An Investigation into Bloodstock as an Alternative Asset Class for Investment Purposes.

Abstract

Following extended periods of economic turbulence intermixed with a succession of global financial crises, High Net Worth individuals (HNWIs) seek to diversify their investments more widely through utilising a broader range of asset classes. In seeking protection from the heavily integrated financial markets and moving beyond the traditional financial asset classes, these investors are now more open than in the past to exploiting the investment benefits of a range of alternative asset classes, once considered to be pure luxury spending by the wealthy (Capgemini 2024). Asset allocation towards investments of passion (I.O.P.) including art; wine and collectibles have become more prevalent as the behavioural needs of investors feature within the investment decision-making process (Campbell et al. 2009). Whilst attention has been devoted to I.O.P., with the investment performance benefits of these asset classes extensively investigated, ever more niche investments have been raised within the academic literature and by the financial services industry. Interest in sporting investments has grown substantially over recent years, with investment in bloodstock (thoroughbred racehorses) previously suggested as a potential asset class by Lester (2006). The Thoroughbred racing industry is one of the most popular areas of sport, second only to football in the UK and watched by hundreds of thousands of enthusiasts at racing events and through television. Underpinning and intertwined with the racing industry, is the breeding industry which sustains the ever-popular racing events through the production of young racehorses. It is the creation of these equine assets through the breeding process, which gives rise to the opportunity for investment. Investment may be made into particular segments of the bloodstock industry, either through breeding-stallions; broodmares or youngstock, with each of these areas offering a different investment prospect. Opportunities to gain exposure to these segments of the bloodstock market exist through bloodstock funds, syndicates and even direct individual ownership, with a readily accessible and liquid auction market available. However, the question arises as to whether an investment into bloodstock presents a beneficial prospect? Despite a large body of empirical research into the performance and diversification benefits of more established asset classes, examination of bloodstock as a potential investment asset class has been virtually non-existent. This research focuses on the investment potential of stallion and yearling bloodstock in comparison to a range of traditional and alternative asset classes, employing a number of well-established performance metrics. Utilising the range of James Cowper Stallion bloodstock indices (1995-2010) and James Cowper Yearling bloodstock indices (1997-2009), financial performance is considered, relative to UK domestic equity; international equity; fixed income; property; commodities; art and wine. Furthermore, the potential diversification benefits which may exist when these asset classes are combined within investment portfolios, modelled using the Mean Variance approach first introduced by Markowitz (1952), are investigated. Findings show both Stallion and Yearling bloodstock to perform favourably amongst traditional and alternative asset classes, with mid-range risk and return performance demonstrated. Stallion bloodstock appears stronger in relative terms than Yearling bloodstock, revealing higher return, lower risk and lower correlation to other asset classes. Stallion bloodstock shows periods of diverging movement in comparison to other asset classes (especially equity) and appears to enjoy the benefits of rising financial markets whilst not suffering the large downside movements when these markets fall, thus potentially offering investors a degree of protection. When added to a portfolio of Traditional; Alternative and mixed asset classes, Stallion bloodstock acts as a strong diversifier by improving performance across the board. In reducing risk under Minimum Risk portfolio conditions and increasing Sharpe ratios under Equally Weighted and Optimum portfolio conditions, Stallion bloodstock enjoys substantial asset allocations (where not fixed) flowing from other asset classes towards this segment of the bloodstock market. Despite fair relative performance in financial terms, Yearling bloodstock fails to perform as strongly within a portfolio scenario, providing some, but more limited diversification benefits and thus ultimately failing to attract substantial asset allocations. For an investor seeking to make an investment into any segment of bloodstock, it is imperative that the fundamentals which drive value are understood, with the factors which do not add value also recognised. The hedonic approach has been well utilised within the empirical literature towards bloodstock valuation (Parsons and Smith 2008; Ng et al. 2013; Kim et al. 2019; PWC 2023), although focusing mainly on the value drivers of Yearling bloodstock and to a lesser extent Broodmares. Very limited research has been directed towards the Stallion segment of the bloodstock market, with the focus being primarily on the North American market (Stowe and Ajello 2010; Stowe 2013; Hansen et al. 2018). Following the strong diversification performance of Stallion bloodstock within a portfolio scenario demonstrated within this research and given the limited attention Stallion bloodstock has received within the literature, this research further seeks to provide investors with greater understanding of the drivers of Stallion bloodstock value from a UK perspective. This research investigates the hedonic characteristics which significantly underpin the valuation of Stallion bloodstock assets, using Ordinary Least Squares (OLS) regression on a sample of established top-class breeding stallions (appearing on the Leading Sires List between 2006 and 2015) first standing at stud within the UK and Ireland (between 1995 to 2012). Subsequently the hedonic drivers of stud fees for the same sample of stallions in their sixth breeding season (between 2000 to 2017) are investigated. Following the established hedonic approach, this research examines the significance of explanatory variables (under Log-linear and Squared Terms conditions) categorised under Personal; Heritable and Racing Characteristics, in relation to the Stud Fee for the year the stallion first comes to stud and subsequently for the sixth breeding season. There are many factors which are thought to potentially affect stud fee, which ultimately acts as a proxy for value in generating a stream of revenue cash flows, which can be discounted to present value. Therefore, a prospective investor, who understands which characteristics are significant in underpinning stud fee, can more readily judge whether the stallion’s auction purchase price represents good value. This research finds that in terms of Racing characteristics, the racetrack earnings of the stallion significantly impact first year stud fee, alongside the win percentage strike rate and the number of Group 1 races won other than at two years old. In terms of Heritable characteristics (i.e. those passing down the bloodline), the importance of the stallion’s Dam being a successful race winner is revealed and shown to increase first year stud fee by 28%. The stallion’s Sires’ stud fee has less of an impact and although significant, the effect on first-year stud fee is small. From a Personal characteristic perspective, the age at which a stallion first stands at stud is significant and impacts the first-year stud fee negatively by 20% per year as the stallion the gets older. As a stallion moves from the start of his breeding career to becoming established (by the time of the sixth breeding season), the hedonic factors significant in determining value change to focus on progeny (offspring) related characteristics. Sixth season stallion stud fees change from the initial first year stud fee as information about the quality and success of progeny becomes available to the market. The success of progeny in the sales ring (measured through mean yearling selling price) is found to be the most influential factor, with the racetrack performance of progeny (in terms of earnings) the other main statistically significant factor. The location of the stud farm where the stallion stands for his sixth breeding season (either within the centre of British horse racing and breeding at Newmarket, or not) was found to be not significant within this research. These findings are important for UK investors wishing to consider an investment into Stallion bloodstock, as they allow an investor to make more calculated investment decisions based on attributes statistically shown to be significant and go some way to preventing overpayment for equine assets, thus maximising potential returns. Additionally, these results aid investors in managing their ongoing returns for equine assets by highlighting the continuing influence of progeny performance in determining stud fees. Overall, this research shows that Stallion bloodstock has the potential to deliver financial benefits and contribute towards improving the performance of a diversified portfolio of assets. Furthermore, in revealing hedonic characteristics which significantly underpin first-year and sixth-year stallion stud fees, this research allows investment to be carried out in a calculated manner. Consequently, this research concludes that Stallion bloodstock is a potential asset class worthy of consideration for investment purposes.