The downside of collectables

Watch out folks. Economists are comparing the artwork of Jeff Koons– currently the subject of a major Whitney retrospective – to the 17^th Century tulip-mania bubble. This sobering comparison is found buried in a 2013 study titled, “The Investment Performance of Art and Other Collectables”, which measured the long-term performance of collectables and was conducted by London Business School’s Elroy Dimson and HEC Paris’ Christophe Spaenjers.

The European academics found that between 1900 and 2012, art, stamps and violins underperformed the equity markets by a wide margin. Stocks posted real returns of 5.2% annually, while art, stamps, wine, diamonds and violins eked out between 2.4% and 2.8%, even though there were periods, such as in the inflationary 1970s, when such passion collectibles shot up in value. The good news for collectors, according to the academics, is that collectables did beat fixed income and gold during the same period.

Dimson’s and Spaenjers’ important point is that markets for collectables are extremely volatile. By their calculation, the price of artwork collapses between 15% and 30% during bleak economic periods. Stamps, for example, have returned somewhere between 0% and 1% for a quarter of the years tracked by the study, and a majority of the stamp returns came from just a few years, with 1976 (77.7%) and 1979 (83.2%) being the most obvious standouts.

The researchers also calculated the real cost of auction house fees and dealer mark-ups. At 25% of the sale’s transaction cost, it would take four years of appreciation on average to recoup the middle men fee. Meanwhile, the cost of storage and insurance, along with fraud and the costs of selling these illiquid investments, raises the economic barrier even higher. Also, remember, the long-term gains on collectibles are taxed in the US at a rate of 28% versus 23.8% for traditional investable assets.

Collectors, the study concludes, are mainly investing in a “psychic return” – pleasure.

Such data notwithstanding, in this era of cheap money, new alternative investment funds buying art, whisky, cars and wine keep cropping up.

A new study by BMO Private Bank showed that more than half the 482 high-net-worth Americans surveyed engage in “hobby investing.”

BMO defines hobby investing as collectible assets which are added to a portfolio for reasons of diversification and “as a way to have and to hold the things investors love most.”

Drilling deeper, the bank found that 62% were engaged in collecting because it “was fun”; 54% said it combined their interests with investing; and 39% said it “provides a sound investment that will grow in value”. It was also something unique to pass down to heirs (40%) and collecting allows one to show off investments to others (38%).

Interestingly, coins topped the list of what wealthy folks are most passionate about collecting, with 38% of those surveyed into numismatics. Oftentimes, wealthy investors start collecting coins because – in addition to being a unique item to hold and admire, rich with history and tales– gold or silver coins are also a proven store of value during hard economic times. Coins were followed by art (36%), then jewellery (31%), and wine (25%) as preferred collectables.

The story has been much the same in Australia, although Eureka Report recently pointed to The great collectables dump currently underway because of a looming Australian Tax Office deadline, which will require all SMSFs to not only fully document the value of their collectables but store them offsite and insure them at market value. Some trustees are choosing their get out of their collectables, and that is seeing assets sold off at fire-sale prices.

In its study, BMO echoed many of the cautionary themes already mentioned in the European study above. Antiques are “very illiquid,” the bank writes, and thus not easily sold, and clients should watch out for fakes in the stamp and coin market. Comic books “may be trendy” but don’t expect the returns to hold up over longer stretches of time.

There is money to be made in wine and art over the long term, the banks says, but such collectables are “not appropriate for those with a short-term investing horizon.” Of course, the aforementioned European study begged to differ; it suggested that collectables, even over longer stretches, are highly susceptible to the transitory interests of collectors and economic freefalls.

In 2012, Barron's warned about the bubble developing in the contemporary art market. It’s not that there is no money to be made in the contemporary art market, or in collectables generally, but, as any good stock picker knows, entry and exit points are important. At this point in the cycle, it might be wise to hold your firepower for the next economic slump. That’s when quality bargains in the art market will, once again, be available to those who have been patient.

This is an edited version of an article first published in Barron’s, and is reproduced with permission.