From fine art and fine wine to vintage automobiles and even comic books, collectible investments have received growing attention as a good investment and a possible hedge against inflation or an equity market downturn. Does the hype match the reality? Let’s review the benefits and potential pitfalls of investing in collectibles.
Many advisory firms have been touting the benefits of various alternative investments, including collectibles. The increase in demand, coupled with a relatively scarce and inelastic supply, has driven prices upward for many collectible assets. Falling under the broader rubric of alternative investments, it is well-known that family offices have long held a strong interest, with ultra-high-net-worth (UHNW) portfolios allocating some 16% to luxury collectibles.
Most UHNW investors state “joy of ownership” as the primary reason for collecting investments of passion. However, the distinction between purchasing collectibles for pleasure or for investment reasons is ambiguous, though surveys show many plan to allocate more of their wealth to it in future years. Whether for joy of ownership, a safe haven for assets or investment return, understanding the impact on wealth is an important consideration.
As support for investing in prized tangible assets, some here and here are promoting their ability to also enhance returns to portfolios. Have, however, collectibles produced attractive returns historically, and as such are they worthy of investor attention beyond their psychological benefits?
A closer look reveals a more intricate story. What we find is that success over time requires that one go beyond the passion to develop skill, patience and perhaps a healthy dose of luck.
Unlike stocks and bonds, collectibles, of course, do not create a stream of future cash flows, only the hope that you might one day sell it at a higher price than you purchased it. This means there is no intrinsic value associated with the asset, making it speculative. This leaves investors who wish to own prized tangibles speculating that the price is going to go up in the future and being willing to wait for that to hopefully happen.
Like other investments in the portfolio, the performance of collectibles should be assessed with two things in mind: What is the return on investment, including the cost to buy in and cash out, and will it provide a safe haven and possible hedging benefits against market volatility?
Quantifiable considerations
So what about the investment performance of collectibles? Given the broad spectrum and heterogeneity of collectibles, analyzing the returns of an overall composite index provides little meaningful guidance. Instead, let’s concentrate on three of the most popular investments: art, classic cars and fine wine. The table below summarizes the returns to these three categories as compared with traditional markets of stocks, bonds and gold.
Performance of Collectibles: Average Annual Returns Jan. 2002-Dec. 2023
As can be seen, collectibles appear to provide returns roughly in line with U.S. stocks. Reassuring, for sure, but this is not the complete picture. Why so?
Importantly, the returns to each of these reported asset classes is shown gross of all costs and expenses. An investor’s net performance will assuredly not match the reported gross returns over time. This is especially of concern for investing in illiquid alternatives. Maintaining an inventory of collectibles is rarely a low-cost endeavor.
While detailed research is scant, it is quite clear that the all-in costs of investing and holding collectibles will be much higher compared with traditional stock and bond counterparts. For instance, sales commissions alone will be 10% to 20% of the gross sales. One would also need to add search and information costs, storage and insurance costs to that as well. So while not clear what the various costs add up to, they will assuredly be much higher for collectibles.
Even assuming historical gross returns consummate with traditional assets, as the figure above suggests, it seems pretty clear that passion investments have unlikely yielded appealing net-of-costs total returns versus traditional assets. Impossible to measure, but transaction costs are a very real aspect of collectible investing. Taken together, the costs of buying and holding collectibles drive their net returns to fall meaningfully below those of traditional markets.
The takeaway message here, as famed investor Jack Bogle has aptly demonstrated: Net return to investors is what matters.
Let’s now dig into whether other quantifiable characteristics might improve their attractiveness. Some have suggested low correlations of collectibles to traditional markets consequently make them appealing. Research has indicated that collectibles do appear differentiated with respect to traditional assets as well as to each other, thus leading to potential diversification benefits. Such findings do strengthen their case for inclusion within an overall portfolio.
However, as everyone is well-aware, alternative investments are notoriously difficult to value, and any valuation happens with a delay. Such lags in estimating and reporting valuations, in turn, impact any resulting return series compiled over time. In other words, the reported correlations of returns for alternatives — collectibles included — are not quite what they might appear at first glance.
This fact hasn’t deterred many from making the claim that alternatives provide an excellent source of diversification. The wide touting of the seemingly low correlations of alternatives broadly has led the CFA Institute to say:
“Correlations are like icebergs floating in the sea: There is a lot hiding beneath the surface."
That is to say, contrary to expectations, adding alternatives to a portfolio will not likely improve overall portfolio diversification. When coupled with the high after-fees and expenses of holding collectibles, the investment case for including collectibles comes under meaningful threat.
Nonquantifiable considerations
So wine, art and other collectibles share the same risk for dropping in value as stocks and bonds and are unlikely to yield excess returns over time. Furthermore, collectibles also do not share the same ample liquidity of traditional assets. Like other alternative investments, including private equity and real estate, collectibles are illiquid and as such more expensive to buy or sell. It takes longer to convert all alternative investments into cash. Their illiquidity makes them susceptible to liquidity squeezes, price bubbles (like the overheated art market in the 1990s or Bordeaux wines in the early 2000s) or challenges in making a timely trade.
Informational and liquidity concerns also lead to valuation issues. Each single case of wine, classic car or piece of art is unique, and its value will depend on its condition, its provenance, sales channel and location.
For all these reasons, the case for collectibles rests largely on the psychological benefits from owning them. Measuring the value of any intangible dividend is a challenge, but as investments of passion, investors buy things that they like but that they hope will also increase in value over time while in the meantime displaying it in their home or leaving it in the care of a museum.
Being knowledgeable could help informed investors detect market trends or source collectibles at lower prices through a private network. So if you have that fine wine in the cellar, and you go to sell it on the market and realize it’s not really worth what you had hoped, one could instead open it for sharing with guests at a dinner party, thus deriving a tangible benefit. Investing in passion assets means you have to be comfortable with whatever the outcome.
One final potential financial advantage of collectibles worth mentioning is related to their potential tax treatment. In several countries, like the UK, certain collectibles are considered wasting assets and as such are often exempt from wealth or capital gains taxes.
Even with spirited and often contradictory pronouncements about their success, many UHNW investors are increasing their exposure to the exotic world of collectible assets. Accounting for costs calls into question the investment thesis for expecting excess returns for allocating to collectible investments.
In the end, investing in tangible assets favors those with a love and a passion for a particular class of collectible and patient capital to invest. Perhaps it is by pursuing this passion that the category offers strong returns in the form of happiness.