Most investors in today's asset markets consider liquidity to be an unmitigated boon. Liquidity is the ability to easily buy - and more importantly sell - an asset close to its market value quickly. Most stocks are very liquid, with bid-ask spreads of just a few pennies or less.
Even bonds, a traditionally less liquid asset class, have become considerably more liquid via the widespread adoption of fixed-income focused exchange traded funds (ETFs) and mutual funds. But there are some unexpected drawbacks to investing in these traditional liquid assets.
Highly liquid asset classes have become a haven for rampant speculation in recent years. Co-located, high frequency trading computer algorithms deftly walk equity markets up and down constantly, scalping just a few pennies from every trade you (or your mutual funds) make. Day-traders, swing-traders and hedge funds complete the speculative encirclement, ensuring that it is nearly impossible for the average person to buy or sell most conventional asset classes without paying the frenzied gamblers their pound of flesh.
Art and antiques, however, are very different financial instruments. They are - in stark contrast to stocks and bonds - highly illiquid. Normally we would consider this to be a wholly negative attribute. And it can be under some circumstances. For example, if you must sell your art collection quickly it will usually only happen at a significant discount to the current market value. But, paradoxically, illiquidity also brings with it some unforeseen and very valuable benefits.
First, illiquidity ensures that speculation - and by extension mispricing - of art and antiques is kept to a bare minimum. The prices you see in the market are therefore real prices, having been established by connoisseurs, dealers, hobbyists and the rare, canny investor. In other words, prices are set by people with a true interest in and deep knowledge of the asset class. Computer algorithms and day traders are blessedly absent from the art market.
Illiquidity also tends to smooth out major market value swings - something wholly foreign to excessively volatile equity markets. This attribute transmutes art and antiques into almost the perfect asset class. If you purchase a piece of fine art at a fair price, the chance of it crashing 30%, 40% or 50% in value over a short period of time is nil. Instead, art tends to compound at a slow and steady rate year after year - oftentimes for decades on end.
While we don't know what that rate will be, it will almost certainly be steady and, more importantly, consistently positive. Art behaves a little like a bank CD in this sense. It will reliably accumulate value until you decide it is time to sell. Art is an investment that lets you sleep soundly at night.
Perhaps the greatest advantage illiquidity provides the astute investor is in keeping investment competition to a minimum. How many armchair analysts - to say nothing of professional analysts - pour over the financials of companies like GE, Apple, Ford or ExxonMobil every day? Do you really expect to uncover a hidden insight into one of these companies that everyone else has missed?
Art and antiques, however, provide the amateur analyst with abundant opportunities to fully explore a diverse and largely untouched asset class. Hidden gems abound, waiting only for a perceptive connoisseur - or investor - to come and scoop them up.
Liquidity, in isolation, is a positive attribute for an investment to possess. But it is important to understand that it also carries with it a whole host of other, less desirable characteristics. Art and antiques, on the other hand, revel in their illiquidity and all the hidden benefits that entails. The savvy investor will not only dedicate some of his portfolio to traditional stocks and bonds, but also pursue the tremendous return potential embedded in the less liquid art and antiques market. Illiquidity is truly the unlikely ally of the art collector.
