The Relevance Of Non-Productive Assets To Wealth Management

The bases of wealth management have long been established, and rest on a bedrock of financial and real estate assets.??Stocks, bonds, property. Growth, income, stability.??Spurred by innovation, cross-pollination of ideas and markets spanning the globe, a new class of holdings has become a legitimate investment: the “non-productive assets”.??Gold had the near monopoly of this segment, which has now substantially expanded to watches, crypto-currencies or sneakers.??Mere collectible trophies or speculative and investable???This begs the question: “How to evaluate non-productive assets?”

Non-Productive Assets: Where Is The Value?

Assessing the value of productive assets is an exercise supported by a powerful toolbox of methodologies, variations on the themes of discounted cash flows, risk premium and terminal values.???The “products” of such assets, from bushels of grain to dividends or rental income, give their owner the comfort that the asset can keep giving in perpetuity without exhausting itself.??A validation of the resulting values is often provided by regulated markets.

Non-productive assets don’t produce revenue or internal value accretion. Their price will be mostly driven by how desirable they will be in the future,??A luxury watch, a valuable painting, an ounce of gold or a crypto-coin will not produce anything intrinsically. Neither will an unexpected member of this list: a AAA-rated EUR government bond now yielding 0%.

The majority will agree that ignoring Warren Buffet’s views on the value of such non-productive assets is done at one’s own peril.??Yet there are transactions out there validating a relentless valuation increase for some of these.??

As an adjuvant for rationalizing some of these sub-asset classes prices, speculative nature and potential, it is helpful to norm the parameters that may drive these factors.??At best, it will help make good investment decisions, and at worst, it will minimize the remorse of having invested or not.?

Valuation Parameters for Non-Productive Assets

Determining an absolute valuation may be too ambitious but creating a nexus of vectors contextualizing key utility characteristics is a constructive exercise.??For those looking for an academic and fundamental approach to this, I humbly refer to Adam Smith who broaches the concepts of?value in use?and?value in exchange.??He explains the difference:

“What are the rules which men naturally observe in exchanging them [goods] for money or for one another, I shall now proceed to examine. These rules determine what may be called the relative or exchangeable value of goods. The word VALUE, it is to be observed, has two different meanings, and sometimes expresses the utility of some particular object, and sometimes the power of purchasing other goods which the possession of that object conveys. The one may be called "value in use;" the other, "value in exchange." The things which have the greatest value in use have frequently little or no value in exchange; on the contrary, those which have the greatest value in exchange have frequently little or no value in use. Nothing is more useful than water: but it will purchase scarcely anything; scarcely anything can be had in exchange for it. A diamond, on the contrary, has scarcely any use-value; but a very great quantity of other goods may frequently be had in exchange for it”?[1]

To analyze contemporary phenomena, I would suggest eight vectors:

1.?????Cost of production

This is certainly the easiest vector to define. The cost of production of an asset is very often available through industry reports, studies or research.???The cost of production of an asset should be considered as a guide for the value of such asset.??It is obvious that barring some industry-specific reason, the assets are going to be produced as long as they can be sold for price higher than its production cost[2].

The cost of mining a single Bitcoin is approximately $35,000[3], mostly caused by the electricity bill required to power the computers through their hashing process.??Different miners may have a different cost of electricity hence there is no universal “cost”.??The same thing would apply to gold, where the average cost of mining is below $900 per ounce.[4]?The cost of production of luxury watches or grand cru wines is more obscure, yet relevant. Further down the line, the relevance of this metric breaks down: the cost for an artist to produce a renowned painting was a canvas, a few brushes and some colorful paint.

2.?????Supply & Substitutes

Endless supply is negative, finite supply is positive subject to fungibility (see Vector 4 below).??The existence of substitutes would somewhat lessen the value of your asset.??A rare and unique painting hardly has any substitutes, but 2,000 acres of Scottish Highlands can easily be confused for another 2,000 acres of land further north.??On the balance of things though, in the words of Mark Twain, land is the perfect illustration of finite supply: “Buy land, they are not making it anymore”

3.?????Market Transparency & Recognition

A valuable work of Aboriginal primitive art will be a joy to behold, however once monetization time comes and you are in Spain, you may find yourself having a hard time unearthing the next custodian ready to part with an amount of cash matching your expectations.??As another example, 10,000 cognoscenti are ready to pay for a Maximilian Busser watch, but 1 billion people will have a good sense of what an ounce of gold should feel like in the palm of their hand.??Larger audiences will bring more transparency and inertia to price, smaller ones allow you to pick a bargain or never find (or afford) the object of your dreams.

4.?????Fungibility

“Tout ce qui est rare est cher”?(All that is rare is expensive) goes the French saying.??Buying an original and unique (i.e. non-fungible) painting is a double-edged sword.??On one hand, a unique piece is rare but on the other, it does not have comparables.??You will not have the support of substantially similar sales to benchmark the price achievable (if you sell) or reasonable to expect (if you buy).??Conversely, a Patek Philippe 5167R is… a Patek Philippe 5167R: but for the wear and tear, two watches would be perfectly fungible.??Coupled with a calibrated (pun intended) supply of a few thousand units, these provide a liquid and transparent market.?

5.?????Alternative uses

Alternative uses for some assets may provide parallel value vindication. Gold as a store of value (in bars) can be melted into jewels, jewels can be melted to provide coating for conductors in microchips or dental crowns.??

For those “hedonists of last resort”, wine is often touted as a great investment, which, if all failed, can always be enjoyed for its olfactive and inebriating properties.

Interestingly, we have seen barren and un-arable land shoot-up in value as their curse, being in a remote and wind-swept area, became a blessing with the advent of windfarms, turning them from un-productive to productive.

A counter-intuitive point as we linger on the issue of alternative uses lies with some collector items.??Watches fetch a high price only if they are “unworn”, with “boxes and papers” – Designate these as an investment and you can’t wear them, so unless you have a Superman vision to look through your own safe deposit box door, they can’t even be used to tell the time!

Don’t dismiss Non-Fungible Tokens, or more esoteric crypto coins as mere non-productive emanations of algorithms for bored millennials.??They may have currency in a “verse”.??We must be ready for a world where a patient’s cancer will be cured in the real world, but advice or treatment rights will be negotiated in virtual worlds with their own virtual currencies.

6.?????Cost of holding?

Non-productive assets are often not merely unproductive.??They are in general inherently attracting recurring negative cash returns.???The list is long and will ring pre-emptive bells: storage costs for your vintage car, insurance for jewelry, or annual maintenance for mechanical items.??Go a little bit further and you will find safe deposit box rental fees, or other freeport storage charges.??Worse, in some countries, wealth taxes create an annual baseline cost to holding art or land, even when unproductive.

7.?????Transaction costs

Unproductive assets do also carry, like other assets, transaction costs.??The friction costs derived from selling at auction are nothing but daunting, adding a buyer’s premium to a seller’s commission.??Online site will charge an access fee.??Check Bitcoin transaction fees. Real estate will have transfer taxes added to notary and legal fees, title search expenses and the like.??These are often tied to the value of the asset rather than fixed costs, so no economies of scale here.

8.?????Flight & Emergency value

The news flows are carrying the sad reminder that despite mankind’s best efforts through people and institutions, war is a daily reality for too many nations, too many ethnicities, too many families.??This provides for a grim introduction to what is in my view a crucial virtue of some non-productive assets: their “Flight and Emergency value”.??What would you take with you that would buy your family that ferry ride to the other side of the river or that seat on the last flight away from advancing armies?

“But can’t you make it just a little more? Please?”

“Sorry, but diamonds […].??Everybody sells diamonds”

????????????Casablanca, Warner Bros. Pictures, 1942

These sub-vectors are worth keeping in mind:

·??????Physical safety

Jewels are easy to transport, are not sensitive to climatic conditions. Gold or diamonds are inert hence perfect.??Work of arts are fragile. Bitcoins are vulnerable in hot wallets if you can’t get access to internet. On a cold key, they could be zapped out of existence by an EMP (“electro-magnetic pulse”) or a poorly calibrated security screening machine.??

·??????Portability

Do you think that Conrad Schumann would have made it over the barbed wire fleeing East Germany with a Jackson Pollock on his back???Surely not.??

Conrad Schumann, photographed escaping East Germany

??????????Peiter Leibing, 1961

Gold is quite heavy – USD 1mm worth of gold is approximately 15kg, while a 20 carat (4 grams) diamond could pack the same value.?

·??????Fraction

With a USD50,000 Rolex watch in your pocket as your only valuable possession, you are transported in a foreign country and merely need a set of clothes and a bus ticket back home[5], for a grand sum of USD 500.??At the village store, the owner is keen to help but how are you going to pay him? Can you give the watch to him and ask for USD49,500 change? It is more likely that you will part with your watch and head back home with your bus ticket and a very expensive ill-fitting suit.

A cynical, albeit similar point was made in Rolex Magazine[6]?– In Flight and Emergency, “fractionnability” matters. If you keep gold for these purposes, going for 1oz coins rather than 12kg bars is a wise advice, even if coins are marginally more expensive on a per gram basis.?

·??????Traceability and anonymity

Either an advantage if you misled them or an inconvenience.??Crypto currencies accounts have also been, indirectly subject to sanctions[7], and void the concept that blockchain based, non-fiat currencies put you outside of the purview of belligerent states.

·??????Counterfeiting

To my knowledge, blockchain-supported assets (from fancy crypto currencies to more sedate Government bonds in dematerialized form) are immensely hard to counterfeit.??However, a number of luxury items or works of art are exposed to this malediction.??Buyer beware…?

From Theory to Theoretical …

We will all have our independent views on how each asset scores and the relative importance of each vector.??A balanced, weight neutral representation is possible with a score of 10 denoting the most desirable characteristic, 1 the least.??Presented on spider charts, these lead to closed surfaces whose “surface” represents the?holistic quality?of the asset: the larger the surface, the more balanced the asset value.

…From Theoretical to Practical..

Laying the above assets along empirical and intuitive risk return axes highlights a consistent relation between “surface” and speculative nature.

… and Practical to Individual

The ratings presented above are not universal, but as you move to the upper right quadrant, rather individual.??“Flight and emergency” value for the resident of a politically unstable country will dwarf relative “transaction costs” or "desirability" for an individual with median income.??“Supply and substitutes”, “Transparency and desirability” will make the Nike Air Force 1 worth every penny of their USD15,500 tag price for the US-based Fintech millionaire collector.

Non-Productive assets will have relevance in your overall estate to the extent they are curated to fulfil a specific role: hedge against FOMO, store of value for an apocalyptic scenario or simply a de-correlated asset, as I will debate in my next article. A word of caution though - putting a value on wines collected by passion is dangerous if you can't afford to drink it, and irrelevant if you can!

Each individual investor must analyse the utility of these assets according to his or her own criteria and situation.??On the road to success, there is no substitute to analysis.

REFERENCES:

[1]?Adam Smith,?"Of the Origin and Use of Money", in?An Inquiry into the Nature and Causes of the Wealth of Nations?(1776)

[2]?I leave aside the distinction between fixed and variable cost of production and their respective impact on the decision to produce or not.

[3]?https://fortune.com/2021/10/26/bitcoin-electricity-consumption-carbon-footprin/amp/

[4]?https://www.forbes.com/sites/greatspeculations/2021/03/30/gold-miners-recorded-record-high-margins-last-year/amp/

[5]?Think of Michael Douglas in the movie “The Game” (1997)

[6]?https://www.rolexmagazine.com/2017/12/cash-on-your-wrist-rolex-as-currency.html#/page/1

[7]?https://www.bloomberg.com/news/articles/2022-03-07/coinbase-blocks-25-000-crypto-wallets-linked-to-russian-users