Wealth Manager

The question invariably leaps to mind after reading a recent study
by Robert Brown, chief investment officer in the Encino, Calif. office
of Genworth Financial. After crunching data on 62 years of price
history through 2003, Brown concluded that rare coins are “a highly
attractive complementary asset category that even with a small allocation
provides good diversification for a well-diversified portfolio...,”
according to his study, published in August 2005 on the Journal
of Financial Planning’s Web site (“Rare Coins: A Distinct and Attractive
Asset Class").

Recently, Brown updated the research, adding
two additional years of performance data through
last November. The long-term performance record
still looks impressive. His proprietary index of rare
coins posted a mean 9.8 percent return for the 64
years through the end of November 2005. That
compares with 12.2 percent for the S&P 500 and 5.6
percent for long-term Treasury bonds, the study reports, although
on a risk-adjusted basis, coins ranked higher than stocks as well as
bonds.

His yet-to-be-published follow-up paper takes a step beyond its
predecessor’s mandate by identifying the main variables driving
rare coin prices, the author explained in a recent interview with
Wealth Manager. Three factors stand out, says Brown, a CFA who
earned a Ph.D. in finance from Northwestern. The leading driver is
economic growth, followed by long-term Treasury bond returns,
with silver prices in third place, he says.

Brown—a private coin collector himself—advises that the collectibles
represent “a critical component of my wealth management
solution.” As CIO of Genworth, however, he cannot recommend
rare coins officially. The reason? The firm isn’t prepared to make
collectibles recommendations—at least not yet.

But for advisors inclined to put a slice of client portfolios into
the likes of an 1808 large U.S. cent (among Brown’s prized pieces),
Genworth’s CIO offers ammunition to the case for using rare coins
in asset allocation plans.

Q: Why did you revise your earlier study?

A: Two reasons: First, I updated the data, which adds two more years of numbers, with performance through November 2005. I also focused on causality from the standpoint of drawing conclusions about what drives rare coin prices, and under what conditions rare
coin investments do well. The results are somewhat instructive [in
that] there appears to be an explanatory connection between rare
coin prices and three variables: How fast the economy’s growing,
performance of long-dated bonds, and the inflation-adjusted behavior
of precious metals, measured by silver.

Q: How did you determine that those three variables are so
influential?

A: Simple statistical tests. Initially, I looked at about 25 explanatory
variables. Most were asset categories, along with some economic
variables like population and gross domestic product per capita.

The three that came out on top were the statistically strongest
variables. And in my mind, they fit with intuition.

Rising GDP, for example, makes sense. The faster the economy’s
growing, the more wealth there is for investing in collectibles. And
vice versa. If a recession or depression hits, you’d expect a pullback
in the wealth available for collectibles.

As for long Treasuries, if interest rates are relatively high, and
bonds are doing well and posting solid returns, people are going
to start viewing bonds as a practical alternative for their wealth. In
turn, that pulls money away from collectibles.

The third component driving rare coin prices is precious metals,
which I suppose is a proxy for people looking for physical assets instead
of securities. And silver usually dominated gold in this respect.

Q: Why is that?

A: Perhaps gold reflects other phenomena, like fear factors, which
is a confusing element [for analyzing rare coin prices] and so I
didn’t use it.

Q: So silver is a superior predicator of rare coin prices over gold?

A: Yes, clearly so.

Q: What about equities? How do they fit in, if it all, to your
model?

A: I was expecting that equities would appear with an inverse relationship
to rare coin prices. That is, when equities did well, they’d
take assets away from coins. But the data didn’t support that assumption. During an isolated time period, sure, there’s a seeming relationship. But it’s not there over the 64-year period I studied.

Q: What’s the worst-case environment for rare coin investing?

A: A period similar to 1980-1993, for example, when interest rates
kept falling. Those years generated larger and larger profits for
bonds because fixed-income securities prices appreciated as inflation
kept surprising on the downside.

Q: Does that mean that rising inflation helps rare coin prices?

A: I looked at whether inflationary surprises on the upside do a
better job of predicting, forecasting or directing rare coin prices.
The answer is no. Bond returns did a much stronger job of directing
rare coin prices.

Q: What’s the bottom line for rare coin investing?

A: First, you want a robust economy—rapidly growing, ideally. You
also want rising interest rates because it undermines the opportunity
cost because you’re probably losing money on bonds. And
you’d like to see investors focus on physical goods. When you have
those three things conspiring, historically that’s when rare coin
prices have done their best.

Q: Are you surprised by your latest findings?

A: Before I saw any of the results, I was fairly neutral on the whole
thing. Before running the statistics, I expected that inflation, inflation
expectations, or inflationary surprises would be one of the
leading variables, but they weren’t. There were other surprises, too. I was surprised by how high the returns were for rare coins versus other asset categories. Over the 64 years through last November, rare coins had a considerably higher return per unit of
risk compared to about two-thirds of the other asset categories I
studied.

Q: In your study, one-year Treasuries post the best return/risk
ratio in your ranking of 18 investment categories. Your reaction?

A: Short-term Treasuries did so well because their risk level is so
low. Those Treasury returns are higher than their standard deviation,
and that’s why they look so good. That doesn’t mean you
should build a portfolio only with one-year Treasuries, because if
you do, you’ll end up giving up much on the return side.

That said, rare coins not only have a very favorable return per
unit of risk; they also have a fairly high absolute historic return:
9.8 percent a year over time on a geometric basis. I was surprised at
how high rare coins returns were.

Q: How did you build your index of rare coins?

A: I used prices published in the so-called ‘Blue’ and ‘Red’ books
[The Official Bluebook Handbook of United States Coins and A Guide Book
of United States Coins, respectively] as far back as they went, which is
to 1941. For each year, I took a sample of 650 coins. The universe was
equally weighted by coins, and it was redefined each year based on
what was in the next book. I chose the highest grades of coins
available in the books for each year. To oversimplify, my index is
made up of the 650 non-gold coins that represent the highest quality
coins across the various denominations. I excluded gold because
I didn’t want any confusing element from gold pricing.

Q: Does the fact that your rare coin index performs impressively
over time suggest that investors should own rare coins?

A: Yes, but with some qualifications. The first is that someone
should ask the question, ‘Why on earth are rare coins generating
these kinds of returns and with such consistency?’ I think it comes
down to the fact that we’ve got robust economic growth, and as long
as that continues—a reasonable presumption—then you can check
that box. The other issue is that there’s a serious question regarding
acquisition and storage costs, along with the information required
to build a coin portfolio. Acquisition costs are significant.

Q: Define acquisition costs.

A: How much you have to pay for a coin over its fair-market wholesale
value. And that mark-up can be fairly high. There’s nothing
wrong with that, but it says something about your holding period;
it has to be considerably long in order to justify the acquisition
cost. In addition, there’s the information hurdle. One either has to
have the knowledge base or work with people who have the knowledge
base to go after the attractive opportunities.

Q: Then does all this suggest that investors should steer clear of
rare coins?

A: Sometimes I hear the comment that the acquisition costs are
so high, and the information so difficult to acquire, that it makes
rare coin investing unpalatable. But I think the two are connected.
One of the reasons that the acquisitions costs are relatively high is
because if you’re doing this right, part of what you’re acquiring is
the knowledge base. That means that you find the dealers with the
knowledge, the connections, the ethics, the pricing, and so they’re
the agents working on your behalf. Yes, there’s a search process involved,
but I’m not sure it’s any different than building a portfolio
of rental properties. You’d have to go out and get expertise and pay
fairly for it. I’m not sure collectibles are any different.

Q: What’s your recommendation on holding periods for rare coins?

A: There are two issues. One is, what point in the cycle are we in?
The other, what’s the time horizon? Rare coins had a rough time
from 1980 to about 2003. That made for a marvelous entry point.
Since then, there’s been a shift of attention toward physicals, as
expressed by the rising prices of precious metals and real estate.
But even if you buy at the right spot in the cycle, you probably still
want to wait a dozen years or more before selling because of acquisition
and disposal costs.

Q: As we speak, in the middle of 2006, is it still a good time to buy
coins?

A: Yes, absolutely. If one asks, ‘Is the cycle with us or not?’ It certainly
is neutral, and probably still favorable.

Q: How long have you been collecting coins and how did you get
interested?

A: I’ve been collecting for about 25 years. Collectibles has always been an interesting area. And in my position as chief investment officer, I’m always asking the question,
‘What are the asset categories, how do they behave, and what are
the alternatives?’ [Coins] started purely as a hobby for me, and
now has progressed to being a critical component of my wealthmanagement
solution. I see it as part of the retirement game.

Q: How big a share are coins in your overall investment portfolio?

A: About 9 percent.

Q: What’s one of your more prized coins?

A: It’s probably an 1808 large U.S. cent, in very nice condition.

Q: As chief investment officer of a financial planning firm, are
you recommending that clients put money into coins?

A: No, because we haven’t structured ourselves to make that a
product offering. Our business model is working with advisors, as
opposed to the end clients. We provide turn-key, client-ready wrap
accounts, investment solutions to our advisor clients, including
broad asset allocations using mutual funds, ETFs, and individual
stock selection through outside managers.