March 31, 2021
One sure sign inflation is back in the spotlight is the flurry of new pitches for investing in “real” assets ranging from vacation homes to vintage cars.
It is easy to see why so many people find this strategy compelling. Bonds and stocks are boring things. Beach houses, vintage cars, fine wine, diamonds and art are not.
Real assets can look particularly attractive right now, when payoffs from more typical investments are low and many people are fretting about a possible return of inflationary pressures. If you can earn as much buying a vintage Bugatti as you can investing in a Government of Canada bond – which is to say, next to nothing – why not go for the classic sports car?
Maybe because things are rarely as simple as they look. When you receive an invitation to invest in real assets – and you will – read it with skeptical eyes.
Consider a new Bank of America report that lists five reasons to diversify into real assets. Those reasons, put forward by chief investment strategist Michael Hartnett, are: 1) real assets are unusually cheap in comparison with financial assets; 2) real assets act as an inflation hedge; 3) real assets diversify portfolios; 4) real assets are “underowned”; and 5) real assets are scarce and more valuable in the coming digital-currency era.
All these rationales sound somewhat credible. To his credit, Mr. Hartnett has compiled a library of fascinating charts, especially when it comes to his first point. By his reckoning, the long-run price of real assets (real estate, commodities and collectibles) is at its lowest point relative to financial assets (stocks and bonds) since 1925.
But is his argument quite as strong as it appears? Another way to say the same thing is that financial assets have performed better than real assets for nearly a century. That is the major reason why real assets now look so cheap compared with stocks and bonds.
Maybe this long-run trend will now reverse. Investors, though, should be aware of the risks that go along with betting against a long-term trend. You may be lucky enough to catch a turning point. Chances are you won’t.
Investors who are tempted by Mr. Hartnett’s logic should also consult a 2018 analysis by Elroy Dimson and fellow researchers in the annual Global Investment Returns Yearbook published by Credit Suisse. Prof. Dimson, of the London Business School, and his associates looked at the long-run performance of “passion investments” such as rare books, classic cars, jewellery, violins, art, wine and stamps.
Their conclusion? Over 118 years, “the average collectible rose 30-fold in terms of purchasing power.” That sounds encouraging. But hold on: “This is equivalent to an annualized price appreciation of 2.9 per cent.”
How attractive that is depends on your baseline for comparison. The returns on passion investments fell far short of the return on a global stock portfolio (5.2 per cent a year) over the same period. They also varied. Art, for instance, went up in value by only 1.9 per cent a year while wine enjoyed annualized price gains of 3.7 per cent.
Real estate suffers from some of the same issues, according to Prof. Dimson’s team. Its after-inflation returns in a range of developed countries from 1900 to 2017 look surprisingly mundane. Moreover, the real returns varied hugely among countries, ranging from a low of 0.3 per cent a year in the United States to 2.2 per cent in Australia. The returns within each country also spanned a wide spectrum, with prices in some cities booming while others withered.
This raises an important caveat: While historical returns on some real estate and some classes of collectibles may look appealing, most investors don’t hold a diversified portfolio of those assets. Rather than betting on real estate, vintage cars, art or wine in general, they typically invest in one house, one car, a few artists, or a limited selection of the world’s great wineries.
There is no guarantee the return on those focused collections will match the return on the overall asset class. Right now, for instance, it is difficult to argue that Canadian real estate looks cheap.
On top of that, most indexes that track the selling prices of passion investments don’t include holding costs or transaction costs. Those range from insurance and storage fees for collectibles such as cars and wine to selling commissions on art.
Many high-end art galleries, for instance, charge a 40-per-cent commission. Buy a painting for $10,000 and you have a work of art that is now worth $6,000 to a new buyer. In time, its value may grow past its purchase price, but it has to grow by a lot to offset transaction fees.
Perhaps the strongest part of Mr. Hartnett’s thesis is his contention that the yields on real estate investment trusts (REITs) and some infrastructure (think pipelines) now look attractive compared with those on stocks in general. By all means, that is a discrepancy worth exploring. But don’t see it as a reason to load up on real assets in general.
This Globe and Mail article was legally licensed by AdvisorStream.