Does investing in collectibles and passion assets make sense?

“Collectors are happy people.” - Johann Wolfgang von Goethe

The world of collectibles and passion assets is a rather obscure one. This report will explore how they could be used to safeguard and further your wealth, and - as Goethe, Germany’s greatest literary figure, finds - make you happy. But first of all: What do we mean by collectibles or passion investments?

How we define passion investments

They are - to start with - all tangible in nature, clearly a prerequisite to allow us to be passionate about them. Whilst a few of them can generate “financial dividends” - think of fees earned from lending the artwork to an exhibition - they all promise an “emotional dividend” or psychological return to their owners. This type of return can be gained from visually displaying the beauty of an exclusive piece of artwork, violin, or fine watch, thereby also signalling wealth and hence prestige of the owner. Other categories can even be consumed (wine and whisky) or driven (classic cars), although this usually reduces the value of the collectible markedly.

British private bank Coutts regularly publishes a ‘passion index’ which consists of a number of categories, ranging from collectibles such as stamps, coins, fine wines, classic cars, to precious items such as jewellery or watches, but also artwork such as paintings and Chinese ceramics and even property. [1] The price range for these collectibles can vary dramatically and there certainly are affordable versions of art, wine, and classic cars, however, those that are being considered as ‘investment grade’ are typically very pricey.

Why is there heightened interest now?

The market for collectible items has been around for centuries. King Charles I. (1600-1649) a rather controversial ruler of England, was an avid art collector, acquiring one of the most impressive art assortments ever assembled. After his execution, the English parliament decided to sell off his estimated 1760 paintings to a number of buyers across Europe. Thomas Jefferson (1743-1826), founding father and the third President of the United States, was known to be a passionate wine collector and is often referred to as America’s first wine connoisseur.

Until a few decades ago, it was predominantly the domain of wealthy, upper class families to indulge in the both aesthetically appealing and status-enhancing pastime of collecting rare items. With the expansion of wealth in developed nations and the creation of a whole new segment of high net worth individuals in emerging economies, passion assets have drawn attention to a much wider circle of potential investors more recently.

The expansion of new potential customers has coincided with a dearth of traditional investment opportunities. Since the financial crisis of 2008 and reinforced by the corona virus induced economic slump this year, the low interest rate environment triggered an - increasingly desperate - search for higher-yielding investments.

Encouraged by regular news reports about spectacular prices being achieved at auctions for certain collectibles, a growing number of investors believe that they have found this opportunity in passion assets. A recent study states that the average ultra-high-net-worth-individual (UHNWI), typically defined as people that have more than USD 30m in investable funds, holds six percent of its total assets in the form of collectibles such as art, cars, fine wines and other sought after items compared to 25% in financial assets. [2] Leaving aside all other assets owned by UHNW individuals, which are primarily real estate and their own businesses, it is intriguing that about one in six dollars of investable assets is being ploughed into collectibles.

To invest or not invest?

It is fair to assume that the popularity of passion assets may be driven by a perception that they provide good long term returns to their investors. And indeed, several market reports seem to indicate this. Knight Frank’s Luxury Investment Index for example shows that arts grew in value by +141% over the past decade. During the same period, the report continues, fine wines and coins have performed +120% and +175%, respectively. The true star according to the report, however, is the rare whiskey segment, with phenomenal 564% growth over the past ten years. [3]

So, should we jump on this bandwagon and consider allocating a relevant amount of our wealth into this asset class? Or shall it best be left to the expert investors who know how to identify the next Gerhard Richter - Europe’s most valuable living artist, which whiskey will turn out to be another vintage Macallan or whether the stamp on offer will perform like an 1863 Plate 77 Penny Red (worth over half a million pound)?

Or perhaps, this is not the right question to pose. Is it really necessary to pick the next super star collectible item? Surely, it was a good idea to be invested in the equity markets, even if you hadn’t picked one of the FAANG [4] stocks early on. After all, the average return of the asset class is what you should care about in the long run. Proponents of passion investments point to further benefits besides their return potential: passion assets add value by helping to diversify your portfolio and by acting as a store of value - the latter being a quality particularly popular in times of excessive inflation. [5]

However, not everyone is convinced. Some researchers, having analysed the asset class in depth, found little evidence that the returns have been attractive once inflation and other aspects are taken into consideration. Also, its vaunted characteristic as portfolio diversifier and inflation hedge have been at least called into question. Other common criticism relates to the fact that they are highly illiquid in nature. Lastly, a lack of meaningful regulation may give an (insurmountable?) edge to market insiders at the expense of less knowledgeable investors. In her recent book on art as an investment class, Gerlis (2014) sows doubt that passion assets should be seen as an investment category in their own right and cites recent industry reports that have downgraded their relevance in general and highlighted their exclusion when calculating a High Net Worth’s investable wealth. [6]

A framework to decide

Some of our clients were true experts in their fields of passion and knew very well what to buy when and when to sell what. Others - perhaps feeling slightly compelled to get into the ‘trade’’ by their friends, have been less successful and regret that they wasted their money. From our own experience when advising wealthy families, we have seen this happen time and again. It is with this in mind why we wrote this report: to shed some light on this exciting topic, but also to equip you with a framework of questions that assists you in asking the right questions when such opportunities present themselves to you.

Having looked at a range of different collectibles and analysed both the academic and industry literature in-depth on the subject, we believe that the attractiveness of passion assets should be determined by focusing on the following dimensions:

Risk and return characteristics relative to traditional assets.
Required return to recoup transaction costs.
Diversification benefit to investment portfolios.
Ability to liquidate the investment.
Reliability of findings based on the breadth and depth of available analysis.

On the basis of this framework, we have generated a weighted average for each collectible. Our forthcoming book goes into great detail on how we measured the various dimensions. Given the length of the analysis we only present the summary of our findings in this report.

And the winner is…

The table gives an overview of all passion asset categories we have investigated and weighted along the framework’s dimensions, mentioned above. Overall, prime real estate and coins have scored highest - driven by at least similar or superior risk-returns profiles versus stocks and bonds, good to strong diversification benefits, and relatively large (i.e. more liquid) markets.

The runner-ups are watches, jewellery, whisky and classic cars which all scored similarly well. While watches and jewellery score identically across all categories, with strong diversification credentials, but high transaction costs, the classic cars and whisky segments achieve this due to different factors. Classic cars have relatively poor risk-return features, but they score better than others on transaction costs, negative correlation with equities and bonds, and possess a relatively liquid market.

Despite their spectacular growth in the past ten years, whiskies were - perhaps somewhat surprisingly - not our top choice. While the financial risk-return trade-off, as well as the low transaction costs clearly favour whiskies, it was less convincing when it comes to portfolio diversification and liquidity of its markets. Furthermore, given that it is a recent investment category, we have found relatively few studies investigating its characteristics, giving us somewhat less confidence in the available data.

At the bottom of the spectrum we find diamonds, antique furniture, wine, and Chinese ceramics which all share subpar risk/return credentials and less convincing diversification benefits.

So, shall we buy coins and avoid a nice bottle of red, then?

It may come as a slight shock to all oenophiles amongst us that fine wines appear to be underperforming other categories (as the occasional drinker of a good bottle of wine, we certainly were!). Similarly, art lovers will be unhappy to see the biggest collectible category of all to rate so poorly in comparison to the others. On the other hand, we expect a clearly audible sigh of relief amongst all property hunters that - after all - it also makes financially sense to own these dwellings.

However, there is neither reason to despair, nor to be overtly jubilant by our analysis - it is, after all, a relative ranking, and based on average outcomes for each category. Savvy wine and art connoisseurs are still likely to outperform these average returns. And the uninformed property investor may end up owning yet another overpriced trophy penthouse flat!

Overall, our verdict is fairly clear: given the market’s peculiarities - be it the high transaction costs, little investor protection and long required lead times to find a buyer or seller - you should only get involved if you genuinely can develop or already have a passion for a specific collectible. It also appears prudent to start your investment journey with relatively small amounts as the learning curve is remarkable steep and the risk of taking a poor investment decision high.

What do you think about passion assets? We would love to hear your thoughts on this. Wishing you a lucky hand with your next purchase.

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Footnotes

[1] See Coutts (2019)

[2] See Dimson, Marsh, & Staunton (2018). Other major categories are the UHNWI’s business (23%), real estate for investment purposes (24%), real estate for own use (16%), and other items (6%).

[3] See Knight Frank (2020)

[4] “FAANG” refers to the stocks of five prominent American technology companies which enjoyed a period of very strong growth during the bull market of 2009-2019: Facebook, Amazon, Apple, Netflix, and Google.

[5] See Dimson & Spaenjers (2011) for the case of stamps as an example.

[6] Gerlis (2014), p.22-23