Luxury watches are increasingly recognised as a unique and compelling asset class, demonstrating a remarkable capacity to generate 'alpha' and preserve wealth, particularly during periods of stress in traditional financial markets. Unlike conventional investments that often mirror broader market sentiment, luxury watches exhibit distinct characteristics that enable them to offer defensive alpha and a degree of insulation from economic shocks. This burgeoning interest stems from their performance, evolving market dynamics, and their inherent qualities as tangible assets.
Luxury watches have shown significant financial performance, outperforming traditional assets like the MSCI World Index (equities) and the Bloomberg U.S. Aggregate Bond Index (bonds) over recent periods. A study covering 2018 to 2023 found that a luxury watch index yielded an average return of 2.01% and a cumulative return of 49.35%, notably higher than the MSCI World Index's 1.38% average and 31.90% cumulative returns, and significantly above the Bloomberg U.S. Aggregate Bond Index's -0.01% average and -0.15% cumulative returns.
Beyond simple returns, the watch index also outperformed traditional indices across key financial metrics, including the Sharpe ratio, Treynor ratio, CAPM (Capital Asset Pricing Model), and Jensen’s alpha. A positive Jensen's alpha for luxury watches indicates that they have generated excess returns relative to their systemic risk as measured by the CAPM. For instance, a $1 investment in a price-weighted luxury watch portfolio grew to $2.23 between June 2010 and March 2020, substantially more than comparable investments in governmental bonds or commodities. The annualised Sharpe ratio for price-weighted luxury watch indices ranged from 0.55 to 0.68 during that period. For specific brands like Rolex, Patek Philippe, and Audemars Piguet, annualised Sharpe ratios reached at least 1.26, vastly exceeding that of stocks (0.71) during the same period, suggesting superior risk-adjusted returns.
Luxury watches have demonstrated particular resilience during periods of market stress. During the COVID-19 pandemic in Q1 2020, when the stock market (MSCI) experienced a serious decline, the watch index was seemingly unaffected. This phenomenon might be explained by a shift in consumer spending; with less money spent on leisure and travel due to social restrictions, individuals redirected funds towards luxury products. Similarly, during the Russian invasion of Ukraine in Q1 2022, the decline observed in the watch index was less visible compared to the MSCI and Bloomberg indices. This relative insulation could be due to the largest luxury watch markets, such as America, China, Hong Kong, and Japan, being less directly affected by the conflict than European and Russian citizens. These insights align with findings that luxury watches tend to perform well during stock market crises and remarkably outperformed all asset classes on a risk-adjusted basis since March 2020.
Compared to other collectibles, which generally yield mixed results but often offer diversification benefits, luxury watches appear to be among the more profitable investments. Studies on art, fine wine, whisky, classic cars, stamps, handbags, LEGO, and sneakers also suggest potential diversification, but luxury watches show strong recent performance. Older studies on alternative investments tend to show them as less attractive than traditional investments, which might reflect societal trends at the time they were written.
A key advantage of luxury watches as an asset class is their low volatility and low correlation with traditional asset classes. Their volatility is comparable to U.S. Treasury bills and notably decreased during bear markets, which contrasts with typical stock market behaviour. This low correlation with stocks, bonds, and gold allows luxury watches to provide significant diversification benefits to an investment portfolio. Mean-variance spanning tests confirm that luxury watches significantly improve the minimum-variance portfolio by lowering its risk.
Adding luxury watches to a diversified portfolio can reduce overall portfolio risk. For instance, including watches can reduce volatility by more than a quarter and decrease the maximum drawdown and weekly value-at-risk (VaR). While they may not necessarily boost overall portfolio returns significantly, their primary contribution is in reducing portfolio risk. For an investor targeting an annual return of 5% with no short sales allowed, adding luxury watches could double the Sharpe ratio to 1.23, as volatility sharply decreases to only 2.35% annually.
However, luxury watches are considered a "safe haven of weak nature". While their returns remain uncorrelated with traditional assets during market stress, they do not necessarily generate positive returns when stocks, bonds, or gold experience strong negative returns. They act as a hedge against stock, bond, and gold markets because their returns are, on average, unrelated to these markets. Mean-variance spanning tests consistently reject the hypothesis that adding luxury watches is not beneficial for a financial portfolio, highlighting their value in diversification.
The luxury watch market is a substantial and growing segment. In 2022, the overall luxury watch market was valued at $79 billion, with $24 billion attributed to the pre-owned market. This pre-owned market is forecasted to grow to $35 billion by 2026 and $38 billion by 2030, demonstrating significant competition for traditional watchmakers. The market is dominated by a few Swiss manufacturers, with Rolex holding a 30.3% market share in 2023 (including Tudor), followed by Cartier (7.5%), Omega (7.5%), Patek Philippe (5.6%), and Audemars Piguet (4.9%).
Scarcity and exclusivity play a crucial role in driving the value of luxury watches, especially in the secondary market. Popular models often have waiting lists stretching up to 20 years. This restricted primary market supply has fueled the rise of secondary, or 'grey,' markets, which improve liquidity and price discovery for collectors. For many models, the secondary market price can double or triple upon leaving the retail store.
Historically, academic research on collectibles, including luxury watches, has been limited due to a lack of thorough and systematic data, as transactions were often decentralized and offline. However, the recent development of online niche marketplaces for luxury goods has enabled systematic data collection, facilitating research into these alternative assets. Despite this, the luxury watch market generally still has low transparency, making expertise in watches and market dynamics highly valuable and expensive. Websites like WatchCharts aim to bring price transparency to the pre-owned market by collecting data from various online retailers and forums. The growing influence of social media and internet dealers has further fueled demand and public awareness of luxury mechanical watches as investments. Events like the discontinuation of a popular model (e.g., Patek Philippe Nautilus 5711) or a celebrity wearing a watch (e.g., Jay-Z with the Nautilus) can significantly impact prices in the secondary market.
The value of luxury watches is influenced by a range of characteristics, which can be analysed using the hedonic pricing method. Key value drivers identified in studies include:
Brand: Brands such as Audemars Piguet, Patek Philippe, and Vacheron Constantin consistently have a significant positive impact on the price of watches when compared to Rolex, which serves as a base category in some analyses. This suggests these brands appeal to a niche group seeking extreme exclusivity. Other brands like Breitling, IWC, Omega, Panerai, TAG Heuer, and Tudor generally have a negative price impact compared to Rolex, indicating they are in a lower price bracket.
Features: Additional functional features significantly increase a watch's price. Chronograph, tourbillon, and rotating bezel are strongly associated with higher prices. These features, while not fundamental to time-telling, offer a "wow factor" and symbolise technical complexity and craftsmanship, appealing to enthusiasts.
Case Material: Materials like bronze, rose gold, and yellow gold contribute positively to watch prices. Conversely, ceramic can have a negative impact compared to steel, though its statistical significance may vary.
Other Characteristics:
Jewels and Power Reserve: A higher number of jewels and a longer power reserve have a positive, albeit low, impact on watch prices. These are appreciated by enthusiasts for their technical sophistication.
Water Resistance: Surprisingly, higher water resistance can have a negative price impact. This might be because brands with high water resistance (e.g., Breitling, Panerai) tend to have lower average prices than those with moderate water resistance (e.g., Audemars Piguet, Patek Philippe).
Style: Sport style watches tend to be the best option from a price perspective, often incorporating features like large cases, chronographs, and bezels that positively influence price. Dress and Pilot styles may have a negative impact on price compared to sport watches.
Crystal: Watches with plexiglass tend to have a lower price than those with sapphire crystal, which is the predominant choice.
Bracelet Material: Steel bracelets often indicate a better price than other materials like leather, rubber, or textile, except for rose gold bracelets. Rubber bracelets can have a clear negative impact on price.
Movement Type: Manual winding movements may result in a lower average price compared to automatic movements.
Beyond these tangible characteristics, non-financial motivations also shape the market. Luxury watches are passion goods, valued for their psychological, social, and cultural significance. Factors like authenticity (including original packaging, certification), brand legacy, and storytelling (e.g., Omega Seamaster as James Bond's watch, Cartier Tank Française on Princess Diana) can boost demand and value. The investor's knowledge of luxury watches, including specific models and characteristics, is crucial for increasing expected returns.
Investors looking to incorporate luxury watches into their portfolios should be aware of several key considerations:
Longer Investment Horizon: As with many collectibles, a longer investment horizon is generally needed to offset short-term fluctuations and manage illiquidity issues.
Market Understanding: A comprehensive understanding of the luxury watch market is essential. This includes prevailing trends, key players, and the granular factors influencing prices, which may not be immediately obvious to outsiders.
Liquidity: Luxury watches are less readily convertible into cash than traditional financial assets. Investors should be prepared for potentially longer holding periods when selling.
Day-of-the-Week Effects: Research indicates that luxury watch returns are generally lower on Sundays. This phenomenon is likely due to the behaviour of professional dealers who comprise the majority of sellers on peer-to-peer marketplaces. As Sunday is typically a day of rest in most Western countries, dealers may not update offers, leading to less price discovery and lower ask-price based returns. Interestingly, higher buyer attention (proxied by Google searches) on weekends does not translate to higher returns, which contradicts some hypotheses related to investor behaviour.
Macroeconomic Drivers: Unlike some other luxury goods that might be tied to personal income or consumption, Rolex portfolio returns are primarily driven by macroeconomic variables related to interest and exchange rates, inflation, and money and credit. This suggests a financial rather than purely consumption-driven sensitivity for investment-grade watches.
Ethical Aspects and Risks: Investing in luxury watches involves risks beyond financial performance. As tangible assets, they are susceptible to theft, loss, damage, and malfunction. Additionally, ethical considerations include ensuring data for indices is obtained legally and that the market does not contribute to exploitation or unsustainable demand.
In conclusion, luxury watches offer compelling diversification benefits and have demonstrated strong performance, particularly during periods of traditional market instability. While demanding a deep understanding of their unique market dynamics and inherent risks, they represent a valuable, increasingly recognised component of a resilient investment strategy.
Featured Image: Photo by Bence Balla-Schottner on Unsplash