Collecting sour grapes

During periods of excess optimism and market froth, collectibles often become a hot topic in the “alternative” investment space. These hold a huge attraction, because, let’s face it, it seems more interesting than stocks.

It’s notable and newsworthy when a 1962 Ferrari 250 GTO sells for over $48 million, or a 1945 bottle of Romanée-Conti sells for $558,000. It grabs attention, particularly among those of us who lust after these cars, or would love to taste just a sip of a rare vintage. It was inevitable that someone would package and sell a fund that also invested in these items.

These collectible funds are not often widely marketed, and so it’s hard to say what asset class kicked off this trend. The first I encountered was a fund that invested in vintage French wines.

These funds can proclaim several advantages for the long-term investor.

First of all—scarcity. You know for sure that nobody is going to be able to manufacture another bottle of 1945 Romanée-Conti. The bottles that exist will be damaged or, hopefully, enjoyed with an amazing dinner. And so supply will shrink over time. Scarcity value will only go up.

Then comes the idea that as more and more of the world obtains excess wealth, demand for the finer things will correspondingly increase, further pushing up values.

And significantly, collectibles are marketed as “uncorrelated” assets. You’ll recall from earlier discussions how attractive it is to own an “uncorrelated” asset, but you will also recall that this classification is often bullshit. Yes, collectibles don’t trade daily and therefore don’t show a high correlation to public equities. However, their values will tend to track the overall economy—specifically the wealth of the top 1 percent. The stock of global auction house Sotheby’s, before it was taken private in 2019, was widely followed as a leading economic indicator. When rich people are buying up collectibles at ever-higher prices, times are good. So the idea that the values of these assets are “uncorrelated” with the stock market is more than a bit of a stretch. In fact, given that they are most often luxuries and not necessities, their prices will tend to be more volatile and subject to declines.

Finally, they offer the individual investor a chance to own a diversified portfolio. So rather than owning one painting or one car—along with being responsible for insurance, storage, and upkeep—you can own a small piece of several items, reducing your risk.

If you’ve followed my thinking on prestige investments up to this point, you’re waiting for me to expose the catch to these funds. You might even be way ahead of me in identifying all of the potential issues they carry with them.

High fees? Check.

Illiquidity? Check.

Opacity? Check.

Bullshit historical performance and correlation numbers? Check!

Most of all, there’s a tremendous amount of complexity hiding in what on the surface appears simple. Sure, it’s art (which always goes up in value, right?), vintage wines (of which there is a limited and ever shrinking supply), or whatever other collectible you may be considering. It’s all rather simple, isn’t it?

Except it’s not simple at all. Valuing a stock or a rental building is relatively easy because these assets (generally) produce cash flows, to which you can apply a discount rate in order to determine a value. In the case of art, for example, who judges which painter becomes famous, and which is forgotten by history? Who determines which of those painters’ works are most valuable?

Barron’s writer Jack Hough explains the situation humorously… and also perfectly:

Take Mark Rothko, who died fifty years ago. He is known for wall-size canvases filled only with hazy boxes of color… In 2014, a Rothko with three hazy boxes sold for just over $4 million—or about $1.3 million per box. The thing is, that same year, a two-box Rothko reportedly owned by Microsoft co-founder Paul Allen went for $56 million. The price-to-box ratio seems off to me.

Essentially, you’re back to trusting the skill of an individual manager to choose the right works of art (or the right bottles of wine or the right collectible cars…) and they aren’t necessarily going to be making the right bets.

And I haven’t even talked about the issue of counterfeits, which is a serious problem that becomes worse as technology enhances the ability of criminals to produce very credible knockoffs.

It all comes down to the same issue I have raised many times in the past. If you’re investing in one of these funds, you’re investing in a business—in this case, a business created to invest in collectibles. And you’re relying on the skill of the people managing that business.

Given the high cost, illiquidity, opacity, and potential for any number of things to go wrong, why would you choose to invest in this business rather than one that is more established, has a history of success, and trades on a public market, with all of the transparency and liquidity advantages that go along with it? Oh, and it doesn’t charge you a management fee, either.

If you like wine, then build a wine cellar and enjoy your collection.

If you enjoy art, visit the world’s great museums. Adorn your walls with pieces that are meaningful to you.

Best to keep these assets out of your portfolio.

There is no need to follow the wealthy crowds into exotic asset classes. You might not have interesting investment stories to regale the crowds with at your next cocktail party, but the freedom of a low-cost, fully liquid portfolio should outweigh that.