It is easy to think about the merits of any asset class as based entirely on its financial return prospects, but what if an asset provides a different benefit – what if it makes us feel good? Are we then happy to accept a lower financial return? A forthcoming paper by Elroy Dimson, Kuntara Pukthuanthong and Blair Vorsatz seeks to answer this question by appraising the investment performance of collectibles such as classic cars, art, wine and stamps. They find evidence of lower financial returns for assets with a positive emotional value. This has broader implications for our investors than simply the world of violins and carpets.

The limitations around the data on collectibles means the methodology applied for the study is complex – it is not straightforward to calculate a Sharpe ratio for English 18^th century furniture – but I will describe the approach in simple terms. The researchers compared the returns of 13 collectible asset class categories over up to 110 years to a risk-appropriate portfolio of liquid securities. They were seeking to answer the question – how does the performance of collectibles compare to traditional, liquid market portfolios of equivalent risk? *

And the answer was that the collectibles underperformed by an average of 2.5% per annum. The researchers contend that while the liquid asset portfolio has only a financial return element, the collectibles have a non-financial return – what they call an ‘emotional yield’ – which is the reason for the performance gap.

What the authors define as an emotional yield is some emotional benefit that is derived from owning the asset. They define this as private enjoyment and social signalling. If I own a valuable painting, there is some utility from the fact that I enjoy looking at it, and from what other people think it says about me that I own it.

If an asset brings us some form of pleasure or enjoyment, then we require a lower financial return from holding it.

Although the methodology underpinning the paper is complex and necessarily imperfect, the idea that the emotional impact of an asset has an influence on its returns is a compelling one. How we feel has a huge impact on our decision making and judgement, but is incredibly difficult to either acknowledge or measure. It seems perfectly aligned with human behaviour – and indeed rational – that if we have two assets, one in which owning it makes us feel good and one where ownership generates no emotional benefit, we will be content with a lower financial return from the one which is more affecting.**

One unanswered question is the extent to which investors know that they are receiving a lower return. With assets such as collectibles, deriving high quality returns data is inevitably difficult, and there is no reasonable way for anyone to compare performance to a ‘risk equivalent’ portfolio of liquid assets. It would be interesting to explore whether investors would be willing to explicitly makes this type of trade-off.

The Wider Implications of Emotional Yield

While the paper focuses on the world of collectibles, the notion that the presence of an emotional yield impacts our required return has potentially broader ramifications. The authors touch upon – but do not explore in detail – the potential for the concept to be meaningful for ESG investors. If we believe our investments are doing good, that makes us feel good, and therefore we benefit from a positive emotional yield and may accept lower returns.

This seems plausible although the level of emotional yield we might derive from holding an asset, must be related to the strength of emotions elicited. For tangible assets – such as jewellery or coins – this can be incredibly strong, as we have full ownership and can hold, see and feel an object. Information about partial ownership of a company and the ESG-related activities it is undertaking is far less salient. To generate an emotional yield, investors need to be made to feel something.

We have discussed only the potential for a positive emotional yield, but what about the opposite situation? Do investors require a higher return for assets that take an emotional toll? Those that make us feel bad for owning them. As with ESG, it is fair to question the emotion that can be generated by simply owning stocks and bond which can often feel abstract. Even taking this into account, however, it would seem reasonable that we want to be compensated for holding assets that make us feel discomfort or some level of guilt. It is perhaps an idea that can be applied to value investing more generally given the negative sentiment that is likely to surround anything falling into that categorisation.***

One other important implication that the authors highlight about the impact of the existence of an emotional yield – on collectibles in particular – is the potential limitations of tokenisation. By their analysis investors owning collectibles achieve a lower return which is offset by the positive emotional impact of full ownership. If a collectible is tokenised and ownership is fractional, an investor bears the cost of the lower financial return, but without the emotional yield. I don’t get to enjoy the painting hanging on my wall, but I might well pay for it.

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One of the most glaring omissions in all discussion on financial markets and investor behaviour is the role that emotions play. When it is discussed, it is generally focused on the negative behavioural implications of fear and greed, and how they lead to poor decisions. This new paper applies a different lens and makes a strong case that how an asset makes us feel when we own it might just impact the returns we are happy to make. 

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* There is a lot of complexity in the methodology which might not make for enjoyable reading in a 1000-word blog post. Please do read the full paper for details.

** When I refer to emotion here, I am talking specially about how holding the asset makes us feel, not the emotions that price fluctuations might provoke. 

*** In a way, we can think of the higher returns required for owning more volatile assets being a form of emotional yield. We want recompense for the stress and anxiety of ownership.

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My first book has been published. The Intelligent Fund Investor explores the beliefs and behaviours that lead investors astray, and shows how we can make better decisions. You can get a copy here (UK) or here (US).

All opinions are my own, not that of my employer or anybody else. I am often wrong, and my future self will disagree with my present self at some point. Not investment advice.