There is more in the world than just stocks and bonds.
The popularity of “alternatives” in the last decade or so was an exploration of seeking potentially less efficient markets with either new sources of return or different risk profiles. Private equity and credit, VC, and other mainstream alternatives are now commonplace and often similar to traditional investing, but these alternatives have a unique distant cousin.
Esoteric alternatives, physical alternative investments in small or strange markets beyond the reach of traditional public vehicles, are a whole frontier of largely overlooked investment. These are often markets that people have often heard about casually, like collectibles, but are rarely seen in a portfolio breakdown:
fine art | wine | Pokemon cards | Lego sets | classic cars | comic books | coins | watches | sneakers | sports cards | toys | Magic the Gathering cards
The underlying markets for esoteric alternatives are often functional with substantial trading and norms, despite being largely not financialized. Secondary markets in fine art and Pokemon, for example, have become large yet operate quite differently than traditional finance. Fine art sales are often done at auction houses like Sotheby’s or Christie’s for one-of-one pieces. Pokemon has developed a unique grading apparatus to verify quality, something that may sound somewhat familiar in corners of traditional investing, while sales are largely done either online or at large in-person card shows.
So, why bother with these markets?
For one, these markets can be inefficient. Alpha, which for this purpose can be thought of as outsized returns from asset mispricing, was more abundant in public markets when information was more scarce and there were fewer sophisticated participants looking for it. Decades of arbitrageurs in the stock market made it an increasingly difficult place to find sustained alpha.
Esoteric alternative markets seem to have been mostly left out of the efficient market phenomenon. A matrix of factors [high transaction costs, incomplete standardization, ambiguous or imperfect valuation, sentiment, barriers to entry, and scarce information] can all contribute to these markets containing actionable opportunities for excess returns. The Lego market, for instance, was found to have highly exploitable return anomalies, even amidst offering very attractive absolute returns (Dobrynskaya, 2022). Investors seek out places where they can get an edge; niche physical collectibles markets could be that place.
Esoteric alternatives can also potentially enhance portfolio diversification. Return streams that aren’t dependent on the financial performance of corporations make these assets distinct from traditional stocks and bonds. The benefits of diversification — smoothing returns, protecting against downside, exposure to many distinct opportunities—are primarily gained from owning independent assets.
[A fun example: as odd as it may seem, research indicates that adding Bordeaux to a traditional portfolio could help enhance risk-adjusted returns (Li, 2021).]
Esoteric alternative markets seem interesting, but how do these behave?
The beauty of these niche markets is that their behavior is notably heterogeneous. Some make for attractive long-run investments on the merit of absolute or risk-adjusted returns. Others are more attractive as diversifiers or even hedges. A phenomenon that can be noticed across many of them, however, is the incredible secular bull markets. For example, the art market can be somewhat less attractive than others for long-run absolute returns; however, the 1940s-1990 brought a phenomenal rally in both length and strength that delivered returns a step above the rest of its modern history, which ultimately climaxed in a bubble during the late ’80s (Goetzmann, 1993).
Niche alternatives can also be subject to intense euphoria. Speculators crowding into the market can move up prices. This is especially relevant due to the absence of short selling or sometimes a lack of numismatic value to keep assets grounded. Comic books experienced an operatic boom and bust in the 1990s; Pokemon resellers have caused parabolic moves in the 2020s; and a sudden run-up in art collapsed during the Great Financial Crisis. Even if speculative, this momentum can sometimes last years.
The presence of cyclicality, sentiment-driven rallies, and distinctive eras in these assets could make them intriguing to tactical buyers who rotate between them as markets evolve.
Hedges and orbits: investors often look for ways to buy into a theme or to protect against it. This desire is abundant across asset classes. Esoteric alternatives can offer both the hedges (protection) as well as orbits (tracking/correlation). Collectible coins have historically been uncorrelated to equities, yet could be another way to play the precious metals market (Maslar, 2019). Wine can have knock-on effects from stock market gains, benefiting from the wealth effect as affluent buyers spend more on luxury items (Dimson, 2015). Classic cars tend to do their own thing: cars historically have little relationship to stocks or bonds and managed to put up double-digit returns during the global meltdown in 2008 (Laurs, 2019).
Final thoughts
These assets are highly idiosyncratic. For many esoteric alternatives, they’re interesting because they are different. Sources of return in these assets can be driven by diminishing supply, condition, community preference, or association; depending on the asset, the main drivers could also be something entirely different. This can create a breadth of different challenges in pricing, and therefore a breadth of opportunities for investors.
Prudent investors desire a wide opportunity set so that they can seek those most attractive exposures. There is more to the world than stocks and bonds.
Indices tracking these markets: Celestial Markets