It is standard practice in investment matters to ‘diversify risk’. Your financial adviser will jovially warn you not to “put all your eggs in one basket”. He will first try to determine your ‘risk appetite’ to then lecture how much money should go into stocks, bonds and cash.
In such standard scenarios, stocks are considered more risky because of their higher price volatility, hence fewer shares and more bonds for those of us who would prefer wealth preservation to wealth creation.
In truth there is not much safety to gain when lending money to a bad company, rather than buying its stock: if the enterprise goes bust, not only will the share capital be wiped out but its bonds too. Distressed banks in Cyprus, Portugal or Italy during the crisis serve as a stark example. But stock prices may collapse and never fully recover, while the capacity to repay debt is still maintained – hence the different ‘baskets’.
The idea that bond and stock prices move in different directions and therefore provide for assuring diversification – a classic assumption still a few decades ago – can be laid to rest in the current monetary environment.
Central banks acting for many years as buyers of everything at all costs have supported both bonds and shares in tandem and pushed asset prices to such dizzying heights that returns have dwindled. The moment this merry game will stop, all asset prices will plummet in harmony.
This makes so-called ‘alternative investments’ look alluring, in respect of both assumed returns and alleged diversification. ‘Alternative’ may mean investment in things which we have hitherto associated with irresponsible spending, like vintage cars, collectibles, wine or art. Funds are launched to allow even small scale investors, starved of yield, to participate. While it is true that many of these consumer items have shown remarkable price rises, I wish to caution.
Luxury markets invariably rise and fall in tandem with financial assets. Once an asset bubble pops, there are far fewer buyers around for fancy toys, jewellery and sumptuous wines, and your shared ownership of that burgundy-red classic Mercedes cabriolet will be worth much less than you and your co-sponsors have hoped for. You may even struggle to find a buyer at all.
Yet the cost to preserve, store and insure your objects of hope will not stop. Instead of cashing in on price rises, alternative investors will be bleeding undiminished running costs.
What is not valued by the market is in most cases not a hidden gem but rejects – pleasing perhaps, endearing, but nevertheless junk
This is not to say that no money can be made from fancy things. A wealthy scrap dealer I had once met used to spend a jolly fortune on his vast collection of super cars, glittering alluringly in the neon light of his purpose-built hangar. Proudly he would tell whoever was listening that every single Ferrari he owned had gained in value over time. He never had to put his shiny ladies up for sale, though, and it is therefore unknown how his ‘investment’ would have fared under duress.
Prominent art collectors have increased the worth of their collection seemingly with ease: Maurice Saatchi in the UK, or the late Peter Ludwig, were held by the art world in such high esteem that completely unknown artists gained immediate market recognition once these collectors took a financial interest. By buying works of unknown artists, these collectors were already creating value, no matter if the art consisted of pickled animals, unmade beds or videos of an eerie landscape on an infinite loop. Such a Midas touch can never be replicated by dim-witted ‘art investors’ like you and me.
Friends of mine have convincingly argued that buying Bordeaux wines on a regular basis and reselling them again every few years has made them enough money to cover their families’ entire consumption. And my dad – who on special occasions would gift to my mother some second-rate jewellery he claimed to have bought at a bargain price from a pawnbroker – was forever refuting marital accusations of extravagance with the spendthrift argument that if we ever fell on hard times we could always sell my mum’s jumble of vintage pieces.
His own mother could have told him otherwise: after the war, with famine threatening, she had to part with her pianoforte in exchange for six eggs and a loaf of bread – and this was long after her last piece of high-class jewellery had been pawned.
Such exotic investments add an additional layer of opacity to the usual unknowns of investment decisions. Whether a work of art, a rare piece of Ming china or a certain Bordeaux vintage are truly worth their money is a question that demands knowledge and expertise, for which blind trust in a fund brochure is no substitute. And like film financing, or putting together money for a West End production, it is also a matter of personal taste, opinion and instinct, which is never the surest way to financial riches.
Passion and conviction will come into play, something not entirely different to the mindset of a gambling addict. There is little upside to assets which are already broadly recognised in the market and therefore well priced. Yet what is not valued by the market is in most cases not a hidden gem but rejects – pleasing perhaps, endearing, but nevertheless junk.
It is also worth remembering that these speciality markets are wildly manipulated. Everything but counterfeiting is permitted, expected and therefore exempt from punishment. Remember the case of the British artist who would brazenly bid in auctions for his own artefacts?
A much better ‘alternative’ in times of dangerously inflated asset prices is to put more cash aside, gradually retreating from full investment. When prices collapse the world will be full again of the most wonderful investment possibilities. And that bottle of Chateau Margaux 1982 will certainly become more affordable. It may be corked, but at least it will be a bargain.
Andreas Weitzer is an independent journalist based in Malta. He reports on the economy, politics and finance. The purpose of his column is to broaden readers’ general financial knowledge. It should not be interpreted as presenting investment advice or advice on the buying and selling of financial products.
Please send in any suggestions for discussion in this column to: editor@timesofmalta.com – Subject: Sunday Times Personal Finance.