Plonk and doodle investing

Recent students of finance will know that theoretically, a "market portfolio" consists of all possible assets that one could invest in, traded in a liquid market. There was a time when this was only very partially true, and even then, the wider range of asset classes to make up a "market portfolio" were only available to the rich.

However, with improvements in technology, better financial engineering, and the sheer weight of money begging to be invested, investment funds specialising in "alternative assets" like fine wine and arts (apart from your run-of-the-mill long-short funds and CDO's/CLO's) have sprung up to meet the demand.

In theory the wider range of asset classes improves the ability of an investor or fund manager to diversify investment risks, as each asset class responds differently to economic and business cycles, and the returns of some asset classes may move in a different direction to certain other asset classes. My question (and perhaps it's because I haven't delved into this long enough) is that a fund that invests in "prestige assets" like fine wine and artwork will be investing in assets that (a) derive their value from conspicuous consumption of the rich, and (b) are traded in very illiquid markets (if at all), and hence pricing signals and valuations are difficult to come by.

I imagine that demand for luxury goods don't change all that much in the stratosphere that the super-rich mingle in, so I guess demand for Bordeaux wines and Picasso paintings are fairly inelastic. Of course, I am also assuming that the noveau riche have marginal impact on the market for luxury goods; and that the funds investing in wines and artwork are not relying on a healthy market supported by freshly-minted millionaires to realise their profits. Because if they are, and the economic cycle turns, then the market liquidity could easily dry up, making it difficult to buy and sell assets at the "right price" and seriously endangering their ability to create significant supernormal returns uncorrelated to "traditional" assets like bonds and shares.

Simply put, if the economy tanks, we will have less rich people, which means less demand for luxury goods, driving their value down along with the rest of the general investment market. Not exactly the definition of diversification. Happy for someone to explain this to me in more detail...