Many of us are looking for the perfect investment – something that produces good, steady returns with modest risk while not being too complicated. Unfortunately, stocks are not that investment, at least not right now. The major equity indices currently sport obscenely high valuations while the underlying companies are cesspools of financial engineering and undisclosed risk. And the dividends you receive from holding shares are paltry – provided you’re lucky enough to own shares in a company that pays any dividend at all.
Bonds, in contrast, are at least a little bit better. They disburse a (usually modest) cash interest payment semi-annually. Unlike dividends, bond payments are almost always contractual obligations, a fact that grants the average investor a certain degree of protection as well as peace of mind. Bonds also reside higher in the capital structure of a company, guaranteeing payment of principal before preferred and common stock shareholders in the event of bankruptcy.
However, bonds aren’t perfect either. Interest rates on most bonds these days are unimpressively low, to say the least. And many corporations have over-levered their balance sheets by issuing excessive debt to finance stock buy-backs and dividends in an attempt to “boost shareholder return”. This leaves them vulnerable to future financial crises where their excessive debt loads may precipitate their insolvency. This financial fragility is a serious concern for today’s vigilant corporate bond investors.
Art and antiques are a compelling alternative to these traditional financial assets. In fact, they combine some of the best elements of both stocks and bonds into a single, largely undiscovered assets class. At its core, investment grade art behaves very similarly to a high quality zero coupon bond. A zero coupon bond is a financial instrument that pays no interest before maturity, but is sold at a discount to its par (redemption) value. Later, when the zero coupon bond matures, it is redeemed at its full par value. The difference between the (discounted) purchase price and the full redemption value is the bond’s return.
Investment grade art and antiques mimic the more desirable attributes of a zero coupon bond. They are purchased for a certain (discounted) price today, and then are later sold (redeemed) in the future for a (usually) higher price. The difference between the purchase price and the sale price of a work of art is profit, just like with a zero coupon bond. However, unlike zero coupon bonds, art has strong future return potential. For example, right now (August 2016) a zero coupon U.S. Treasury bond with 5 years to maturity yields 1.15%, while a 10 year yields 1.56% and a 25 year zero coupon bond yields 2.31%. These aren’t the kinds of returns that will allow you to retire one day to a warm beach surrounded by palm trees. And although I will not (and cannot) make any specific promises in regard to the future performance of art and antiques as an asset class, I will say that it won’t be very difficult for art to beat 2.5% returns over the next couple of decades.
Another potential downside of zero coupon bonds absent from art is that they have specific redemption dates that may not mesh with your evolving financial goals. This means you may be forced to reinvest proceeds at a lower interest rate from a bond that matured earlier than you wanted, or, conversely, forced to sell into the wildly unpredictable financial markets if you need cash before maturity. Art, on the other hand, can be “cashed in” by selling it whenever you like, although I don’t advise doing so before you’ve achieved a minimum holding period of 7 to 10 years. But this longer investment horizon is offset by the fact that the art market isn’t subject to the serial boom-bust cycles that are commonplace in today’s stock and bond markets. The art market – largely devoid of speculators and hedge funds – tends to appreciate more steadily and predictably than paper assets.
Another great feature of art is that it has no counterparty risk, a major consideration when buying zero coupon bonds. Because a zero coupon instrument pays no cash flows before maturity, it is very exposed to the prospect of the issuing authority declaring bankruptcy before maturity. This is why investors usually only purchase zero coupon bonds issued by the most credit-worthy institutions. Of course, the drawback of buying a bond with a good credit rating is that it will have a very low interest rate. Art and antiques, however, cannot go bankrupt. This allows a prudent art investor to wait out the occasional poor market while, in effect, receiving substantial principle protection. In addition to this enhanced asset security, art and antiques have far higher return prospects than traditional assets classes. Investing in art and antiques is like having your zero coupon bond cake and eating it too.
Traditional financial assets – stocks and bonds – are an important part of a diversified investment portfolio. They have their place. But art and antiques are overlooked investment gems that shouldn’t be excluded from a savvy connoisseur’s asset allocation model. Art combines some of the best attributes of stocks (high returns) and zero coupon bonds (minimal reinvestment risk) and then surpasses them both by eliminating the possibility of default. There may not be any such thing as a perfect investment, but art and antiques come as close as anything I’ve ever seen.
