High net worth individuals are becoming increasingly concerned about the possible failure and collapse of the global political, financial, economic and monetary systems. To hedge against uncertainty like Europe’s ongoing debt woes, Brexit delays and the economic and fiscal concerns in the United States, these individuals are investing in alternative or non-traditional tangible and intangible assets to preserve their nest eggs. Traditional financial investments in capital assets like stocks and bonds become far less attractive during times of volatility. Alternative investments diversify portfolios, provide significantly greater returns relative to traditional investments and often also invoke emotion considering that investors are collecting assets that they are passionate about. The features that make these investments different when compared to traditional forms of investment are their relatively low liquidity, high purchasing costs and difficulty when it comes to valuation.
There is a broad spectrum of tangible assets that investors can choose from, ranging from the more standard assets like gold and silver, diamonds, jewelry, watches, cars and real-estate to more exotic assets and collectibles like artwork, wine, antiques, rare stamps and coins, Egyptian artefacts and even comic books. Whilst tangible investing refers to buying assets that have a physical form, there are also several intangible investment options available to investors. This includes hedge funds, private equity, venture capital, derivatives and more recently cryptocurrency.
Gold Hoarding on the Rise
Governments around the world are continuing to run up unsustainable debt levels. Fitch estimates that the total global IOU stands at US$66 trillion, which amounts to 80% of global GDP. Debt in the United States alone is almost ten times the size of France, Germany, Italy and the United Kingdom combined. The financial asset bubble game might be coming to an end and gold appears to be a more sensible investment. Basel III rules are coming into effect in April and will introduce new capital ratios meant to protect financial institutions from insolvency. Gold's liquidity haircut in Basel III is increasing to 85% from 50%.
Central banks already responded in 2018 by buying gold at the highest levels since President Nixon took the dollar off the gold standard in 1971. The renewed focus on gold investments could create an intriguing transfer of wealth to individuals in emerging economies. Indian women, for example, carry 11% of the world’s total gold stocks on their bodies in the form of jewelry and ornaments which is more than the total gold reserves of the United States, Germany, France, Italy and Russia combined.
The Era of Digital Gold
There have been several unsuccessful attempts to make a digital gold currency to serve as an alternative payment system once the internet went mainstream. Since the establishment of Bitcoin and blockchain technology a new era of gold-backed cryptocurrency is emerging with several countries looking to issue their own gold-based cryptocurrency. The idea is that a token or coin represents a value of gold which gets stored by a trusted custodian and can be traded with other coin holders. One of the major risks of course is that while the blockchain accounts for the coins, accounting for physical stored gold is far more complicated. Bitcoin itself has also been touted to be the cryptocurrency equivalent of ‘digital gold’ after its price reached parity with gold (by ounce) during 2017.
Know the Risks
Apart from the aesthetic pleasure of owning alternative investments, their potential store of value is the overriding positive when investing in some of these assets considering that they are not as easily affected by inflation or the stock market, unlike other assets. This is demonstrated by the fact that the purchasing power of the US dollar has declined by nearly 97% in the 100 years following the creation of the Federal Reserve, whereas the inflation-adjusted value of an ounce of gold has increased by more than 300% during that same time period. Gold, in the form of bars or coins, is virtually indestructible and is the traditional safe haven against economic uncertainty and inflation. The quality of fine wine gets better with age before it passes its prime and like the prices of artworks, rare coins and stamps they generally appreciate in value. In light of these positives, high net worth individuals should consider five risks when entering into or increasing their alternative investments:
Affordability – It is advisable to consider alternative investments once individuals have a well-diversified stock market portfolio. Diversifying into some of these alternative tangible and intangible assets can provide wealth protection but it does not mean that individuals should place their savings at risk by selling all of their stocks in order to load up on them.
Understanding – Individuals should do their due diligence when evaluating collectibles and other non-traditional investments. They will also need to learn about the things that they want to buy before investing. Knowledge and expertise about the artist that creates the artwork or the area where the fine wine is produced, for example, will be required in the hope that the investment will grow in value over time. A cost-benefit analysis could also be beneficial when comparing investment choices between say gold bars and gold jewelry. The former is more pure and retains value when sold whereas the latter is easier to hoard and transport across gold bullion restricted areas.
Purchasing – There needs to be an awareness of current values and where and when to buy, sell or hold. Always purchase gold bars or coins, jewelry and diamonds from an established dealer. Investment-grade wines should be purchased from a reputable wine broker since wine houses do not generally sell directly to the public.
Protection – Alternative assets require care and management when it comes to conservation, display, storage and insurance. High net worth individuals also need to guard against theft when storing their assets, whether they are physical like gold or virtual like crypto assets. Safekeeping of gold can be fairly simple since a substantial amount will fit in a safe deposit box, whereas the storage of private crypto keys requires the investor to be a bit more tech savvy. Whilst digital safe haven equivalents could provide an alternative to physical gold it is unlikely that they will completely replace the tangible asset in the foreseeable future. Certain investors will prefer the higher degree of control when it comes to protecting physical gold whereas other investors won’t want to hold physical gold due to the cost of storage. Apart from protecting against theft, other collectibles like wine and artwork need extra care and may be susceptible to damage. It is worth noting that protection costs like storage fees and insurance could offset the benefits of your alternative investments.
Market – High net worth individuals do not want to lose money and are concerned about the possibility that the market price of specific alternative assets will decline or expected profits won't materialize. Some collectibles, like wine, are not completely detached from stock markets and a significant economic slowdown could potentially hit wine prices due to there being fewer buyers. Gold and silver prices can also be volatile due to the involvement of day traders and speculators. Investors in collectibles, like art, should be aware that changing consumer tastes could also drive prices up or down. Other jewelry items, such as diamonds and gemstones, have different price drivers and are exposed to technology-driven disruptors like synthetic diamonds. In short, the price of some of these alternative assets is dependent on several unstable factors making them speculative investments and some of them cannot be resold quickly for a profit. The onus is on the investor to stay on top of relevant market developments.
High net worth individuals may become more interested in alternative investments if global uncertainty continues in the coming months. In order to manage these investment risks effectively, individuals should be responsible with their investment choices, seek out specialist advice from a portfolio investment perspective and do their due diligence at a niche asset level. In addition, once the assets have been purchased priority should be given to their protection, maintenance and storage, and unique market conditions should be monitored until the eventual sale of the assets.