Julian Howard – GAM, From Wealth Briefing

Editor’s note: As is regularly mentioned on these pages [wealthbriefing.com], the hunt for yield and safety in a turbulent global economy has helped drive the market for such “alternatives” as art, fine wine and even classic cars. At Swiss-based investment house GAM, Julian Howard, investment communications director for private client advisory, takes a look at the field and argues that in many cases, the arguments that might lead an investor to seek collectibles in fact should logically lead to the case for good, old fashioned equities instead. As ever, while this publication is pleased to share his views, it does not necessarily endorse all the opinions of the article.

2012 saw a frenzy of buying in the world of alternative and collectible assets. In November that year, more than 350 works by Andy Warhol were sold for more than £10.7 million ($16.9 million) at auction in New York and then a few days later came the most successful sale of post-war and contemporary art in history with Jeff Koons’s Tulip sculpture achieving a staggering £21.2 million.

In property, a 45-bedroom mansion overlooking London’s Hyde Park was recently placed on the market for a record asking price of £300 million. Cars have not been immune from the madness either. A 1936 Mercedes-Benz 540K Special Roadster (one of just 30 built) sold for over £7 million in an auction in California this summer.

What does all this tell us? Pithily, that these assets are probably overpriced now but more interestingly that the desire for wealthy individuals to diversify their portfolios shows no sign of abating.

This should come as no surprise, particularly to those in the investment industry. Interest rates around the developed world are on the floor and government bonds in the US, UK, Japan and Germany are all yielding less than 2 per cent. The higher-yielding corporate bonds will give you maybe 5 per cent but with more risks attached – companies can’t print money after all. As for hedge funds, achieving the “old normal” of cash + 5 per cent is looking increasingly elusive. In equities, medium-term returns have also been poor, with the MSCI World Index in dollars delivering -0.6 per cent annualised for the last five years to end December 2012.

Worse still, a series of PR disasters – some self-inflicted, some unavoidable – have contributed to unprecedented outflows from stocks and shares. Trading scandals, frauds and high-frequency trading make up part of a wider list of reasons why investors have shunned equity markets until very recently.

But on closer inspection alternative assets offer no panacea. Illiquidity, the corollary of exclusivity, looms large. Classic cars, rare art, fine wines and high-value property trade in far lower volumes and overall values than equities. This means that buying and selling is significantly harder than picking up the phone or going online. Supply and demand can sometimes be binary, with total drought in either direction the norm at specific times of the economic cycle.

And the liquidity issue raises another problem in that it breeds a false sense of security that such investments are somehow “more stable” than investment funds or securities. For collectibles and alternatives, the relative lack of trading forums, reliance on infrequent auctions and subjective independent valuations all make it hard to appreciate what they are worth at any one moment. Exchange-traded financial investments are better in this sense; transacted millions of times a day, it is fairly easy to ascertain at any moment what a blue chip stock would attract in the event of a sale.

The intention here is not to polarise wealth management investment into a false choice between financial versus other assets. The watchword for managing wealth must always be diversification. What has happened recently though is an exodus out of equity markets into what can fairly be described as “fully priced” assets both within the investment industry, in other words, bonds, and beyond it (property and certain collectibles).

This is a shame because a sure-fire way to risk carefully accumulated wealth is to follow the noise and buy high only to then sell low in frustration further down the line. Perhaps most surprisingly, many of the themes behind the recent breaking of records across collectibles and alternatives can also be accessed through equities.

New-found Chinese wealth is as much in evidence in the retail luxury goods sector as in the auction rooms of London, New York and Hong Kong. Holding listed luxury goods stocks therefore represents an obvious way to tap into this trend. But there are even smarter plays out there. How about the UAE shopping mall operator benefiting from Chinese visitors coming to the country to buy designer watches and handbags at better prices than they can back home? Such an approach carries with it all the advantages of listed equity investment, i.e. price transparency, good governance and liquidity but with less of the aggravations associated with the alternatives.

As for the future, equities’ recent toxicity amongst investors leaves them very open to a sharp upward correction in the event of even just a partial return to favour. The triggers for this are not hard to imagine; moderate progress on the US “fiscal cliff” or eurozone debt fronts would probably be enough.

But more fundamentally, it’s worth considering what an equity share actually is. Sure, you can’t live in it, drive it, gaze at it or even drink it but it gives you something just as enticing – a share in the future profits of a company. Remember that the publicly-owned corporate entity was responsible for transformative (and highly lucrative) technologies like the railways, airliners, PCs, software operating systems and the iPad.

And it will be publicly-owned corporate entities that bring us the benefits of 3D printing, vertical farming, crowd-funding, cloud computing and gene therapy in the years to come. In this context, assets which can capture the wealth generated by innovation and enterprise warrant a long-term place in any diversified investment portfolio.

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