Alternatives? Forget About Hedge Funds, Think Farmland, Instead

Yesterday, I tweeted a graph of the Liv-ex Fine Wine index, generally considered as the benchmark index for red wine investments (specifically, Bordeaux red wine). It showed that wine prices have come down by roughly a third since early 2011. Some interesting reactions on my tweet stated that this has something to do with the Chinese, known for their insatiable taste for Bordeaux wines. But, as the Chinese government tries to facilitate an orderly transition of the economy, the opportunities for some of these speculative investments could have waned. Unfortunately, as plausible as this may sound, I can’t tell if this is really the case. The graph did raise another question, however. How did other ‘promising’ alternative asset classes like hedge funds or gold perform in recent years.

Exotic alternatives

To get a grip on this, I calculated the average annual return over the last ten years on a number of, arbitrary chosen, alternative asset classes. Three years is just a little too short to get a meaningful indication. The results are shown in the graph below. The graph reveals an interesting picture. Where ‘traditional’ alternative asset classes like commodities and hedge funds have performed very poorly over the last ten years, more exotic ones have thrived. Timberland and Farmland did exceptionally well, beating even equities over this period. And what about wine? The last few years may have been though on wine investments, but over a longer-term horizon wine does stand out positively with an average annual return of just under 10%. Finally, gold is the only familiar name that also is among the top performers.

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R1

Now, there are of course many more exotic examples of alternative investments, but chances are that they are pretty hard to invest in. Art is an example of this. I wanted to add art to the list, but how many people can actually by a Monet or Van Gogh? Also, the valuation method is quite different for paintings than for gold or equities. The leading Mei Moses Art indices only track ‘repeat sales’. So, if a painting was bought in 1990 and sold again in 2014, only then would it enter the art index. Therefore, a lot of valuable paintings, that are preserved and not sold, will not enter the index. But, just to give some clue of the art returns, JP Morgan analysis revealed that art realized an average annual return of 7.5% in the ten-year period up to 2012.

What about risk?

So, the more exotic alternative assets have fared pretty well, while more common alternatives have lagged. But what about risk? The graph below shows the average annual risk for the selected assets over the last ten years. The picture is a bit different this time. Wine and gold have not only realized high returns, they also have experienced relative high risk. The same holds for commodities with an average standard deviation of over 20%. As expected an investment in US government bonds is accompanied by a relative low level of risk. The alternatives timberland and farmland are not that risky as well. One caveat here could be the pricing of timberland and farmland. Just like real estate these asset classes have shown signs of sticky prices, which underestimate the risk.

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R2

The final graph shows the realized Sharpe ratios. Again, one should be aware that the Sharpe ratios for timberland and farmland could be exaggerated due to an underestimation of risk. But even then the difference with the more common alternative asset classes, commodities and hedge funds, is massive. The latter two would not have brought much excitement in your portfolio over the last ten years. At the same time investing in farmland and timberland would have been a far better bet.

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R3

Perhaps it is wise to start thinking about the alternative investments of the future, already!

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