MSc. Thesis Classic Cars: A New Alternative Investment Vehicle? Date: 21-09-2017 Student: Dries Laurs ANR: 747398 Supervisor: prof. dr. Luc Renneboog Second reader: dr. C.A.R. Schneider Abstract This thesis investigates the price determinants and investment performance of classic cars. We investigate a sample of over 29,000 classic car auction sales conducted between January 1998 and July 2017. A hedonic regression methodology is used in order to construct several constant-quality classic car price indices. Based on these indices, we estimate that classic cars appreciated in value by around 3.37 % and 5.63 % annually, respectively in real and in nominal terms. Compared to other asset classes, return performance has been strong. Over the period covered, only gold outperformed classic cars. When we incorporate dividend yields into equity returns, we find that equities as an asset class slightly outperform classic cars. On a risk-adjusted basis, the performance is similar, with both asset classes showing Sharpe ratios of around 0.30. Comparing the risk-adjusted performance of classic cars to other asset classes, we find that gold and government bonds outperformed classic cars, as measured by their larger Sharpe ratios. We find that classic car investments partially hedge against inflation. Accounting for non-synchroneity in the returns between classic cars and equity markets, we find a much stronger relationship between the two than initially expected. This shows that wealth effects are important drivers of classic car returns. While this limits the diversification potential of classic cars, the systematic risk of classic car investments remains low. Contents 1. Introduction ..................................................................................................................................... 1 2. Literature background .................................................................................................................... 3 2.1. Alternative investments ........................................................................................................... 3 2.1.1. Background on ‘alternatives’ ................................................................................................ 3 2.1.2. Collectibles and the market for classic cars ........................................................................... 3 2.1.4. Recent developments in the collectibles market .................................................................... 5 2.2. Reasons for investing in collectibles ....................................................................................... 6 2.2.1. Return outperformance ........................................................................................................ 6 2.2.2. Diversification ...................................................................................................................... 7 2.2.3. Hedging benefits ................................................................................................................... 8 2.2.4. Nonpecuniary rewards ......................................................................................................... 9 2.3. Costs of investing in collectibles ........................................................................................... 10 2.3.1. Transaction costs ................................................................................................................ 10 2.3.2. Illiquidity............................................................................................................................ 10 2.3.3. Opacity and asymmetric information ................................................................................. 11 2.3.4. Other costs ......................................................................................................................... 11 2.4. The returns on collectibles investments ............................................................................... 11 2.4.1. Methodologies for measuring returns on collectibles investments ...................................... 11 2.4.2. Returns on art investments ................................................................................................ 13 2.4.3. Returns on investments in other collectibles ...................................................................... 14 2.5. The risks of investing in collectibles ..................................................................................... 18 2.5.1. Stylistic risk........................................................................................................................ 18 2.5.2. Changes in income .............................................................................................................. 18 2.5.3. Price risk............................................................................................................................. 19 2.5.4. Speculative bubbles ............................................................................................................. 20 2.5.5. Forgeries, frauds and theft .................................................................................................. 20 2.6. Collectible cars as an investments class ............................................................................... 21 2.6.1. Classic car price indices ...................................................................................................... 21 2.6.2. Value drivers of a classic car ............................................................................................... 22 2.6.3. Investment performance of classic cars ............................................................................... 24 3. Data and Methodology ................................................................................................................. 26 3.1 Data ........................................................................................................................................... 26 3.1.1. Auction records of classic car transactions ......................................................................... 26 3.1.2. Other data .......................................................................................................................... 27 3.1.3. Descriptive statistics .......................................................................................................... 27 3.2 Methodology ............................................................................................................................ 30 3.2.1. Hedonic regression model ................................................................................................... 30 3.2.2. Hedonic characteristics ....................................................................................................... 31 4. Empirical results ............................................................................................................................ 38 4.1.1. Hedonic regression results .................................................................................................. 38 4.1.2. General classic car price index ............................................................................................ 40 4.1.3. Sub-indices ......................................................................................................................... 42 4.1.4. Classic cars and other assets ............................................................................................... 47 4.1.5. Collectible car investments and inflation ............................................................................ 50 4.1.6. Collectible car investments and equity markets .................................................................. 53 5. Robustness test .............................................................................................................................. 54 5.1.1. The issue of parameter instability ....................................................................................... 54 6. Conclusion and discussion ........................................................................................................... 56 References........................................................................................................................................... 58 Appendices ....................................................................................... Error! Bookmark not defined. [Page intentionally left blank] 1. Introduction The relatively low-yield environment that has characterized financial markets in the past years has left investors seeking for greater returns. In this search for yield, investors’ focus has shifted away from traditional asset classes such as stocks, bonds, and cash. Instead, capital invested in alternative investments has been increasing steadily. In recent years, one alternative asset class that has been gaining in popularity among investors is that of ‘collectibles’, also referred to as ‘emotional assets’. Emotional assets could potentially provide greater returns than traditional asset classes. But there are other benefits that ‘investments of passion’ (Dimson and Spaenjers, 2014a) might offer. First, it is often argued that these type of investments are relatively uncorrelated to more traditional financial investments. From a diversification perspective, this makes them attractive candidates to add to a portfolio. Next, holding these assets could also provide hedging benefits against market