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Art as an Alternative Investment Asset

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Abstract

The paper constitutes a discussion of the trend around the rise of art as an alternative investment. With financial markets in turmoil, art as an alternative asset class is being incorporated into portfolios in the interest of diversification. Art's low correlation with the equities market and desirable risk and reward ratio, as price appreciation defies all logic, makes it an attractive investment. The volatility, irrationality and illiquidity of the art market make it hard to compare to more conventional investments. The paper will look at how investors are treating art as an asset class and how art compares to more traditional assets such as equities and bonds.
Electronic copy available at: http://ssrn.com/abstract=1112630
Art as an alternative investment asset.
Raya Mamarbachi*, Marc Day* and Giampiero Favato *, §
* Henley Management College, UK.
§ Corresponding Author (email: giampiero.favato@henleymc.ac.uk)
Abstract.
The paper constitutes a discussion of the trend around the rise of art as an
alternative investment. With financial markets in turmoil, art as an
alternative asset class is being incorporated into portfolios in the interest
of diversification. Art’s low correlation with the equities market and
desirable risk and reward ratio, as price appreciation defies all logic,
makes it an attractive investment.
The volatility, irrationality and illiquidity of the art market make it hard
to compare to more conventional investments. The paper will look at how
investors are treating art as an asset class and how art compares to more
traditional assets such as equities and bonds.
Electronic copy available at: http://ssrn.com/abstract=1112630
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Introduction.
The role of art is changing. Art is no longer just appreciated for its
aesthetic value and the expression of its lofty ideals but as an investment.
Developments within the art market over the last ten years in the UK
have been followed almost as closely as those within the stock market.
Prices paid for pieces have gained international publicity and art as an
object of investment has become particularly alluring. The art industry
has really come of age: it is now worth over $3 trillion and has an annual
turnover of $30 billion1. It has its own indexes for tracking performance
(Mei Moses All Art Index, Art Market Research and artnet.com),
showing that returns are just as attractive if not better in art than the stock
market. Art has become the new hip must-have investment.
Indices tracking the performance of fine art have held up well in the
recent economic slowdown with auction houses continuously reporting
record prices. While art has been debated for quiet some time, there has
been little investigation into the reasons why only a handful of the many
small art funds that have proliferated during the past four years has been
successful in building significant public and financial support. With
uncertain stock market returns and interest rates at their highest in
decades, nervous investors are now considering alternative investment
avenues.
Art as an investment has an increasing demand coupled with an
absolutely limited supply and the ability to survive the economic
downturn. Although putting money into art is not as straightforward as
investing in bonds or equities, the market is attracting increasing interest.
Art as an asset is in a class all of its own. While art is seen by many in the
financial community and beyond as an attractive investment as it
outperforms more conservative investments, it is also extremely risky. It
is an alternative investment earning capital gains rather than a dividend.
Art does not behave in the same way as other assets such as real estate, or
bonds. As investors take on a more hands-on approach to wealth
management and portfolio diversification and with heightened exposure
to alternative investments, the worlds wealthiest are looking to find
adventure in new territories.
1 Source: Thompson financial data, 2006.
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Investing in art disregards the traditional benchmarks of financial
analysis. Since art does not generate an income stream, such as dividends,
the ability to assess a value by calculating future cash returns based on
estimating future inflation and interest rates cannot be used to value a
work of art. Instead it is a bet on the price appreciation of something
whose values defies financial logic. Moreover, art incurs a negative
income in the form of storage, insurance, transportation and other
associated costs. Whilst contemporary art has appreciated enormously in
value over the last few years, not all art works earn a positive rate of
return.
The economics of art.
Art is a heterogeneous product, artworks are unique. Loyalty to an artist
is low and the perceived value of the product very much depends on art
dealer’s taste. There is a lot of competitive pressure in the industry and
barriers to entry are high due to high fixed costs, these include the finding
and commissioning of artists, advertising, insurance, and distribution.
Costs of exiting the industry are also high as it is difficult to liquidate
assets. There exists a clear mutual interdependency between firms,
dealers, and art fund mangers. The big three auction houses (Christies,
Sotheby’s, Philips,) are said to be price-makers and not price-takers. The
art industry tends to compete on uniqueness of artwork and not on price.
The relationship between supply and demand for art is very similar to
luxury goods. To begin with, there is limited supply, giving art a higher
value. Secondly, exclusivity that comes with art often leads to higher
prices, thus having an affect on the demand curve. There are a number of
indicators that point towards an inelastic demand curve, these include:
Changes in taste
Changes in income
Pricing and accessibility
Threat of substitutes
In the art market there are “numerous pricing strategies and commission
packages” (Schweizer, 2008). Artists interested in maximizing their
profits will set relatively high prices, which relates to quality and
exclusivity like luxury goods, in turn decreasing accessibility. Art fairs
that represent galleries and dealers represent the lower priced end of the
market as they rely heavily on volume sales than charging customers
premium prices.
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Art prices can be assumed to be determined by supply and demand.
However, there are many factors that affect the price of art within art
markets, such as uniqueness of product and limited supply of works.
Price is very much dependent on consumer preferences and
differentiation. There are two types of cost affecting the price: production
costs and selling costs (Jyrämä, 1999). In art, as a rule, the price of the
works of art consists of its production costs plus the aesthetic value of the
piece. Selling costs is associated with the making of a new artist in terms
of distribution and public relation efforts.
Factors affecting price are intertwined can be divided into four groups:
1) the work of art,
2) the artist,
3) the market and
4) the macroeconomic environment.
Factors relating to the work of art include the quality, content of the
work, technique used, size and the authenticity of the artist.
Artist’s fame and the valuation of previous are important.
One key distinctive feature is the rarity of the works. Legitimization and
reputation affect both the demand and supply side. Customers are reliant
on the opinions of expert buyers to determine whether the price is correct
or not.
Macroeconomic factors include “the state of the economy and economic
upswings and downswings which the art market follows” (Post, 2007).
In practice, perfect knowledge of a market does not exist, and this is the
case in the art industries. The market can be characterized as highly
uncertain and knowledge is scarce. Thus the imperfection’s in the market
becomes a tool of competition. In art markets, information on markets
and products, including potential customers is a way to achieve a
competitive edge. There is no substitute for art, art products are unique.
Furthermore, benefits sought by customers are numerous and the motives
for art purchasing is wide ranging. Art consultant Mr. Philippe Abdini
believes that the demand for art in the Middle East region “is not only due
to fashion, and it being in vogue, but to the concept of showing off to
your neighbour your new found wealth” (Abdini, 2007). Value in the art
market is particularly variable and unsupported as it’s based on a lot of
intangible measures such as taste, fashion, mood, and importance.
The top price for a painting by Takashi Murakami was $624,000. Since
then, the legendary art dealer Larry Gagosian has sold Murakanis and in
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November 2007 one was auctioned for $2.4 million (Douglas, 2008).
However, “there is a danger that the market for a work becomes an over-
dominant measure of value which has a downside risk should something
as simple as confidence fall” (Gerlis, 2007).
Art as an alternative investment asset.
The relationship of art as an investment brings up the question of how can
art have any correlation to a mainstream asset class? The consideration of
art being lurched into the same field as stocks, bonds and shares, causes
much dismay to many within the art community. Gallery owner Guy
Peppiat believes that, “art funds are dangerous, and unsafe for the market.
They have not been set up for the right reasons and are destroying the
notion of what art stands for, aesthetic beauty and too be admired in one’s
private collection or in a museum” (Peppiat, 2007). Artist Maria Bell-
Slater also deems “these funds which effectively act like hedge funds to
not be good for artists. They tend to keep artists work in storage for at
least 12 to 18 months before selling them. Art should be about enjoyment
and being displayed” (Bell-Slater, 2007). However, economists and
banking institutions have quite responsibly shown the link between art
and investment and most importantly, how art can be considered along
side tradition financial assets.
Assets are grouped together based on their characteristics of their
underlying companies. Just as in managing traditional assets, art is
grouped based on the period in which it was made, the artist (whether
they are living or dead), style and medium. The main attraction of the art
market and the prime reason for its resurgence as an investment is its low
correlation with other financial assets. Art is in a “special asset class of its
own as it is generally more risky then stocks, bonds and securities and
should in theory generate higher returns for investors” (Kusin, 2007). Art
acts as an asset because it is a piece that is owned and holds monetary
value and can be exchanged for such a value. However, the issue of value
is often subjective because of its heterogeneous nature. Traditional assets
are homogenous commodities they cannot be differentiated, as they are
the same value per stock per company. In art, each piece is unique, thus
making it a market comprised of heterogeneous products.
Art fund mangers have touted the inclusion of 15-30% return of
portfolios as a suitable investment and inflation hedge, citing benefits
such as diversification and price appreciation while recognizing
drawbacks such as illiquidity and high transaction costs. The
attractiveness of art as an asset class is not solely because of its shown
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returns. Today’s high net worth individual wealth is over $30 trillion and
is increasing by 7% per annum. Currently, $300 billion is potentially
available to be invested in art (ABN AMRO report, 2005). Art market
consultant, Spencer Ewen explains the appeal of art by "unique features
of international marketability, a comparatively low correlation to other
stock, lack of transparency and the possibility of desirable risk/reward
ratio where if you get it right profits can be large” (Ewen, 2007).
When it comes to asset planning, one of the key concerns for investors is
how well an asset can hedge against inflation. Due to the high volatility
of art’s value, it is necessary to invest over a longer period to adequately
hedge (Schweizer, 2008). India, one of the booming markets for
contemporary art, works by leading painters have shown price
appreciation in value of twenty fold since 20002. Annual inflation has
remained low. Art which outperforms inflation has become a valuable
and sought after holding for an overall portfolio. The present situation of
art as an inflation hedge can be explained through the past, “it was the
inflation panic of the late 70’s-early 80’s that was the real economic fuel
behind the new vitality of the art market. This newly prosperous,
aesthetically orientated generation, saw their cash eroding in value and
rushed to put their money into tangible assets such as art” (Deitch, 1989).
Many art dealers flaunt the tangible characteristics of art as a valid asset.
Philipe Abdini “it’s safer than shares it’s always there and there will
always be a value for it” (Abdini, 2007). There is truth to the theory that
when the stock market is in a downturn the art market booms. When
markets are bad, people like to invest in something they can touch
(Schweizer, 2008).
While some speculators see inefficiencies in the market as an
opportunity, in relation to the art market the weaknesses have led to
varying support. Some banks support investing in art especially investors
favoring a buy-and-hold strategy. Art presents an alternative approach to
the diversification of portfolios, giving investors optimal allocations and
an opportunity for risk (ABN AMRO report, 2005). It offers returns that
can outperform other asset classes with small or negative correlations to
traditional classes. Art investment can also decrease a portfolio’s risk
because of its low or negative correlation to domestic or international
equity. Investing in art can also have tax benefits. In the United States,
the Internal Revenue Service considers an ‘investor’ in art someone who
can claim that one’s interest is purely as an investment, and indicates that
one must consult occasionally with experts and subscribe to the relevant
2 Source: Thompson financial data, 2006.
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periodicals (Grant, 2006). Furthermore, the structure of the art market is
relatively unregulated, prices fluctuate and returns are high. “The demand
for art is very much dependent on people’s wealth, the belief that this
wealth will last and on the whims of society’s taste” (Gerlis, 2007).
Despite the promises of large returns and the hedging against inflation,
many features of the new commodity of ‘art’ have investors shying away
from it. For one thing, art is very volatile, as an alternative asset it has
performed in some decades then others. In the 1970’s, gold was the best
investment, providing a lower degree of risk than stocks. Art at that time
provided the most nominal twelve month returns, but provided the
greatest chance of loss (Sandler, 2006). In the 1980’s, however, art
outperformed gold, stocks, bonds and real estate. In the following decade,
art returned to its slump. Gold and many commodities showed over 50%
loss. Currently, only real estate and some small stocks have been
performing well, making art and S&P shares the worst ventures (Sandler,
2006). Art, gold and commodities offer the least attractive risk-reward
potential, but provide inferior returns while generating substantially more
risk (Merrill Lynch report, 2006). These three asset classes may be more
appropriate investments for those with truly long term horizons
(Ginsberg, 2007).
A characteristic that is unique to art among asset classes is supply and
availability. There is an inelastic supply for art, since most tradable art is
trapped in private collections while dealers wait for a deluge resulting
from one of the four eventualities: death, debt, divorce, or dissolution.
Many desirable pieces from old masters to contemporary art are held in
museums, which have de-accessioning restrictions (Groysberg, Podolny
& Keller, 2006). Some commentators describe the art market as
inefficient because of the absence of market prices where values cannot
be determined due to lack of published data. Unlike other markets, the
transparent sales of the art market are only held at auctions, on set dates
and in specific seasons. “You don’t wake up one morning, look at the
FTSE, phone your broker and say ‘get out of industrials and into
impressionists’…..if you are buying shares, you can sell them and know
what price you’re going to get. You can’t do that with art (Ecsktein,
2006).
There are many disadvantages in art. These include liquidity, pricing,
performance, costs, track records and conflict of interests. Concerning
liquidity, most art funds cannot just sell the majority of their artworks
from one day to the next, for the sake of retaining their value they are
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normally held for a period of 18 months and thus characterized with high
illiquidity (Ewen, 2007). Regarding pricing and performance, there is no
price standardization and transparency in the market. Art fund managers
can only rely on Mei/Moses Fine Art Index, artprice.com or Art Market
Research. These are however boutique indexes and have not been given
the stamp of approval by any formal ratings agency. Art needs to be
estimated on size, date of creation, condition, name and reputation of
artist. “Price opacity of art is a unique characteristic that will remain. The
market is unregulated and pricing is based on strong networks and
information shared between dealers and clients. It’s a bit like a
conspiracy” (Abdini, 2007). In relation to, the fourth drawback, costs, in
the art market they are hidden. “They are associated with distribution
channels in the forms of commission rates, insurance, transportation and
value added taxes. The fact is that owning art costs money” (Kusin,
2007). Investing in art funds is a nascent market and track records have
not yet been established. Managers of these funds may have esteemed
credentials, like Philip Hoffman, CEO of The London Fine Art Fund was
the Finance Director for Christies for 20 years, their ability to achieve in
this capacity has not been tested yet for more than a couple of years.
Inherent in fund structures are conflicts of interest, for example,
acquisition strategies when dealers inventory are concerned. The
appraisal and purchase of the value of an artwork should be from an
independent party.
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Art funds’ risk.
The British Rail Pension fund is the one of the most prominent examples
of art investing, where in 1974, for nearly a decade thereafter, invested
2.9% of its overall retirement fund portfolio in the art market. Buying Old
Masters, Impressionist paintings, Chinese porcelain, medieval works of
art and antiquities under the guidance of Sotheby’s from 1987 to 1999,
cashed out in a series of sales, the portfolio of artworks sold for roughly
$300 million. With good advice and during a time when the markets were
booming, even though there was not a gain on every purchase, the
pension fund came out ahead, with a reported compounded annual return
of 11.3%. While the British Rail Pension fund success is often hailed as
positive proof of art investment, there are many who are skeptical and
who believe that its downfall was due to over diversification.
However, over the years a number of smaller investors have attempted
investment funds, hoping to achieve the same amount of success. These
included in the 1990’s the Athena Fund marketed by Merrill Lynch, in
2000 Fernwood Art Fund backed by Wall Street veteran art collector,
Bruce Taub, ABN AMRO Art Fund and Falk Art Management. All have
since closed their doors. On the frontier for art fund investment are
emerging markets, areas such as the UAE, India and China. Art from
these countries are relatively cheap and will become more valuable in the
years to come. It has been reported in the press that there are small groups
in India, Singapore and China that are speculating.
The most recent initiatives in formalizing art as an investment that are
still standing was launched in 2004, The Fine Art Fund, owned by Philip
Hoffman and, in 2005, The Art Trading Fund by Justin Williams. Both
are privately owned and not backed by banking institutions. Newly
available research, new indices and strong investor interest because of the
high performance of the art market have helped these two companies
flourish. Spencer Ewen, Managing Director of a London based art
investment consulting firm believes that “the springing up of art funds
will go a long way towards making art a mainstream asset class” (Ewen,
2007).
Art funds pool resources to exploit the inefficiencies in the art market, by
providing active management in art purchase and maintenance and have
access to market intelligence and expertise not available to private
individuals. Art fund managers that were interviewed for this paper
believe that they offer the following benefits: access to art expertise,
insider knowledge of the art market, low transaction costs if you are an
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investor in the fund, due diligence services, good advisory services and
the potential for higher returns. Participating in an art fund gives access to
co-investment and adds diversification benefits to a portfolio. Drawbacks
in their view are minimal; they take the form of fixed exit strategies and
lack of personal involvement with art (Williams, 2007).
Return on investment: art compared to other assets.
Investing in art has multiple benefits. Art has several attractive return
characteristics for a long term investor, including low correlations with
other asset classes and that it holds up well during weak economic
environments (Post, 2007). Unlike stocks and bonds, art prices tend to
have a positive correlation with inflation. The greatest risk involved in
investing in art is that there is low transparency into the market. The art
markets inefficiency is what makes investing in art so difficult. Expertise
in the art market and knowledge of surrounding tax issues are scarce
(Schweizer, 2008). The art market is driven by the following attributes:
Art is a heterogeneous asset. There are few pieces of art of a
specific author traded each year despite the number of fairs and
auctions in the market.
Market transparency is low.
There are large differences in expertise between buyer and seller.
There is low liquidity.
Transaction costs are far higher than other markets.
There are psychological benefits of owning arts, which are not
calculated in the case of owning other financial assets.
The art market has a much weaker equilibrium process than other
securities.
For dead artists, elasticity of supply is equal to zero.
The inventories of stocks can be substituted by other securities, but
each individual work of art is unique.
Monopolies with art doe exist – mainly for owners of art.
The equilibrium price is unknown, so an objective evaluation (for
example the present value of future cash flows) is often impossible.
Mr. Karl Schweizer, Head of Art Banking for UBS feels that “successful
investment in art requires extensive know-how about the artistic quality
and authenticity of the object to be acquired but also peculiarities of the
art market”. In addition, it requires the investor to understand
international factors affecting art such as exchange rate movements,
cultural factors affecting art and market preferences.
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One of the greatest problems facing art as investment, is the question of
value? Price value of art is a derivative of an emotional value and clearly
reflects supply versus demand. The highest price one is willing to pay is
often attributed to a work of art. This is indicative of the auction system
and in most cases the price that has been paid is not reflective of the
piece’s true value. The market virtually lives on the frequently differing
views of its players especially when contemporary art is concerned. Such
works do not usually allow a final, detached and historically supported
quality assessment (Kusin, 2008). This is the greatest challenge facing
today’s players. There is no sustainable formula to assessing a piece’s
ongoing value. This is normally done through due diligence services, by
looking at past sales, and the artist’s position in the market in terms of
success and decline. The ultimate figure is purely guesswork.
Moreover, the value of an artwork stems from multiple factors, it is tied
to, for example, the rising demand for artworks and increasing prices,
which is driven by increasing global wealth. Value of artworks is
constantly changing so one must be aware of artists’ markets when
buying. The Fine Art Fund considers a number of different factors when
making a purchase to determine the value. These include: the condition of
the work, the track record of the artist at auction and its freshness to the
market among other things (Hoffman, 2007).
In the market for art, the prices behave randomly; there can be large gains
and losses occurring within short holding periods, while returns during
longer holding periods are very close to zero, indicative of a random
process with a mean of zero (Baumol, 1986). Art yields a flow on non-
pecuniary viewing services and capital assets, yielding a return from
financial appreciation and is a market thought to largely benefit from
surplus liquidity in the financial markets. Capital markets can temporarily
stimulate the art market in the bull market phase through profit taking and
portfolio restructuring; but they do not determine the long-term price
behaviour in the art market. Even in times of weaker growth and an
unattractive capital market trend, the art market has managed to rise
significantly.
Most segments in the art market react quickly to the changes in the
economic environment, especially for objects in lower price categories.
Economic slowdown brings a drop to demand while increasing supply
and thus forcing selling (Frey, 2003). However, this does not effect or
rarely does so for artworks in the top price category since wealthy
individuals have substantial purchasing power, even in economic
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downturn. Thus the distribution of income and wealth plays a key role in
assessing the price sensitivity of the individual sectors of the art market.
With a market such as art functioning in a grossly disparate manner, one
must consider if this is an alternative that will service the needs and tastes
of the investor or if a more traditional investment should be regarded.
While bonds or stocks are homogenous goods for which markets open
every day, this is evidently not the case for art; transactions for paintings
for which prices are known through auction houses are infrequent and
paintings are the perfect example of heterogeneous goods.
Mei &Moses track sales in a database that now approaches 10,000
transactions. By focusing on repeat sales of the same piece, they hope to
account for the fact that works, even by the same artists, are not identical
(Palmeri, 2007). Other compilers of data use different approaches. Art
Market Research uses results from the big auction houses but lops off the
top and bottom 10% of prices under the theory that outliers unduly
influence averages. Its contemporary art index shows the category
returning 8.7% over the 25 years ending in 2005 (Art Market Research
Index, 2007). This is lower then the art returns from Mei and Moses.
Whichever method is used, it’s unpredictable for investors to count on a
similar return, especially if they’re buying works from emerging artists.
Nearly all of the research into art as an investment concludes that it is
riskier than stocks. Drawbacks include that it is far more difficult to get
the same level of diversification in art that you would from mutual funds,
which can contain hundreds of stocks. Commissions to buy or sell art at
auction through a dealer can easily top 15% (Schweizer, 2008) far higher
than what you would pay for a stockbroker. Liquidity is poor, even in hot
markets items fail to sell at auction. If you are lucky enough to have long-
term capital gains, art work is taxed at the full 28% rate vs. 15% for
securities (Palmeri, 2007). Furthermore, dividends are limited to the
enjoyment you get from looking at the art.
The uncertainty roiling the financial markets over the last few weeks has
many asking questions about the future of the market for art. Maybe the
market is ripe for correction (Taylor, 2007).
The graphs reported in appendix are comparing four art indexes from
London based Art Market Research (ArtQart, Modern Art, Contemporary
Art, American Art) with UK and US real estate indices, hedge fund
indices, bonds, and equity (The New York Stock Exchange, FTSE 100,
S&P 500), over a two year period, February 2005 to January 2008.
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Looking at the overall picture over the last two year period, annual
returns for art continue to exceed the return for stocks, bonds, equities
and real estate, making it a good contender for those interested in
diversifying their investment portfolio. The period looked at was short
term, however, as stated earlier in the chapter, in the long term stock
performance dominates art over the last twenty five years (Mei/Moses Art
Index, 2007).
Sentiments about the future outlook of structured
investments in art.
As for the market ahead there is great speculation into where art will be
going. At this time, the market is in a great place for all sectors especially
contemporary art, which is continuously increasing, and furthermore the
art market is becoming more global with the emergence of Contemporary
Indian and Chinese Art. With the emerging markets in India, China and
United Arab Emirates, art pieces from these regions are becoming more
and more popular. Not only is art being bought from these countries, but
as people are getting richer there are more investors from these global
regions. Patriotism is also an important part of the growth of the art
markets in developing countries; many collectors are buying works from
their own countries as a patriotic measure and as a confirmation of their
cultural identity. While the art market is clearly in a boom right now and
although there are predictions of increasing the value of the market, we
know “everything happens in cycles” (Ewen, 2007). While the market is
up right now it’s inevitable their will be a decline in the future.
Conversely, Ewen’s sentiments are not shared by all of the art market.
Many are increasing their work force, new galleries are opening and there
seems to be a constant supply of new clients wishing to start buying art.
As long as global wealth creation continues the art market can evade a
slump. Time will tell whether the credit crunch and looming recession
will have any affect on the art market. “Wealth is a big contributing factor
to the success of the art market. The ‘hedge fund’ billionaires are
encroaching into the territory” (Ginsberg, 2007).
The idea of not buying into what is ‘in’ or something that will bring
prestige is a lesson that has been learned from the art boom of the 1990’s,
where the Japanese infiltrated the market and bought significant amounts
of half decent Impressionist paintings. Since that catastrophic event in the
art world, the market has been making maneuvers to make sure that an
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incident such as that does not happen again. Art professionals are
concerned with the future of the market and making sure that it is an
industry that remains strong. Therefore the presence of creative artists is
important, as well as, servicing clients so that they will be challenged and
excited by art.
What is the outlook for art funds themselves? The results of my research
and interviews have lead me to argue that art funds have difficulty in
meeting investor expectations and this is a key reason to why so many
have failed. Going forward they need to be aware of these specific
causes: lack of institutional support and management issues. High net
worth individuals ready to consider investing are said to be having
problems grasping the concept of art funds because of the lack of market
transparency, lack of liquidity, ease of exit from the fund and a
misunderstood risk/return ratio. Ultimately for art funds to become
successful they will need the involvement and backing of some of the
major banks SGAI AI Art Fund could have a fighting chance in the
future. From an institutional point of view, many of the funds lack
structure from both an organisation and a legal aspect (Schweizer, 2008).
In addition, banks make most of their revenue from commission fees
from transactions, in art funds your money is normally lucked up for a
period of 5-9 years.
Management of art funds is a rare combination of experienced investment
skills and art market professionals. Institutions and private investors are
concerned with this especially when it comes to the senior art advisors.
Art advisors credentials hold little weight in the financial industry, and
they are presumed to be lacking in ability to manage money, their role is
also questioned because of the perception of conflict of interest. Are they
acting on the behalf of the fund or because they are unable to persuade
their own clients to buy the art? Most of the expertise in the art market
lies with professionals who buy and sell art on their own account and that
is in addition to advising a fund – this does lead you to wonder who is on
the same side, against or in dispute with each other? Art funds need to be
structured in a manner that protects them from such risks. The interviews
have revealed that art fund managers prefer the private equity model over
a hedge fund model as there is less risk.
Other deficiencies that art fund managers need to worry about are making
sure that the structure of the art fund is clearly communicated. Potential
investors are most concerned about the spread being too high. Huge
money is spent in fees going to intermediaries and professional advisors.
As art funds do not give a yield, the running cost of the fund most come
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from profits taken on pieces of art works sold or on interest of un-
invested money. Such an added expense to a fund can affect the rate of
return. Extra costs such as insurance, shipping, storage must also be
considered in addition to management fees.
Another concern for art fund managers is the fact that institutions, are
calling for the art market to be regulated. Many in the art world believe
that this will never happen. Economist argue that in the future the art
market will be provided with a vehicle for price transparency, the large
majority agree that private sales data, around the 50% mark, will never
become available to those without insider knowledge. Art funds should
be more concerned with obstacles facing them such as removing the
mystery surrounding them in terms of how they operate. They are seen as
the “last bastion of the asset market” (Ewen, 2007) and have loose
intellectual property rights. The art market can be characterised as being
localised and protectionist, gallery owners are themselves obstacles in
their own rights and behave with silo mentalities.
The fact that art indices only work in the secondary art market and not the
primary one is another obstacle. The Mei/Moses indexes are based only
on auction results, not on private sales. Reliability of information makes
it difficult to develop a reliable index. Another problem to note within the
art market index is how often such an index can be updated to reflect
current trends. Art Market Research index is updated monthly but
Mei/Moses indexes are updated annually due to the smaller number of
transactions in the art market place.
Social changes in taste and the way art funds are perceived can make or
break them. Many private collectors have banded together against the
notion of investing in an art fund, thinking it ‘unethical’ as they believe
collectors should buy what they love and not confine themselves to
limited areas of art and artists. The excitement to them comes when they
find that ‘fantastic’ piece. Collectors are less likely to invest as they feel
they need control over their purchases and want some sort of quality
control.
The entering of more art funds into the market will create volume and
greater choice for investors, all positive things for investors. As the
concept is fairly new, time, has presented the gravest concerns for
investors, track record will be corrected with the increase in competition.
With more competition comes more public financial support which will
help establish investor confidence.
16
The art market lags behind the stock market in its trends, so how the
panic over the financial markets, sub prime mortgages and credit squeeze
will affect the price of art is yet to be soon. Anyone whom can provide
liquidity to a market that has none –whether by buying up or downgraded
mortgages or, potentially, by creating a market in art futures stands to
make a lot of money (Taylor, 2007). Many in the financial world believe
this is where the art market is heading and it’s the beginning of a major
liquidity squeeze.
While the returns on art may not always beat the stock market and art
may not always be the fastest growing asset, when measured against
spending on rapidly depreciating alternatives, it’s a great asset and
provides valuable portfolio diversification. There is a value of putting a
portion of ones asset into art, as the art market has echoed the stock
market over extended periods. Different kinds of art investments offer
radically different risk return profiles. Buying the works of contemporary
art, such as brand new ‘undiscovered’ artists is a very high
risk/potentially high reward approach. How long the contemporary art
market will continue to keep rising remains unclear especially as it is very
much linked to the taste and interest of the wealthy.
17
References.
Abdini, P, 2007, Interview with Mr. Abdini, Director, Bellamy’s, 27th of
September, 2007
ABN AMRO Bank, 2005, Art Funds Initiative: 2005 Global Road Show
Art Trading Fund, 2007, Art Trading Fund Investor Report, August-
October, 2007
Baumol, W, 1986, “Unnatural Value: Or Art Investment as a Floating
Crap Game.” American Economic Review, 76: 10-14
Bell-Slater, M, 2007, Interview with Mrs. Bell Slater, Artist and
Volunteer at Artfunds.org, 10th of November, 2007
Deitch, J, 1989, The Business of Art, Prentice Hall, N.J.
Douglas, S, 2008, Larry Gagosian, Intelligent Life, The Economist,
vol.1, issue 3, spring, pp. 100-107.
Eckstein, J, 2006, “Treating Art as an Asset Class,” Investing in Art,
Jeremy Eckstein and Associates, London
Ewen, S, 2007, Interview with Mr. Spencer, Partner, Seymour Art
Consultancy, 26th of October, 2007
Frey, B, 2003 “Art Markets and Economics: Introduction,” University of
Zurich, Journal of Cultural Economics, Vol. 21, 2003
Gerlis, M, 2007, Interview with Mrs. Gerlis, Journalist, Art Newspaper,
18th of November, 2007
Ginsberg, M, 2007, Interview with Mrs. Ginsberg, Curator, British
Museum, 19th of December, 2007
Grant, D, 2006, “Art investment companies begin to make purchase,”
Main Antique Digest, 20th September, 2006
18
Groysberg, B, Podolny, J, Keller, T, 2006, “Fernwood Art Investments:
Leading in an imperfect marketplace,” Harvard Business School
Publishing, Cambridge, M.A., 2006
Hoffman, P, 2007, Interview with Mr. Hoffman, Director, The Fine Art
Fund, 18th of December, 2007
Jyrämä, A, 1999, Contemporary Art Markets: Structure and Practices,
Helsinki School of Economics and Business Administration.
Kusin, D, 2008, Interview with Mr. Kusin, Owner of Kusin & Co, 8th of
January, 2008
Mei, J.P and Moses, 2002, M, “Art as an Investment and the
Underperformance of Masterpieces”, American Economic Review,
December 2002.
Merrill Lynch/Cap Gemini & Ernst & Young, 2006 “The World Wealth
Report2006”.
Palmeri, C, 2007, “The Artful Investor. New research calls art a smart
investment, but skeptics point to high costs and high risk”, Business
Week, March 12th, 2007
Peppiat, G, 2007, Interview with Mr. Peppiat, Gallery Owner, 17th of
October, 2007
Post, S, 2007, Interview with Mrs. Post, Membership Director,
Contemporary Art Society, 11th of November, 2007
Sandler, L, 2006, “Art Is Among Worst-Performing Investments, Merrill
Lynch Says,” Bloomberg.com
Scheweizer, K, 2008, Interview with Mr. Schweizer, Head of US Art
Banking, 11th of January, 2008
Taylor, K, 2007, “Seeking a hedge for art,” The New York Sun, August
13th, 2007
Williams, J, 2007, Interview with Mr. Williams, Director, Art Trading
Fund, 2007
19
APPENDIX
Figure 1: Art vs. NYSE
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Figure 2: Art vs. S&P 500.
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20
Figure 3: Art vs. FTSE 100.
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ARTQCON Index
ARTQMOD Index
ARTQART Index
Figure 4: Art vs. Hedge-funds.
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PX _ L A S T
Hedge funds indices chosen for comparison are listed below:
Credit Suisse Tremont Hedge Fund (HEDGNAV)
Barclay Global Hedge Source Fund (BGHSHEGDG)
Hedge Fund Research Equal Weighed Strategies (HFRXEW)
21
Figure 5: Art vs. Bonds.
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Figure 6: Art vs. Real Estate.
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S PR E IT Inde x P X_ LA S T
F 3R EA L Index PX _L AS T
AR T QAR T Inde x
P X _L A S T
AR T QMOD Inde x
P X _L A S T
AR T QC ON Inde x
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22
Figure 7: Art vs. All Indexes.
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2007
S PX Ind ex P X _L AS T
NY A I ndex PX _L AS T
BG HS H ED G Inde x
PX _ L AS T
HE DG NA V I ndex
PX _ L AS T
HF R XE W Index
PX _ L AS T
S PR E IT Index P X_ LA ST
F3 RE A L Index PX _L AS T
AR TQ AR T Index
PX _ L AS T
AR TQ MOD Inde x
PX _ L AS T
AR TQ C ON Index
PX _ L AS T
AR TQ AME Ind ex
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The movement of international art prices in conjunction with other asset prices is preliminary to our understanding whether art is a luxury good. It is well known that there are linkages between art market prices and equity prices. However, less is known about the structure of dependence between these variables and the influence of gold prices and sentiment. We analyse art prices, at the outset using Granger causality and error correction models (ECM) to capture the long term dynamics between art prices, equity markets, gold prices and investor sentiment. The dataset we use is unique and covers British art prices from 1895 to the present. Initial results do not give a complete picture of price movements or a fitting description of wealth effects; to rectify this we look at short term dynamics in the art market. We assume a regime switching model to describe the movement of prices using a threshold variable that drives prices into possibly locally explosive regimes. These results indicate a dynamic wealth effect in that high (low) stock prices lead to subsequent increases (decreases) in art prices. However, this approach means that elasticities are now stochastic, and we redefine what a luxury good is. This is further explored by directly calculating elasticities from our model and its variants to analyse properties of art as a luxury good. Our threshold approach gives deeper insight into the impact of different market conditions than conventional ECM and cointegration modelling.
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This paper constructs a new data set of repeated sales of artworks and estimates an annual index of art prices for the period 1875-2000. Contrary to earlier studies, we find art outperforms fixed income securities as an investment, though it significantly under-performs stocks in the US. Art is also found to have lower volatility and lower correlation with other assets, making it more attractive for portfolio diversification than discovered in earlier research. There is strong evidence of underperformance of masterpieces, meaning expensive paintings tend to under-perform the art market index. The evidence is mixed on whether the "law of one price" holds in the New York auction market.
Interview with Mr. Kusin, Owner of Kusin & Co, 8th of January
  • D Kusin
  • J Mei
Kusin, D, 2008, Interview with Mr. Kusin, Owner of Kusin & Co, 8th of January, 2008 Mei, J.P and Moses, 2002, M, “Art as an Investment and the Underperformance of Masterpieces”, American Economic Review, December 2002
Interview with Mr. Williams, Director, Art Trading Fund
  • J Williams
Williams, J, 2007, Interview with Mr. Williams, Director, Art Trading Fund, 2007
Interview with Mrs. Gerlis, Journalist, Art Newspaper
  • M Gerlis
Gerlis, M, 2007, Interview with Mrs. Gerlis, Journalist, Art Newspaper, 18 th of November, 2007
Interview with Mr. Hoffman, Director, The Fine Art Fund
  • P Hoffman
Hoffman, P, 2007, Interview with Mr. Hoffman, Director, The Fine Art Fund, 18 th of December, 2007
Interview with Mrs. Bell Slater, Artist and Volunteer at Artfunds.org
  • M Bell-Slater
Bell-Slater, M, 2007, Interview with Mrs. Bell Slater, Artist and Volunteer at Artfunds.org, 10 th of November, 2007
Contemporary Art Markets: Structure and Practices, Helsinki School of Economics and Business Administration
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Jyrämä, A, 1999, Contemporary Art Markets: Structure and Practices, Helsinki School of Economics and Business Administration.