The EconomistFebruary 24th 2018 Finance and economics 612
B
ONDS, shares and Treasury bills are all
very well, but in the end they are just
pieces of paper. They are not assets you
can hang on the wall or display to admir-
ing neighbours. Many rich people like to
invest their wealth in more tangible form;
property, of course, but also collectibles
such as art, fine wine and classic cars.
Is that wise? Elroy Dimson, Paul Marsh
and Mike Staunton of the London Busi-
ness School (LBS) have run the numbers
for their annual analysis of the financial
markets in the Credit Suisse global invest-
ment-returns yearbook. Some of these as-
sets have done rather better than others
(see chart). Fine wine delivered the best
returns; surprising to cynics who might
assume that, in the long run, the value of
wine vanishes as it turns into vinegar.
Really old wine often has historical reso-
nance. A bottle of Chateau Lafite Roth-
schild from 1787 was sold for $156,450 in
1985 because it was thought to belong to
Thomas Jefferson.
Estimating the returns from these as-
sets, after costs, istricky. Indices covering
art ormusical instruments are much less
comprehensive than those covering
shares. There may be an upward bias in-
herent in collectible returns, as successful
works are more likely to survive.
Transaction costs, if valuables are sold
at auction, may be 30-40%. But these are
the kind of assets that tend to be held for
many decades (and passed between gen-
erations) so the annual cost burden may
compare reasonably with equities, which
are traded much more frequently.
Then there are the costs of insurance. If
people want to keep a Stradivarius at
home, theft is a big risk; robbery with vio-
lins is a serious crime, after all.
But tax is a potential advantage for col-
lectibles. Financial assets come with in-
come streams that have historically beentaxed at marginal rates of 40% or more. Art
and stamps generate no income stream
and incur tax only when they are sold. The
academics calculate that, after tax, collect-
ibles have generated higher returns than
equities for British investors since 1900.
On top of that, investors may get an
“emotional return” out of owning these as-
sets, which may be as much a hobby as an
investment. Anyone who has met an own-
er of a classic car will know they can dis-
play spaniel-like devotion to their vehicles.
What about the largest asset that many
people hold—their home? The total value
of global property was around $228trn at
the end of 2016, against $170trn for equities
and bonds. The academics are highly scep-
tical of a recent paper* that claimed hous-
ing has enjoyed equity-like real returns
with less risk. Theythink this is an example
of Twyman’s law: “If a statistic looks inter-
esting or unusual, it is probably wrong.”
In terms of rental income, they say the
study made “heroic” estimates ofthe effect
of agency fees and voids (periods when
the property is empty). When it comes tothe level of house prices over the decades,
the LBSacademics say that a number of
downward adjustments need to be made.
The most significant is that the quality of
the housing stock has improved. Over the
past century homeowners have spent a
great deal of money on extensions, cen-
tral heating, indoor plumbing and so on.
When all the adjustmentshave been
made, the real return on housing has
probably been less than on equities but
more than on government bonds.
Perhaps the most surprising finding in
the yearbook is that gold and silver have
both done worse than cash and bonds
over the past 118 years, despite high infla-
tion during much of that period. In fact,
gold performed best in real terms (al-
though only as well as Treasury bills)
when there was sharp deflation. Gold did
substantially outperform T-bills during
high-inflation periods, but this hedge
comes at a long-term cost.
In the long run, equities have been the
best-performing asset class, with a global
real return of 5.2% since 1900. But that
does not mean investors should assume
those high returns will continue.
The prospective return on shares is
equal to the real return on riskless assets
(such as T-bills) plus a risk premium. That
premium is now around 3.5% a year, the
LBStrio think. As the real return on T-bills
is currently negative, that suggests a real
return on equities of around 3%. The LBS
academics made a similar forecast about
low returns in 2000. The real return on
shares since then has been 2.9%. If the pro-
fessors are right again, more investors will
be tempted by Bordeaux and Bugattis.All in the best possible taste
Diamonds not foreverSource: “Credit Suisse global investment returns
yearbook 2018” by E. Dimson, P. Marsh, M. Staunton,
London Business SchoolAverage annual real returns, 1900-2017, %
10123456 +–
Global equities
Wine
Stamps
Violins
Global bonds
Art
Platinum
Gold
Silver
DiamondsnilButtonwood
Investing in the finer things of life..............................................................
*The Rate of Return on Everything 1 87 0-2015 by Òscar
Jordà, Katharina Knoll, Dmitry Kuvshinov, Moritz
Schularick and Alan Taylor
Economist.com/blogs/buttonwoodpostpone such feral competition, at least
until Russia and Saudi Arabia can wean
their economies off oil.
But the perils of such a strategy may
outweigh its benefits. If it works, and prices
rise sharply above $70 a barrel, itwill flush
out yet more production in America and
other big producing countries such as Bra-
zil, as happened before 2014. That would
reinforce what the IEA calls the risk of his-
tory repeating itself. So OPECand non-
OPECproducers would need strategies to
keep prices from rising too high as well as
falling too low. Bassam Fattouh of the Ox-
ford Institute for Energy Studies, a think-tank, says that might require joint invest-
ment approaches, which are “extremely
difficult, if not impossible”.
If prices tumble, countries would need
to cut production further. In OPEC’s history
Saudi Arabia has reluctantly played the
role of swing producer, regulating its out-
put to keep the market in balance. A suc-
cessful long-term arrangement would
need Russia and OPECmembers to share
more of the burden, which they have most-
ly been loth to do.
A further concern is Saudi Arabia’s
OPECstrategy once Aramco sells shares to
investors. Mohamed Ramady, the authorof a new e-book, “Saudi Aramco 2030”,
says that relations between partially priva-
tised oil companies and their governments
become strained when the interests of gov-
ernments clash with those of share-
holders. “Privatising Aramco could then
become a double-edged sword for the
kingdom,” he writes.
At present, Saudi Arabia’s rulers appear
to believe that the risks are worth taking.
They may have more to fear from a restive
population at home than shale producers
abroad. But they underestimate the risk of
shale, and overestimate their own ability
to manage the market, at their peril. 7