Editorial

Alternative Assets are all the rage in the asset management business these days.  Private equity, hedge funds and real estate are all sometimes touted as the alternative assets that will, depending on the sales pitch, either protect your portfolio from the next global financial crisis or boost your returns into the stratosphere.

An alternative asset is simply any investment that is not positively correlated to the two major existing asset classes: stocks and bonds.  Investing a portion of your portfolio in alternative assets should increase your returns while reducing your risk.  That is the theory, anyway.

In reality, most of the assets considered alternative by the mainstream financial industry actually aren’t very alternative at all.  Instead these “false” alternative assets are pushed by large financial firms because the big banks and brokers already understand them well.  In other words, they are conventional assets that have been repackaged to look new and different.

Another reasons giant financial companies like “fake” alternative assets is that there is sufficient liquidity to buy or sell hundreds of millions or even billions of dollars worth of them without overwhelming the markets.  It is a case of investing for philosophical and practical convenience rather than investing for maximum return.

Private equity, for instance, refers to equity placements that are not listed on any public stock exchange.  But at the end of the day, private equity is actually just common stock in companies that cannot access the public capital markets for whatever reason – usually due to the issuing company being too small, too distressed or privately held.  This means their correlation with traditional stock markets is more or less total.  Even worse, private equity is rather illiquid due to being unlisted; buying and selling (especially selling) is difficult.

Hedge funds are a catchall for limited partnership investment vehicles targeted at institutions and high net worth individuals.  Hedge funds can invest in almost anything and pursue a myriad of different investment strategies, both long and short.  However, “investing in almost anything” is really a euphemism for investing in almost any “paper” asset.

Once again this brings us straight back to the public equity and debt markets.  Sure, hedge funds can invest in private equity too, but private equity is just common stock in disguise.  Therefore, hedge fund correlations with the broad market averages are generally very similar, unless your fund likes to go short.  But then again, you can easily short equities in your E*TRADE online brokerage account yourself.  There is no compelling reason to throw management fees at a hedge fund to do it for you.

Real estate perhaps has the best claim in the group to truly being alternative, but even this asset falls short.  When most people mention real estate, what they are really mean is developed real estate (buildings of some sort) that is rented out to tenants.  It doesn’t matter whether the real estate in question is a warehouse, mall or apartment complex; the concept is the same.

But real estate’s Achilles heel is that it is almost universally funded via debt – the ubiquitous mortgage.  So in a financial crisis, when banks aren’t granting mortgages, you can expect the value of real estate purchased with debt – pretty much all real estate – to decline substantially.  Indeed, this is exactly what we saw happen in the Great Recession of 2008 – 2009.  Unsurprisingly, this causes real estate to become very closely correlated to stocks and junk bonds during crisis scenarios.

So what are the real alternatives to these pseudo alternative assets?  The answer is art and antiques, of course.  These little known sleeper hits of the investment universe have little correlation to either stocks or bonds.  And although they may decline in value marginally in a financial panic, they will surely rebound quickly once the worst of the crisis passes.

Art and antiques are as close to an undiluted claim on future global GDP as one can hope for in this world.  But isn’t that all that any prudent investor is really looking for these days – a simple, safe, and tangible investment that will grow predictably for decades to come?

The year was 2003 and I couldn’t believe what I was seeing on eBay. I had just completed a search for Japanese one yen coins. These are large, silver dollar-sized coins that Japan minted from the 1870s until World War I.

I was shocked by the results that were returned. There were dozens of slabbed (3rd party certified) mint-state (mostly MS-63) silver Japanese one yen coins available for a buy-it-now price of only $60.

These were impressive coins in the highest possible condition with implicit authenticity guarantees due to their certification. But only $60 a coin? Really? Why were they so cheap? And why were so many available?

In the end, I never bought any of them, although in retrospect I desperately wish I had. Today, the same coin – certified and in the same condition – would cost you about four times as much – $240 give or take. That translates into a compound annualized return of slightly over 12% before commissions and fees.

So what went wrong? Why didn’t I grab the great deal that was staring me in the face when I had the chance, especially considering I had no doubt that it was a great bargain at the time?

Unfortunately (or maybe fortunately), certified Japanese silver 1 yen coins weren’t the only asset trading cheaply at the time. I was also making frequent purchases of pre World War I European fractional gold coins at the time. In the stock market I was into oil and gas royalty trusts.

My attention was being pulled in many different directions and in the end I didn’t feel I had the time or energy to strike out into yet another area. I also wasn’t making great money at the time and a couple hundred dollars was a lot of money to me. These reasons all amounted to excuses on my part.

In retrospect I could have easily bought a few Japanese one yen coins, simply thrown them into a safe-deposit box and happily ignored them for the next decade or two. I could have earned returns that would have made most stock market participants sick with envy.

I think the primary reason I didn’t acquire any silver Japanese one yen coins was due to a concept I call “opportunity fatigue”. Even when we are presented with great bargains, opportunity fatigue causes us to second-guess ourselves in two ways.

First, how can a quality asset trade so cheaply? This is a variation on the efficient market hypothesis which states that all pertinent information concerning an asset is already embedded in its price. Therefore, if an asset is available cheaply, it must be because it isn’t very good.

Otherwise all other market participants would have already recognized its value and bid it up. Of course, in the real world efficient markets don’t really exist; they are a theoretical construct of academics who don’t understand just how irrational and trend-following investors actually are.

Second, even if you do buy an undervalued antique it is unlikely that prices will begin moving up immediately. Instead you will still see a dozen or more very similar antiques just sitting on the market for the same price. It usually requires several years of an asset wallowing in low-price obscurity before enough buying pressure accumulates to definitively and permanently raise prices.

In the meantime, opportunity fatigue wears us down.  We are left with the nagging feeling that we’ve sunk our hard-earned money into a loser, an illiquid asset that – on a good day – is worth no more than what we paid for it.

It is very important not to succumb to opportunity fatigue. It can be one of the costliest dangers that you will face in the field of alternative investments. One way to mitigate this risk is to systematically make purchases in your chosen asset category on a regular basis – basically dollar-cost averaging. The other way is to keep in mind that by investing in art and antiques – the cutting edge of alternative investments – you will undoubtedly be, temporally speaking, far ahead of more average investors.

In these circumstances it shouldn’t be surprising that the rest of the crowd doesn’t catch on for a few years. In fact, that is the primary advantage of investing in art and antiques. It gives you ample time to accumulate both greater market knowledge and a significant position, in stark contrast to all the momentum chasers that will surely come later.

Perhaps you have heard the saying “possession is 9/10ths of the law”? People are beginning to realize just how true this statement is, particularly in regards to financial assets. For instance, the stock that you own in a corporation represents fractional ownership of the company.

At this point, most people don’t even get a pretty paper stock certificate. Instead your fractional ownership is represented by virtual digits somewhere in a server farm. The corporation’s appointed transfer agent is actually the entity that keeps track of who owns what. So why does all this matter?

It matters because sometimes, even in developed nations, owning an asset theoretically doesn’t always translate into owning it a real, permanent way.

For example, if the company you hold shares in goes bankrupt, the most likely outcome, after a lengthy bankruptcy reorganization, is for your common shares (fractional ownership) to be cancelled. Poof! Gone! Just like that. There is no compensation.

Don’t think it can happen to you? It happened to shareholders in previously illustrious companies such as Kodak, GM, Borders and Lehman Brothers. These were all well-known companies that were at one time leaders in their respective industries. It didn’t matter. All of their outstanding shares were eventually cancelled without restitution. This tragedy will undoubtedly repeat – quite legally – in the future.

Maybe you believe this warning doesn’t apply to you because your retirement account is stuffed full of bonds? Well, bondholders almost always take write-downs on their holdings during corporate bankruptcy proceedings as well. Sometimes unsecured creditors, like junior debenture (bond) holders, take losses of up to and even exceeding 90%! This is the unfortunate fate that RadioShack’s unsecured bond holders encountered in 2016.

But, you protest, I only invest in the safest bonds: government, state and municipal debt. Well, these conservative financial instruments aren’t as safe as they used to be either. Puerto Rico is currently in the process of trying to declare bankruptcy. Its triple tax exempt bonds, a perennial favorite with individual investors, are sure to receive haircuts (losses) in the near future.

Greece too, is struggling again with imminent bankruptcy after writing down its debt just a few years ago. While Puerto Rico and Greece are trailblazers today, many other local and national sovereigns are sure to follow in the tumultuous years to come. And unsuspecting investors are the ones who will suffer the loss.

Even savings accounts are no longer sacrosanct. The concept of “bail-ins” has been floated for banks under extreme duress in some countries. Under these circumstances, depositors would forfeit some percentage of their checking and savings accounts to help recapitalize the banking system.

Think it can’t happen? It already did in Cyprus and looks like a near certainty in Greece as well. Sure, it is the last strategy that politicians embrace when they can’t beg, borrow or steal anymore funding from anywhere else. But the fact remains that when things get rough, it is definitely still an option.

What is a prudent investor to do? Sell all your stocks and bonds? Withdraw your life savings from the bank and horde it under the mattress? I wouldn’t do that.

But I do believe that art and antiques offer a sophisticated, safe alternative to the legalized theft that can occur in financial markets. While the market value of any particular artwork will fluctuate, particularly in times of economic dislocation, the chance of it declining in value to zero is nil. And if you wait until any economic chaos subsides you have a good chance of recovering any theoretical losses. An antique can never be cancelled or restructured in bankruptcy. Art and antiques, unlike stocks and bonds, are forever.