Albert Babayev<br />Frontier Investment Report: Vintage Watches<br />Executive Summary<br />The purpose of this report is to discuss Vintage Watches as an alternative investment and assess the viability of the product as an investment “frontier.” Frontier markets provide investors with opportunities to yield higher returns in comparison to advanced and clustered markets. As investors continue to seek out new opportunities for their longer-term portfolios, vintage watches provide unique advantages as an alternative investment. The product, which derives value from such elements as scarcity, complications, and condition, has also done extremely well over the long-term and given its low correlation to other products, is a sound investment tool to spice up a portfolio of diverse products.<br />Vintage Watch Fundamentals<br />The Vintage Watch market, or rare watches from circa 1970 or older periods, resembles other alternative investments, such as rare coins, fine art, rare wines, jewelry, and precious stones, in that these are safe tangible haven assets in volatile markets. The rare watches are commonly exchanged at more popular auction houses dedicated to the collectibles market. These include Sotheby’s, Christie’s, Antiquorum, and Bonhams. Investors refer to the vintage watch exchange as a “gray market” of dealer-to-dealer and dealer-to-consumer networks. <br />The most profitable vintage watches include Patek Philippe, known to investors as the most profitable vintage class among watches, Rolex, Vacheron Constantin, Audemars Piguet, A. Lange & Sohne, Breguet, Longines, Cartier, Heuer, and International Watch Company (IWC). Paul Maudsley of Bonhams considers Rolex the world’s most collected watch brand. Exhibit 1 shows some of the recent sales at the Sotheby’s November auction.<br />Exhibit 1: Recent Vintage Watches sold at Sotheby’s<br />Vintage Watch NameYear Additional DetailsPricePatek Philippe Ref. 1463R195118K Pink Gold, Chronograph, Tachometer$182,500Patek Philippe Ref. 2499J196818K Yellow Gold, Perpetual Calendar, Moon-Phases$308,500Rolex Ref. 62621970Cosmograph, Daytona Paul Newman$102,865Rolex Ref. 62631966Oyster Cosmograph, Daytona Paul Newman$250,516Vacheron Constantin Ref. 42611945Flat 18K Pink Gold, Minute Repeating$191,456<br />Why Invest in Vintage Watches<br />As with art, experts suggest that investing in the vintage watch market is suitable if the investor has a longer-term horizon, looking to protect value over a certain period of time, and finds sentimental and aesthetic appeal in the watch investments.<br /><ul><li>Investors looking to exploit inefficient markets and avoid crowded trades would especially appreciate the vintage watch market as many arbitrage opportunities exist (there are very few vintage watch specialists around the world).
The illiquid nature of the market could yield higher longer-term returns, while liquidity among scarce watches can always be found within popular auction houses, albeit the high transaction costs.
Black Swans are not a high risk within the market since the watches are relatively illiquid (less risk of liquidity event which would cause significant price discounts) and have maintained stable returns for a long period of time (Exhibit 6). High demand will also help values from dropping.
Additionally, as Exhibit 3 shows, vintage watches are an excellent diversification tool given the relatively low correlation to other asset classes and the investment is therefore a good method to hedge against portfolio risk.
Similar to art investments, vintage watches provide investors protection against inflationary risk. This might explain why Asia, where inflation concerns are significantly high, represented the largest export market for Swiss watches in 2009, accounting for 48% of the total value exported. </li></ul>Furthermore, while Exhibit 2 shows that gold is the most attractive historical investment between June 2003 and February 2009, Vintage Watches provided the second highest return during the period (20%; 4% annualized), while proving to be the least volatile and having a minimum drawdown. Additionally, as Exhibit 4 shows, 4/5 watches in the index had returns between 21% and 144% (4% and 24% annualized) during the same period that the S&P and the 10 Year Bonds lost 18% and 24%, respectively.<br />Exhibit 5, which shows a longer-term return period, shows that watches and clocks have done quite well between 1976 and 2009, with a 380% return, or 11.5% per year.<br />Valuation of Vintage Watches<br />While exclusivity and scarcity are among the most important drivers of the vintage watch market, several extremely important factors are used to consider the pricing and value of the watches.<br /><ul><li>Complications - Unique and still functional complications are intricate mechanisms, such as perpetual calendars, extra dials (second hand or timing function), chronographs, and moon-phases.
The most attractive watches are those manufactured by distinguished European watchmakers – preferably Swiss, German, or French. Rolex and Patek Philippe are both Swiss, while A. Lange & Sohne is German.
Condition – the market demands near mind condition, however exceptions are made in the case of scarce products.
Brand matters; Patek Philippe, Rolex, Vacheron Constantin, Audemars Piguet, A. Lange & Sohne, and Breguet are some of the more exclusive and most in demand.
Exclusivity; (A. Lange & Sohne produces less than 1000 watches per year).
Watchmakers known for producing innovation are more in demand; Rolex produced the first watches with automatically changing day and date indicators and also was a pioneer in developing waterproof timepieces. Patek Philippe was responsible for creating the perpetual calendar, split seconds hand, chronograph, and the minute repeater.
Aesthetic, sentimental pleasure from product – this is difficult to value and depends on collector’s needs.
Could be worth up to 70% more at auction if it is accompanied by original casing and documentation (Bonhams).
Precious metals and watches carrying diamond inlays are more valuable.
Scarcity and exclusivity; Discontinued watches fetch a much higher value. A rare 1943 Patek Philippe watch sold for GBP2,675,400 at a Christie’s auction in May 2010, the second highest price paid for a wrist watch ever – double its pre-auction estimate. The watch was billed as “unique and historically important.”
As is evident in fine art, extremely scarce and popular watches might have significantly higher returns than the broader vintage watch market. </li></ul>Cons/Risks<br /><ul><li>The most serious risk in the vintage watch market is fraud. With prices of many of the watches capturing over $100,000, fraudulent watches have been known to enter the marketplace with almost identical features to the real timepieces. Reputable dealers should be considered before buying the watches.
Scarce and collectors’ watches are extremely expensive to maintain and upkeep. This cuts into an investor’s returns.
The most popular place to obtain above market value pricing is at auctions. Auction houses charge high transaction fees associated with buying and selling vintage watches. This could lower your returns.
The most valuable, rare, and important vintage watches are worth well over $25,000, which creates a barrier to entry for many investors looking to break into the market.
No public pricing data exists creating additional barriers for beginners trying to break into the market. Additionally, the transactions are infrequent and prices vary significantly, even for 2 identical watches.
Though vintage watches are an excellent tool for diversification, they are also extremely expensive, as an individual should diversify the Vintage Watch risk as well by investing in several different watches. Such an investment portfolio of multiple rare vintage watches could cost hundreds of thousands of dollars and if combined with other asset classes, would only be suitable for multi-million dollar portfolios. Another way to break into the market, however, is by investing in Vintage Watch Funds.
Precious Time, launched in October 2010 as a Luxembourg Specialized Investment Fund (SIF), invests in 400 of the market’s strongest watches, which include 50% Patek Philippe, 30% Breguet, Rolex, Audemars Piguet, Vacheron Constantin, and Cartier, 10% Exceptional contemporary watches, and 10% into cash. The fund uses a Committee of Experts to evaluate potential investments and has a very optimistic outlook of 15% net per year. The fees are 2.5%/20%.
The second fund dedicated to vintage watches is the Novium Vintage Watches fund (Exhibit 6). The company, which was launched in January 2009, has seen an annual return of .5% vs. the equity sector’s 14.34%. The fund defers from Precious Time in that it primarily invests in Rolex watches.
Although none of the vintage watch companies are publically traded, several watchmakers are subsidiaries of publically traded companies suggesting that this is another area to consider in terms of an investment strategy. LVMH is a parent company of Tag Heuer, Zenith, Chaumet, and Hubolt. The company had a positive return of 2.3% during the 2003-2009 horizon. While the company is not correlated to the S&P market, it is also not correlated to vintage watches, which might suggest that this is not a good alternative to the vintage watch exposure.
My Investment</li></ul>Given the risks and benefits of the vintage watch market, I would invest in the vintage watches by selecting some of the lower priced vintage timepieces and diversifying the portfolio by selecting among 4-5 different watchmakers. This would create the following benefits:<br /><ul><li>Aesthetic value – as someone who really appreciates watches, I would enjoy having several vintage watches with various “complications” as collectible items as well as frontiers.
An excellent hedge against inflation during uncertain currency expectations and Fed decisions.
Low correlation to other markets and low volatility would create protection against the remaining portion of my portfolio.</li></ul>My time horizon will be longer term, 15-20 years, as I do not expect to obtain high returns during the shorter term future. There would be a higher likelihood that my investments would appreciate in value over the longer term future.<br />I would allocate 3-5% of my overall portfolio towards vintage watches in order to hedge the overall risk of my portfolio. The other portions of the portfolio would be allocated across equities, bonds and cash markets.<br />My investment will not include the vintage watch funds as I have not witnessed the favorable returns of the funds over a long period and I will also not be able to receive some of the aesthetic benefits within the vintage watch arena through those funds. Investing in public equity, while could be a great hedging mechanism against other segments of the portfolio, do not offer the same value I will be looking for as investing directly into the vintage watch market. <br />Conclusion<br />Following extremely volatile economic events as well as more efficiency in the global markets, it is evident that intelligent investing in alternatives is one way of breaking out of crowded trades and creating value. The vintage watch market with its added benefits provides an excellent way of creating that value and delivering the necessary hedge against portfolio risk and correlation.<br />Exhibit 2: June 2003 - March 2009 Returns<br /> <br />Exhibit 3: Correlation Matrix<br /> WatchesS&P10 Yr BondGoldLVMHS&P0.566252 10 Yr Bond-0.140260.594659 Gold0.8396320.214807-0.46619 LVMH-0.294340.1191120.315176-0.38318<br />Exhibit 4: Selected Watches for Index<br />Exhibit 5: Clocks and Watches: 1976 – 2009 (Art Market Research)<br />Exhibit 6: Novium Vintage Watches<br />74428163957000<br />