Some of the arguments made that supposedly justify buying "alternatives", such as art or other collectibles, can in fact lead to a strong case for equities, argues GAM.

Editor’s note: As is
regularly mentioned on these pages, 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-listed 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.