of $2.2 million. It had not been on the market since 1980 and was bought by an anonymous telephone bidder.
Demand is driven by the wealthy classes emerging from Russia, Japan and Asia, and the Chinese, who are keen on collectibles.
According to Bloomberg, Asia will see the fastest growth in the billionaire population in the next few years. The number of Asian billionaires will rise by 27% to 1,003 between 2018 and 2023, making up more than a third of the total billionaire population of 2,696. The billionaire population growth rates for North America and Europe are 17% and 18%.
This is a lot of spending power chasing a few rare items.
The consumption of wine is growing in China by 20% a year. The Chinese have become keen buyers of fine wines, pushing up prices. Tastes vary across nationalities, cultures and over time, which means that demand, and prices, will vary across different segments of the collectibles market.
The investment returns for collectibles depend on continued flows of funds and interest driven by growing wealth and on the ability to identify trends in taste, and access to the rarest, most sought after items.
“If we have data, let’s look at data. If all we have are opinions, let’s go with mine.”
This amusing quotation is from Jim Barksdale, the former Netscape CEO. Data should beat opinions every time. Regrettably, the media often publish exotic opinion and present it as fact.
Despite widespread use of collectibles indices, there is a major problem with the data. Most indices use repeat sales – the price between one sale and another – to estimate the change in prices of the asset class.
Sales tend to be non-random, with pieces which have performed well or are in vogue coming onto the market more often than the bulk of art held by collectors. Many collectables are held and traded by private collectors. These prices are rarely visible and are not captured by the data.
Many do not rise in value. Some go out of fashion, affecting prices, and others hang on a wall, or sit in a cellar, safe or garage. These unseen ‘prices’ create an upward bias in the published numbers. Transaction costs are rarely taken into account, yet for art sales these can be as high as 20% to 25%.
If you are researching, then seek out the extra costs which erode the headline returns, such as storage, insurance, and buy and sell commissions.
Where do collectibles sit in a portfolio?
Collectibles sit in the risk assets component of your investment portfolio. Returns are likely to be volatile.
For example, fine wines were flat for the first part of the twentieth century. They went through a boom and bust around the Second World War and have risen since then. The data set is poor quality compared to traditional investments. This makes it difficult to understand the full return and risk picture.
The correlation of prices to the growth in wealth is correlated to equity markets. This makes them weak diversifiers of equity market risk. A lack of liquidity is not an endearing attribute in a portfolio; ask investors in the Neil Woodford Equity Income Fund.
Leaving aside the extra layer of costs of owning a collective investment product to access assets, the returns of collectibles sit between bonds and equities.
Given that an allocation to collectibles replaces an allocation to a diversified pool of company shares, in the absence of any great diversification benefit, the case is hard to make for their inclusion. The research by Stanford Business is useful:
‘When we compared the investment returns and risk of all the styles of art to a portfolio of other assets, we found that art investments would not substantially improve the risk/return trade profile of a portfolio diversified among traditional asset classes such as stocks and bonds.’
What about costs and regulatory protection?
Remember that going out and buying a few cases of wine or a painting is a bit like picking a specific company’s stock. You may or may not get lucky. Even professional fund managers fail, in the main, to pick stocks that do better than the market after transaction costs. Will a fine wine manager do any better?
A collective investment approach, via a fund, makes more sense, but it is not without its own material issues. Increased interest in collectibles has spawned a rapid growth in art, fine wine and other asset class funds. Logic suggests the costs of running such funds will be high, as each piece needs to be identified, valued and purchased privately or at auction.
Transaction costs will be high. According to the Art Fund Association, art fund management fees range from 1% to 3% per annum plus 20% of the profit on sale.
Funds are also likely to be illiquid, given the nature of the assets held, and lock-ins of five years or more are not unusual. Performance of the funds will be dependent on the skills and trend-picking abilities of the manager. Given that much of the money invested flows into well-known names and items, small funds may have problems accessing these areas of the market and diversifying their portfolios.
The alternative – picking new emerging artists – is a highly risky business. Funds are likely to sit outside of the regulatory regime, i.e. unregulated collective investment schemes (UCIS), which are only available to sophisticated investors and carry higher operational and investment risks.
It may seem disappointing that tangible, aesthetic items of historical interest and beauty, about which one can get quite passionate, may not represent good investments in practice. It is important to remember that good investing should be dispassionate and logical at all times.
By all means indulge your passion on a small scale. Drink it, gaze at it, wear it or throw the roof down, but don’t think of collectibles as financial investments that are contributing to your portfolio, unless you get lucky.
At Capital we believe luck is not an investment strategy. Own them only if you enjoy them.
If you can’t see the wood for the wine, and would like to speak to a chartered financial planner to discuss your investments, contact Capital today.
This article is distributed for educational purposes and should not be considered investment advice or an offer of any product for sale. This article contains the opinions of the author but not necessarily of the Firm and does not represent a recommendation of any particular security, strategy or investment product.
Information contained herein has been obtained from sources believed to be reliable but is not guaranteed.
Past performance is not indicative of future results and no representation is made that the stated results will be replicated. Errors and omissions excepted.