David Stevenson: Far from child’s play

Panic may be what’s driving markets at the moment, but that doesn’t seem to have fazed entrepreneur Luke Heron. In possibly the worst circumstances known to investors, he has pulled off an initial public offering (IPO) of a new fund that invests in the most alternative investment idea I’ve ever encountered: children’s illustrations.

Heron is one of a growing number of finance professionals trying to make collectables more transparent as an investment class. His company – Storyboard Assets Plc, traded on the PLUS market, market capitalisation £1.2m, launch price 205p – is focusing on collecting the wonderful illustrations of artists such as EH Shepard, Beatrix Potter, Cliff Wright and Quentin Blake. They are drawn from classic books including AA Milne’s Now We Are Six, Richard Adams’ Watership Down, and JK Rowling’s Harry Potter series.

It’s a brave investment idea but not because of the underlying market. In fact, despite being a relatively new collectable class, children’s illustrations have been shooting up in value as more private investors try to reconnect with their childhoods through these illustrators’ works. My own children are obsessed with Roald Dahl – my little boy loves The Twits – and I would pay lots of money to own the accompanying illustrations by Blake.

No, the real reason it’s a brave idea is because
collectables are far from being proven as holdings in a listed fund. The omens aren’t good.

Stamp dealer Stanley Gibbons, for example, has seen its share price collapse in recent weeks as investors run from any investment likely to be hit by a withdrawal of liquidity. Since August of 2007, Stanley Gibbons’ shares have consistently under-performed the market, even while its stamp indices have remained steady.

Avarae Global Coins, managed by Noble Investments, is another example. It manages a collection of investment-grade rare coins. Back in August, it released decent results, showing a move into profitability and a 13 per cent net asset value uplift to 10.9p. How did the market react? It marked down the shares to their current 6.25p – a level at which I think they rate good value.

It isn’t hard to see why the markets are wary of alternatives. Investors know that more illiquid markets will take longer to fall but, when they do, they’ll fall faster than liquid markets, as distressed sellers bail out.

There’s already evidence that this is happening in wine. I’d personally give contemporary art weeks rather than months before prices topple, too.

This vulnerability to severe market disruption underlines another key concern: the vulnerability to “multiple standard deviation” events. In other words, extreme once-in-a-lifetime falls. Collectables’ prices can move very quickly and in the wrong direction, despite an army of passionate
collectors supposedly “sustaining” the market price.

Still, just because an asset class is vulnerable to periods of extreme volatility doesn’t mean that it will be a bad long-term investment. We don’t see headlines saying “Abandon equities
for ever”.

So I think investors need to start treating these alternative assets as they would any other: by analysing the numbers. And that’s precisely what has been happening in the last few months, courtesy of a group of academics from Holland, helped by former money manager Bernard Duffy, who is now head of a putative fund of funds called Emotional Assets Management and Research.

In a paper entitled Emotional Assets, economists Campbell, Koedijk and De Roon analysed 30 years of data for 14 collectable markets – ranging from modern art to books, wine and rare maps – and came up with fascinating conclusions.

First, returns do vary but, on average, many have been very satisfactory: wine’s average annual return over the 30 years has been 11 per cent, followed by art at 9 per cent and violins at 8.4 per cent. Poorer performance, however, is evident in coins up 2.9 per cent, clocks, watches and diamonds up 4 per cent, and stamps up 6.4 per cent (see my online diary for the full list).

Second, certain collectable prices tend to be heavily correlated. Diamonds, coins, books, maps and stamps seem to fall into this
category.

Third, and most importantly, you need to buy a portfolio of alternative assets, rather than a few coins or children’ illustrations. Or, as the economists put it: “We also see that the broad portfolio of a variety of emotional assets provides a significant contribution to the mean-variance portfolio, with a significant increase in the Sharpe ratio.”

This is behind Bernard Duffy’s big idea – he’s aiming to launch a fund next year that will invest in 14 different sub-funds across these markets.

But fourth, there’s still more work to be done before these alternative assets really make it into the mainstream. The economists say: “We would advise only a small allocation . . . given the risk of the unknown, with greater risk looming in these types of markets, then we would take a more conservative approach.”

We just don’t know how these assets will react to severe market disruption and deflation. So, until we know the answer, I’d write them off as investments. Then again, if anyone’s got a Twits illustration going cheap…
adventurous@ft.com