Investing Knowledge

This week my mini-series on alternative investments, complete with corny headlines, continues with an assessment of rare coins as an asset class. I will be examining whether they make sense as a diversifier within conventional portfolios (those containing a mix of equities and bonds), and if so within which economic scenarios do they shine. As usual with this series we're not interested in the pleasure or satisfaction of owning a coin collection; we're interested in only the financial aspects.

Features of coins

Rare coins have a number of features which make them potentially attractive to a conventional investor.

1. Like stamps, there is a well established collector base which is growing all the time. We are not talking about gold coins, priced purely on their bullion content, but coins whose value depends on quality, scarcity and provenance.

2. There is limited or diminishing supply due to neglect, abuse, theft and accumulation by "permanent" collections (museums and foundations). Economics 101 teaches us that in this scenario if demand is stable, or increasing, prices will rise.

3. There is a transparent market. Coin (Milan: GCN.MI - news) collecting is a global phenomenon with a large number of buyers and sellers trading through auction houses and dealers. Price manipulation is virtually unheard of and is set by the fundamental operation of supply and demand. There are well documented prices for almost any type of coin.

4. Affordability levels mean there is a large demand base. While there are coins that change hands for millions of dollars there are many collectible items with prices as low as £100. One of the main drawbacks of other alternative investments is that initial investment levels are high. Not the case for coins.

The case for coins

I have unearthed two pretty good sources of information on rare coin price prrformance.

First, and most authoritative, is research conducted by Robert A Brown; "Rare Coins: A Distinct and Attractive Asset Class". Published in 2005, Mr Brown took a look at 62 years of coin prices and constructed an annual price change history. The evidence was quite conclusive; adding coins improves returns and lowers risk, mainly because coins outperform bonds in periods of high inflation.

However his research also points out the folly of arbitrary long-term return claims. While from 1941 to 2003 coins returned 10.5% a year, for the 18 years to 1999 coins returned a rather unimpressive 0% annual increase. Ah, is this why the coin peddling websites don't quote the full story? This performance fact should not be a surprise; coins are as cyclical as any other investment; the important thing is that they appear to have a slightly different cycle to equities, and therefore provide a degree of protection. They rose 14% a year in the 18 years to 1981, when the S&P 500 (news) was relatively flat.

My second source is Neil and Silvano DI Genova's book, "The Investors' Guide to US Coins". Again they produced an exhaustive and rigorous portfolio price history and showed five year annual price performance against a variety of assets. I provide an extract in the table below which compares coins with the MSCI World Equity Index.

So coins tend to thrive when either inflation soars or equities drop. That's quite useful.

How to gain exposure

As usual with collectibles there are two main routes to gain exposure. The do it yourself route (buy your own coins) or the managed fund route. If you are new to coins the only way to effectively pursue the DIY option is to develop a relationship with a trusted dealer like A H Baldwin or Spink. Alternatively, for about £5,000, a custom portfolio can be constructed. 

Indices in 2008 indicate flat or slightly increased price levels, thereby providing some protection during the recent turmoil. Only some protection, because if you bought at the retail price and within the year tried to sell back to a dealer you would probably face a 20% loss because of the dealer's profit margin.

The only fund in the UK to invest solely in coins is the AIM-quoted fund Avarae (LSE: AVR). Launched in 2006, it quickly went to a premium to net asset value (NAV). How times change! It dropped over 50% in 2008 and now trades at 7p with a NAV (in November) of 11p and a one year return of -22%. Well call me old fashioned but that doesn't scream low volatility -- especially when coin prices have been flat or rising over the last year.

Funnily enough, Avarae gets advice form the only UK-quoted coin dealer, Noble Investments (LSE: NBL). The high demand for coins means business is booming. Its sales in the half year to February 2009 increased 38%, earnings rose 24% and the dividend (covered about four times by earnings) was increased by 18%. 

I'm tempted, but am disappointed that once again we have found an asset which in theory should protect us from equity falls but in practice doesn't come up to scratch. In other words, the investment vehicle exposes us to the disadvantages of equity risk with none of the advantages of the underlying asset we are interested in.