EDITOR’s NOTE: This story has been changed from the print version to correct the title of John Hekman, an economist and managing director at the L.A. office of FTI Consulting.

An armored truck rolls up your driveway and an armed guard hands you a black leather case. Buying diamonds as an investment, you see, is not like buying stocks.

But putting aside the unusual delivery aspects, Chris Duffield and Kristopher Schellhas are betting that investing in diamonds could be the next big thing.

They founded Investment Diamond Exchange LLC, or IDX, a Santa Monica firm that sells diamonds – the actual stones, delivered by that armored car – to investors with a standing promise to buy them back. The company is one of a handful of firms trying to turn diamonds into an investment commodity much like precious metals.

“The two key things any market needs are price transparency and liquidity,” said Schellhas, 30, a former commodities trader at the Chicago Board of Trade. “Those are two things the diamond industry has lacked. Now, you can see prices on our website, and we create liquidity. You have the ability to sell your diamond position back to us.”

In short, Schellhas and Duffield are trying to become market makers, but for a product that’s only been regarded as a potential investment for less than a decade.

Until just nine years ago, South African diamond giant DeBeers controlled most of the market, allowing the company to influence prices – and keep investors out, said Edahn Golan, editor in chief of diamond price index Idex Online in Tel Aviv.

“It made no sense creating any sort of financial vehicle based on polished diamonds as long as one company could manipulate prices,” Golan said.

But that monopoly was broken up in 2004 when the company pleaded guilty to price fixing. Other big firms now have more market share, leading to increased competition. Diamonds have been appreciating about 4 percent annually and investors have started to take an interest. IDX and other companies see opportunity as a result.

IndexIQ, a manger of exchange-traded funds based in Rye Brook, N.Y., last year filed a request with the Securities and Exchange Commission to create a fund backed by diamonds. GemShares LLC of Chicago earlier this month filed a request for another exchange traded fund, GemShares Physical Diamond Trust.

“This is the first time the industry is seeing this much interest from the investment side,” said Paul Zimnisky, chief executive of Madison, N.J., firm PureFunds, which manages an ETF that’s invested in diamond mining and retailing companies. “There’s a real, fundamental investment story behind diamonds. Demand is forecast to increase and there’s limited new supply.”

Murky market

Diamonds are valuable, portable and essentially indestructible, and their value is not correlated to that of other commodities or broader markets. That makes them a potential safe haven for investors, said Paul Miller, managing director in the Westwood office of Irvine wealth management firm First Foundation Inc.

“People are always looking for noncorrelated asset classes,” he said. “In order to diversify, you want something that’s going up when other things are going down. Gemstones are another way to do that.”

But Miller and others note that investing in diamonds isn’t easy. The first step is to buy diamonds at a fair price. But most diamond exchanges are private, open only to diamond traders and jewelers, leaving investors to buy at retail prices that can be twice as high as wholesale.

Diamond price indices such as Idex Online list only the asking price for specific stones, not the sale price, making it difficult for investors to know if they’re getting a fair deal.

What’s more, unlike a piece of gold, an individual diamond’s price depends not only on its size, but on its shape, the quality of its cut, color, clarity and other factors.

And once investors have the diamonds, they have to be able to sell them. That’s difficult to do without taking a loss, said John Hekman, an economist and managing director in the L.A. office of FTI Consulting, a West Palm Beach, Fla., financial advisory firm.

“There’s never been much of a secondary market for diamonds,” Hekman said. “If you buy a diamond for $5,000 then try to sell it back, you’re going to get very little.”

Nuts and bolts

IDX aims to get around the diamond-pricing problem by listing prices on its website, InvestmentDiamondExchange.com.

Cutting and polishing factories provide diamonds to IDX on consignment. (The factories process raw diamonds into the stones used in engagement rings and other jewelry.)

Prices are set by cutting factories and IDX tacks on 5 percent. Even with that markup, diamonds listed by IDX are between 15 percent and 50 percent cheaper than stones of similar quality for sale by major diamond retailers, according to a comparison of IDX and Zales.com prices. For instance, IDX recently listed a top-quality1.05-carat diamond for $23,899. A similar diamond listed on Zales.com costs 42 percent more, or $33,968.

Duffield said IDX can charge a smaller markup because it doesn’t have brick-and-mortar stores or jewelers on staff. And by getting consignments from many factories – he wouldn’t say how many – IDX creates competition and drives down prices.

IDX isn’t the only diamond exchange where investors can buy actual diamonds, but it is unusual in that others, such as Singapore Diamond Exchange Private Ltd., typically require minimum investments of hundreds of thousands of dollars. IDX has no such minimum. Schellhas said the company has even sold to noninvestors who want diamonds for jewelry.

For each diamond listed on IDX’s site – there is about $25 million worth at any given time – the company notes the size, color, clarity and other factors, as well as two prices: a sale price, which includes IDX’s 5 percent margin, and a buy-back price, the price the company would pay an investor selling a similar diamond.

By promising to repurchase diamonds from IDX customers, and by listing buy-back prices, IDX allows customers to track the value of their diamonds and lets them know they’ll be able to cash out if they want.

When an investor calls IDX, a sales representative helps them build a package of diamonds based on a budget and investment goals. An investor might want many smaller diamonds that can later be sold off piecemeal, or fewer large diamonds that are expected to appreciate more. IDX sells only top-quality diamonds between 1 and 5 carats in size – the types most in demand.

Once an investor’s diamonds are selected, IDX has them sent to the Gemalogical Instituteof America Inc., a non-profit diamond examination company in Carlsbad. There, they are inspected and individually sealed into plastic packages. The investor wires money to IDX and diamonds are delivered the following day by armored truck or guaranteed shipment, depending on the value of the order, arriving in a leather case designed to fit in a safety deposit box.

Schellhas and Duffield said they expect investors to hold on to their diamonds for at least five to 10 years. When investors are ready to sell, they call IDX to lock in a price, the company arranges for pickup and money is wired to the investor.

Ten years out

While IDX’s prices are significantly lower than those of mainstream diamond retailers, they’re often only slightly lower than those of online diamond seller Blue Nile Inc., for example.

And IDX’s prices are often significantly higher than diamond prices listed on private diamond indices. However, those indices don’t provide detailed information about the quality of the diamonds, making price comparison challenging.

“I think they’re taking a step in the right direction,” said Zimnisky at PureFunds. “But at the moment, I don’t think there’s any vehicle or index that makes the price of diamonds transparent enough.”

What’s more, IDX is just one company and a startup at that. FTI’s Hekman cautioned that if the company goes bust, an investment in diamonds could suddenly become much harder to unload.

“If they’re not around 10 years from now, who is willing to buy these diamonds?” Hekman asked. “I respect their attempt to create a market here, but it sounds pretty risky.”

Schellhas and Duffield said diamond buyers can sell to whomever they choose – other investors, a local jeweler – but they acknowledge that other potential buyers likely won’t offer as much as IDX will. That means investors could take a big haircut if IDX fails.

“A jeweler would buy them back from you. Are you going to get what you want or what you’d get from us? No,” Schellhas said.

But he and Duffield said they have strong cash reserves – which they’ll need if investors start wanting to sell – and strong financial backing. They say they’re in the process of a multimillion-dollar fundraising round but declined to offer more specifics.

IDX had its first sales last year and is already profitable, Schellhas said. Just last week, the company was in the process of closing a sale of $15 million worth of diamonds to an investor. That sale alone would represent revenue of $750,000 for the 10-employee company.

One customer, Manhattan Beach resident Jon Kubler, said he’s not concerned about whether IDX will be around a decade from now. He bought diamonds valued in the six figures – he declined to be more specific – and said he plans on holding them for the foreseeable future.

“The benefit to me is risk mitigation – it’s a hedge,” he said. “It’s something I can own that, based on demand, should increase in value. Unless we’re in an overall catastrophic economic state globally, I think this is something that will be passed on.”