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Investor 500: Go ahead and drink it

No matter what their purveyors will tell you, 'alternative investments' such as liquor, art and stamps do not belong in a portfolio designed to maximize returns and minimize risk.

drink it

After a Honus Wagner card sold for US$1.3 million at auction, more copies turned up in attics and basements. Bids dropped to US$25,000. Kathy Willens/AP

Anyone who bought and held Nortel shares between 1995 and 2000 is a lot happier than someone unlucky enough to have done exactly the same thing between 2000 and 2005. That’s the dirty little secret about buy-and-hold investing, which only works well if you acquire an asset at a lower price than it can muster when you want, or must, sell.

Nobody, not even billionaire investment gurus like Warren Buffett, can control (not legally, anyway) what an asset will be worth when circumstances dictate that it is time to let it go. That’s why diversification is such an important part of building an investment portfolio. Simply put, reducing your exposure to market ups and downs, across sectors and asset classes, reduces the volatility of your net worth. But there is diversification and then there is diversification, which brings us to the controversial topic of alternative alternative assets.

Thanks to the Great Recession, the investment world is once again flush with folks pushing collector items as investment-grade assets fit for Joe and Jane Average to use in diversification strategies. Anecdotes of spectacular returns abound. Unfortunately, for collectibles, there are also plenty of risks and hidden costs, which is why independent market experts say investors looking to optimize their returns should keep their nest eggs free of collectibles.

That’s despite some compelling evidence to the contrary disseminated by purveyors of investment exotica. Using auction data from 1996 to 2009, Swiss economists Philippe Masset and Jean-Philippe Weisskop recently created a General Wine Index (GWI) and used it to compare the performance of fine wine as an investment to the Russell 3000, which measures the performance of publicly traded American companies. They found the GWI steadily rose while the Russell 3000 declined between 2001 and 2003, after the Internet bubble burst. From 2005 to 2008, the GWI doubled. From there, it dropped 17% as markets tanked. But the Russell 3000 index lost 47% in the same period. “Neither the terrorist attacks in New York, nor the burst of the Internet bubble, nor the boycott of French goods after the Iraq invasion have had much effect on wine prices,” the economists noted in a study published by the American Association of Wine Economists.

“The inclusion of wine in a portfolio,” they concluded, “especially more prestigious wines, increases the portfolio’s returns while reducing its risk, particularly during financial crisis. This is true for all model portfolios both during bull and bear periods.”

Over at William Grant & Sons, the independent family-owned British distillery, spokeswoman Farah Tayabali pours a different brand of the alternative investment idea. “In times of economic hardship and volatile markets,” she says, “it isn’t entirely unusual for people to turn to drink. But these days, when people turn to spirits, it isn’t to forget their sorrows, but to boost their bottom line. With whisky boasting a shelf-life significantly longer than wine, many collectors find it a most profitable investment.”

Tayabali points to the World Whisky Index, established a few years ago in the Netherlands, where a limited-edition, 50-year-old Macallan single malt sold for ?’11,750 at auction last year. In 1983, the same whisky sold for about ?’200.

Meanwhile, at Stanley Gibbons, the U.K.-based collectibles dealer, rare stamps and autographs are billed as “the perfect platform to diversify your wealth,” typically offering “10% market returns per annum.”

According to the company’s marketing material, the Great Britain Rarities Index, a collection of 30 classic stamps recommended as investments by Stanley Gibbons, jumped about 40% while equity markets tanked in 2008. The compound return of this index between December 1998 and late last year was 275%. The best-performing stamp increased 540%. The worst showing over this period was a 131% increase.

What about autographed pieces? Stanley Gibbons says the items in its Fraser’s 100 Index showed a cumulative increase of almost 280% between 1997 and 2008, and an average compound increase of 12.9%.

The numbers used to support these arguments are clearly impressive. But they are also misleading, since investors do not always end up with the best-performing assets on the market in their collections, comparable to items put up for auction. Nor do they typically buy and hold items only during the selective periods used to market these assets to investors. Furthermore, the performance of a collectors’ index based on auction prices does not reflect the actual return of a real investor.

“I suspect that wine’s relatively low asset-price correlation during the financial crisis was entirely a function of the fact that it wasn’t really an asset class in the first place,” Reuters blogger Felix Salmon noted after reading the wine study results posted by Masset and Weisskopf. “If and when it becomes an asset class, then correlations are bound to rise.”

Among other things, Salmon pointed out that the Swiss economists treated wine as a cost-free investment. “In the world of their paper,” he says, “it costs nothing to sell wine, it costs nothing to store and insure wine, and it costs nothing to buy wine, over and above the hammer price at auction. On planet Earth, of course, none of these things is remotely true. So far, I have yet to see a story on wine as an investment which takes into account reasonable estimates for these costs. If and when such a study comes along, I’m pretty sure that wine will suddenly look much less attractive as an asset class.”

This criticism was met with some ridicule. “If wine isn’t a good investment,” one reader responded, “then why do all the big papers write about how good it is?” The answer, of course, is that hyping collectibles provides a good story that people want to believe, especially during tough times. But that doesn’t make them safe investments.

Stanley Gibbons’ website makes a big deal about the lucrative score legendary investor and bond market analyst Bill Gross made a few years ago, when he sold a collection of stamps, which cost him about US$2.5-million, for US$9.1 million. But it fails to mention that Gross, a co-founder of Pacific Investment Management, will not tarnish his reputation by recommending stamps as an investment-grade asset. “Mr. Gross does not do interviews on his personal stamp collection,” says PIMCO spokesperson Mark Porterfield. “It’s a hobby, not an investment.”

Stanley Gibbons also fails to mention that volatility can wipe out the value of collectibles just like any other traditional investment, especially in the John Hancock market. Before Princess Diana died, a Christmas card signed by the royal fetched about US$2,500. After her tragic accident, they sold for more than US$10,000. But in 2001, during the dot-bomb period, sellers would have considered $2,000 to be a good price.

William Grant chairman Peter Gordon certainly doesn’t share his public-relations department’s enthusiasm for booze as an investment. Sit down with him for a whisky tour, and he’ll talk your ear off, going on about his company’s experiences with distribution partners in Canada or how Glenfiddich was the first to introduce the world to single malt. He’ll certainly mention the impressive market value attached to a rare bottle of 1937 Glenfiddich, which is worth more than $20,000. But he won’t advise anyone to buy any of his firm’s products for their portfolio, unless they have purposely put aside some mad money and are looking to seriously roll the dice. In fact, if you sample Scotch with Gordon long enough, he’ll tell you that he thinks investors are probably better off spending the significant time and capital it takes to start a new distillery.

The Ontario Teachers’ Pension Plan spends a lot of time investigating the merits of alternative assets to help protect its multi-billion-dollar holdings from volatility. It has put money into music royalties, but it won’t take a flyer on fine wine, 50-year-old Scotch or rare stamps. It doesn’t even play around with art, another risky market sometimes touted as a way for Joe and Jane Average to diversify. According to spokeswoman Deborah Allan, the markets for these collectibles are simply not large enough to attract major institutional investors.

The lack of big money chasing collectibles is why David Kotok, head of New Jersey-based Cumberland Advisors, advises average punters to follow his lead and stick to drinking fine wine. “Collectibles,” he says, “are okay if you have extra cash and do not need liquidity. But average investors are looking for trouble when venturing into these very specialized areas.”

Wall Street economist Robert Brusca invests in Scotch. But, he says, “it rarely lasts a week or more.” Like Kotok, he doesn’t see collectibles as a viable part of diversification strategies, at least not for average folks, because they require a lot of knowledge and are not liquid investments. He notes that you can’t pick up a financial paper and check out the price of your rare stamp. And if you call a dealer for a quote, you may not get a good price if the dealer knows you need cash fast.

Simply put, when you read a story about alternative assets that sounds too good, you should probably ask why that is the case.

Better yet, look at history. In 2007, The Wall Street Journal SmartMoney site ran a story that noted collecting rare cars was a good idea because the super-rich spend millions on them. “A 1965 or 1966 Mustang is a great starter car,” an auction expert advised readers, noting the market price at that time for a good-quality car was between US$25,000 or $30,000. There are plenty of these Mustangs listed today for under US$15,000.

In the late ’80s, another WSJ story quoted Richard Young, president of Newport, R.I.-based Young Research & Publishing, who insisted baseball cards were a more attractive investment than gold, which was trading for under US$500 an ounce at the time. “Every good set of new cards, not some, but every set, will go up in price in the future,” he said. “They are the ultimate nostalgia investment.”

Back then, the card for former Pittsburgh Pirates shortstop Honus Wagner, one of the first inductees into the Baseball Hall of Fame, was considered the hottest property on the market. One Wagner card eventually sold for US$1.3 million because the player had them pulled from distribution in the early 1900s. Baseball cards used to be issued with tobacco, and according to legend, Wagner didn’t want to encourage smoking. Whatever the case, collectors thought the Wagner card was extremely rare. But media hype and soaring prices sent fans into attics across North America, where numerous Wagners were found and dusted off for auction. Bids dropped to US$25,000. Then declining interest, not to mention Pokemon and Yu-Gi-Oh cards, cut the market off at its knee pads, forcing Sotheby’s and Christie’s to halt regular big-money auctions.

Investors can read all about the baseball card bubble in Dave Jamieson’s Mint Condition: How Baseball Cards Became an American Obsession. In the meantime, they should listen to Jacqueline Nelson, an associate editor at this magazine. Like other believers, she once collected cheap, stuffed Beanie Babies as an investment, and picked up a limited edition Lady Di memorial bear before prices jumped over $10. According to her market guide, which was Nelson’s bible at the time, the investment was supposed to jump at least 60-fold by 2008. Today, it is worth under three bucks. “I’m still waiting for my Lady Di Beanie Baby to be worth something,” she says. “And that sucks.”

Collectibles are nice hobbies. But as U.S. financial planner Ross Levin said the last time they were being hyped, don’t bet your retirement on the future value of an ” Adam-12 lunch box.”