Autumn 2012

INSIDE VIEW: Are you motivated by pleasure or profit?

ModelAspirations for buying passion investments can cloud one’s investment decisions, says Peter Brooks of Barclays.

Passion investments or treasure assets have been gaining popularity as substitute investments, especially in the current economic climate. Passion, however, can diminish reason in our financial decisions.

Many traditional assets have not performed well and volatility has increased, making it a stressful experience for investors.

If bonds, equities and real estate fail to provide good returns for their respective risks, investors ask themselves whether investments in collectibles can provide an alternative.

Collectibles include jewellery, art and classic cars. They are not without risk.

Auction houses across the globe make headlines with new records being set – whether it is the growing popularity of Chinese contemporary art or the mind-boggling sale price of Edvard Munch’s The Scream.

The potential danger comes from our tendency as humans to use these small yet high profile sales as representative of the entire class of collectibles.

Collectibles are often illiquid and highly selective markets. Any price signal must be taken with caution if you are investing for financial reasons.

A recent Barclays report, entitled Profit or Pleasure? Exploring the Motivations behind Treasure Trends, shows that 90% of high-net-worth individuals in India agree that it is difficult to find things that will remain secure in terms of financial value.

The figures for China (70%), Singapore (59%), and Hong Kong (57%) suggest that there are many nervous investors whose primary focus is to protect their wealth.

While that is a clear recognition of recent market conditions, many Asian nations are still in the early stage of their wealth aspiration cycles. With some looking for reliable stores of value and individuals becoming wealthier, there is scope for a significant shift to collectibles.

The emotional and social attachment to treasured collectibles means that investors are extremely likely to make sub-optimal decisions about when to buy, sell or how much to pay.

Although many of us of think investing in collectibles is for purely financial reasons, the attribution bias often means that our opinions change.

If our investment is successful, we are likely to commend ourselves for being a smart investor with a great eye for spotting the right gems.

But if our collectibles fall in value, we convince ourselves that we were buying something we liked rather than an investment for value appreciation.

The attribution bias is about giving ourselves the justification we want to hear instead of an objective assessment of our decisions. It can be dangerous since we fail to recognise our misguided choices and fail to learn from them.

Are Asian investors likely to fall into the psychological traps of investing in collectibles? The answer is not clear.

The most common motivations given for treasure investments were to share with others and personal enjoyment. This clearly demonstrates that there is a large emotional tie to collectibles that can lead to biases.

The endowment effect measures the difference between the price we are willing to pay for an item and the price we would then accept to sell it.

Economic theory suggests that the highest price we will pay and the lowest price at which we would sell, are equivalent.

Typically, we all want a higher price to sell an item we just acquired – it is as if we need to be compensated for the loss of not getting enjoyment from it.

For someone who is investing for purely financial reasons the difference should be small – since it is unlikely anyone other than a trader would flip a collectible immediately, the difference can be described as a minimum return expectation that would compensate for the emotional loss of not having the collectible.

For collectibles, this is a critical measure of how badly calibrated we may be.

We found that Asian investors had a smaller endowment effect than global counterparts but still much higher than could be considered reasonable.

We found that Indian investors required the lowest average increase of 36% in the value of their collectibles to consider selling them within a year of purchase.

Singaporeans required a 52% increase, those in Hong Kong 55% and mainland Chinese 64%. These are difficult to achieve in any asset and show the value we assign to our non-financial motivations.

When we asked what the motivations were for owning treasured collectibles, we were told that the top motivations are: to show them off to others; pure investment; and to gain the respect of others.

A large proportion of respondents agree that it is their duty to share valuable possessions for the good of society – and also agreed that they would lend some of their possessions to museums or exhibitions for societal good.

While altruistic, to show collections off and to earn respect are indicative of status and lifestyle motivations – precisely the types of motivations that can induce greater emotional connections with assets and accentuate any psychological biases.

Investing in collectibles can be fraught with danger. Illiquid markets can send you erroneous price signals; we can deceive ourselves via the attribution bias and grow emotionally more attached to items as they confer lifestyle and status enhancements.

Collectibles are a store of value, but the risk-reward trade-off is less observable and often less important compared to the enjoyment from buying the right item, which comes mostly from its aesthetic appeal.

Peter Brooks is a behavioural finance specialist at Barclays

©2012 funds global

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