Collecting may be fun, but it is not the same as investing
We are all attracted to things that we perceive as rare or beautiful, but are those classic cars, fine wines and expensive watches investments or just a collectable curiosity?
It’s very difficult when you start investing to differentiate between a good investment idea and a bad one. Alongside conventional asset classes such as bonds, equities and property, there is a proliferation of ‘alternative’ investments that claim to have low correlation to publically traded assets and thus offer good portfolio diversification.
In the last few years a whole host of specialist funds and investment schemes have been launched that aim to make money from collectable assets. This includes art, fine wine, precious stones, stamps and classic cars. While all of these have their own merits - art can be hung on your wall, cars can be driven and wine can be drunk - they are not investments in the purest sense as none of them generate a regular yield, or organic growth as the equity market does.
What these assets do very well is to appeal to the inner collector in people, and are based on the premise that because an asset is beautiful, or scarce, it must go up in value over time.
In short, these types of asset rely on the, rather unkindly named, greater fool theory, which states that the price of an object is not determined by its intrinsic value (a canvas covered in paint has an aesthetic value only), but by the belief of the buyer that there will be another buyer who will pay more for it in the future.
This is a risky strategy as tastes change over time. Antique wooden furniture from the Regency period was seen as the height of sophistication thirty years ago, but is now looked down on rather sneeringly as ‘brown furniture.’ Some auction houses have now stopped selling dining room tables and chairs as modern living, for many people, no longer has the space or requirement for it.
The classic car market seems a case in point. Collectors are typically middle-aged and have a bias towards the cars they wanted as youths, but will their children also covet the same vehicles? Time will tell.
History is littered with rather esoteric investments that seemed a good idea at the time, and then later proved to be costly mistakes. Famously the Dutch tulip mania (which burst in March 1637) saw some strains of a single tulip bulb sell for as much as ten times the average annual income of a skilled craftsman. Last century, during the 1930’s, natural pearls fell in value by 90% when cultured pearl farms were developed in Japan and the South Seas, and in more recent years the now-laughable Beanie Baby mania of the late 1990s saw soft toys that cost a few dollars reportedly account for 10% of eBay’s sales and retail for many times more.
Have you thought about trading costs?
When we buy and sell exchange traded funds (ETFs) within IG Smart Portfolios there is a market bid-offer spread. The market price is kept in equilibrium: the bid is what someone wants to buy at, and the offer is what someone will sell at. Our average (Bloomberg quoted) bid-ask spread is 0.16%. This means it will cost an average of 0.08% on top of the mid-price to buy the ETF portfolio.1
If you could buy and sell many collectables at a tight market spread, that would make the round-trip cost of ownership more attractive. The reality however is that because these assets are quite niche, matching a willing buyer and seller normally requires an intermediary, whether that be an auction house or a dealer.
The intermediary has to a make a margin, which might be around 20%. Using a rough example, someone buying a painting at auction for £1000 might typically pay a 20% buyers commission to the auction house making a pre-tax price of £1200 (VAT is payable on the commission). If the market doubled over the next few years, and they sold the painting under the hammer for £2000, again a commission of 20% would be paid, resulting in a net return of £1600. Herein lies the problem: an illiquid asset that doubles in price might only result in a 33% gain for the owner. This assumes that there were no management fees, insurance or storage costs to have paid in the interim.
By all means, don’t let this piece put you off collecting! There is much pleasure and satisfaction to be gained from doing so, but when faced with ‘collectors’ investment opportunities it can pay to think with head rather than the heart.
1 In actual fact the trading costs for IG Smart Portfolios clients should be lower than the Bloomberg quote. This will be subject to another article.