Art as a Financial Asset
Throughout history, art as an investment has been endemic to the art world, though with varying degrees of importance. However, the recent rise in demand for contemporary art, bolstered by a rise in disposable wealth among the world's richest, has inflated the price of art in both private and public markets to exorbitant, never-before-seen levels. With this increase in price has come increased visibility and coverage by press, critics, and other media outlets, and a strong degree of scrutiny has followed. The massive globalization of our financial sectors as well as the greater transparency and acceptance that investments have enjoyed in the eyes of the public have increased the desire to maximize returns from all sectors of the economy, and new theories of diversification and hedging incentivize investment theses with low or negative correlation.
Massive demand and an increase of consumers in the art market has provided a degree of liquidity that hasn't existed prior, lessening the stigma of reselling art, and helping to create a commodity-based art market that lends itself well to speculation and investment. With sought-after characteristics of sustained returns, low correlation to debt and equity, and a seemingly recession-proof model of sustained demand, the progression for financial institutions and funds to venture into the art world was inevitable.
Indeed, art has had a history of success in the investment markets, though with considerable volatility and controversy regarding its strength. In 2011, the art market outperformed the S&P (a common indicator of the stocks markets) by 9%, and returned nearly 11% to investors, which is an extremely significant margin in the investment markets. The Mei Moses All Art Index, an indicator of art performance, has recorded six years of returns in excess of the S&P. This index was constructing by Jianping Mei and Michael Moses, and was created using public auction house data over the past fifty years, on artwork that has been sold more than once to track changes over time. Until the 2000's, according to the index, art has followed a boom-bust cycle, peaking in 1990, with an average return relatively similar to stocks.
After 2000, however, commensurate with a giant bull market in the art world, art has consistently outperformed the stock market. Some articles have cited the overall market as growing at over 40% per year, However, results have been mixed; since the art market is extremely fragmented, with different geographic, style, socioeconomic, and quality segments subject to different drivers or risk and volatility, it is difficult to provide an overarching return with a definitive answer in terms of the strength of the investment market. It seems that in general, risk is greater than equity markets and return is generally lower, suggesting that its value lies more in diversification than as a primary investment. Below is a graph of the Mei and Moses art index, showing the variation in segment, in comparison to the S&P:
Mei and Moses concluded that art trends had a low correlation with equity markets, and generally outperformed stocks. There is clearly a lack of consensus in art market historical return valuation, no doubt due to the youth of the analysis and lack of agreed-upon metrics. What we can safely conclude, though, is that art can be highly useful in a diversified portfolio due to its non-correlation with other asset classes and the obvious increase in demand for its investment potential. Below is another analytical graph developed by Mei and Moses highlighting the increased returns of portfolios that include art as a hedge:
Contemporary art investment surged after 2000 for several key reasons. The increasing sophistication of the investment community became comfortable with conceptualizing complicated financial vehicles such as derivatives and credit default swaps, that eventually accepted art as another commodity that could be valued and traded in a specialist market. The availability of capital increased, with wealthy private and institutional investors having more money at their disposal after the market boom of the late 1990s and increasingly willing to take on more risk and diversify away from traditional investment portfolio into new areas of investing, such as art. A third factor was the perception that existing portfolios were failing to keep pace with inflation, through capital appreciation or through revenue flow, and were easily seduced by the rising prices of the art market, the sustained demand, and the perception that demand would always outweigh supply. Art indices and increased coverage on prices and returns helped legitimize art as an attractive alternative investment in this regard. Finally, in an era that saw a significant increase in the number of wealthy individuals, art became an attractive means of signaling wealth and status, with buyer's preferences shifting to an emphasis on appreciation of culture in the new millennium.
Another indicator of the increased demand for art, and the entrants to the art market, is the recent number of art funds that have been created. Art funds, in theory, are in a unique position to profit from the appreciation of art and the current bull market, as they possess several distinct advantages to dealers: they are capable of lower costs and overhead, as they don't require large exhibition spaces, they can employ a broad selection of expertise (unlike dealers who often specialize), the large capital bases provide unprecedented purchasing power, and longer, buy and hold investment horizons are possibly the ideal way to invest in art. Art is very unique, in that it a superior good (meaning as wealth increases, demand for the product increases) yet it is highly uncorrelated with other popular investment vehicles.
However, these funds have historically produced unexpected, disastrous results, suggesting an inherent weakness of art as a standalone investment. According to an essay by Noah Horwitz, 35 highly-publicized investment funds have opened since 2002, attempting to capitalize on the rising demand in the marketplace and the greater emphasis on art as an investment. Instead of utilizing art as a tool for diversification, the funds invested nearly 100% of their capital in art. Today, 20 or no longer operational, six have produced results below expectations, six are undetermined or haven't been operational for a sufficient time period to form a conclusion, and only three have met or exceeded expectation. This corresponds to an 8% success rate, and nearly a 60% failure rate, which are clearly dismal statistics. Only two of these "successes" have achieved returns over 6%. Non-traditional art investment funds have similar results. The Tosca Photography fund, long one of the successful art funds over the last decade, closed in October of last year, and is liquidating its collection, though it is achieving remarkable returns for its initial investors. It seems that regardless of the literature claiming successful returns on art, financial firms have been unable to capture it in the long term.
Why is it so difficult to gauge the art market, and if there really are a history of high returns, why is it so hard to capture them? One facet of the problem is the difficulty in valuing a product that delivers no cash flows or has no inherent value. Most of valuation depends on the buyer, and the emotional connection derived from the artwork, the aesthetic qualities associated with it, and the following subjective value produced. Because art produces different effects for each prospective owner, valuations may differ greatly depending on who the buyer is, and thus prices are hard to predict and normalize. Other important drivers of value include market demand, which is the ultimate indicator of prices in the public auction market, and is very susceptible to manipulation and the "herd mentality" that assigns price based on perception. Liquidity is of paramount concern in the speculation and investment markets, and not as significant for long-term collectors; because art generally has a high face value, the confidence that it can be quickly and easily resold to capture future returns is extremely important for investors who need to ensure returns regardless of market conditions. Because there are no central exchanges for artwork, daily volume is severely limited relative to other forms of investment, art has an extremely high liquidity risk associated with it, and this risk will factor into prices, further inflating them. Prestige is also an important factor, as brand names of artists and auction houses lend considerable weight in determining price -- often an association with an artist increases value to a greater degree than the actual substance of the art, Damian Hirst being a prominent example.
Because of this inherent uncertainty, prices are given in an estimate range, allowing for substantial variation, with a high risk of incorrect valuation due to the lack of comparables for contemporary art. Other factors can include seller's motivations, which might be boredom with the piece or a desire to "cash out" and liquidate due to financial concerns, and buyer's motivations, which might be a particular attraction to a piece of art, or a desire to ride a market wave of momentum. These interest rarely align. Scale, size, quality of materials, aesthetic considerations, and condition can also produce substantial variation in price, and further complicates valuations. With so much variability in market valuation, unique to the art market as a whole, it is very hard for correct valuations and mutually agreed upon prices to be reflected in auctions, and as a result market inefficiencies and manipulation play a great role in affecting market activity. All in all, the inherent uncertainty of the marketplace complicates investing to a degree not found in other markets, and severely impairs the ability of professionals to engage in arbitrage or capital allocation, and maintains inflated prices and decreases expected and realized returns for investors.
Market inefficiencies are another factor that inhibits the success of the investment market. As has been shown, conflicts of interest, asymmetry of information, manipulation of public interest, and other problematic conditions prohibits the complete efficiency of the marketplace. Because art does not produce cash flows or pay out dividends, its value for investors rests entirely in its resale price, and because of the longer-term investment horizons, many factors can alter its price during the time between purchase and sale. Much of the cost consists of "sunk" items, such as transaction, storage, insurance, and shipping expenses, and since it is difficult to alter these line items, the only way to increase profit is to increase resale vale. Unfortunately, many unethical factors exist for this very purpose. The market is fraught with secrecy and manipulation, with the public market served by auctions in which the houses serve as middlemen. They are not subject to regulation or oversight; the government treats the art market as one that deals in luxury goods, and thus does not provide legal protection for its participants. Players in the public markets deliberately collude to deceive unsophisticated investors, lured by highly publicized prices and fanfare. Chandelier bidding occurs when dealers or agents attend the auctions and deliver fake bids to protect their artists and artificially drive up the price; the ultimate buyer thinks that the next highest price was a reliable indicator of market value, when in fact it lacked all substance. There is no transparency in the bidding process. The auctioneer functions as an effective agent for the seller, with guarantees, minimum bids, reservation prices, and other enticements, none of which are available to the public. The buyer pays almost all of the commission. Unsophisticated buyer enter auctions because there is no other way to establish value in the young auction market; unlike other industries, no two works of art are identical, there is no basis for comparison, and most of the value is subjective.
Auctioneers, when confronted with the deception, argued that removing this type of artificial bidding would remove "drama" from the market, and threatened to leave New York if regulation passed. The only guidelines successfully implemented required auctioneers to identify the pieces in which they had a financial interest, but even then, the identifications were minuscule, incomprehensible symbols in their auction catalogs that ultimately produced no change. Indeed, auction corruption has been rampant, as Alfred Taubman was recently sentenced to prison for his collusion in a six-year price fixing scheme with fellow auction house Christie's, an event that was perhaps indicative of a more endemic problem in the art industry. Assymetry of information is a problem that is more rampant than ever. There is little regulation, and certainly no incentive to disclose information to the public in an effort to increase transparency, a quality that is extremely important for investor confidence. For example, Damien Hirst's golden skull, entitled For the Love of God, was announced to be sold at a price of $100 million, which would make Hirst the highest-paid living artist in history. However, it was later revealed that the owners of the majority stake in the purchase were none other than Hirst himself and his gallery, in an attempt to inflate the price, increase his prestige, and perhaps save face.
These problems used to occur in other markets; the stock market experienced its share of price-fixing and collusion by experienced investors in the 1920s, and that behavior is now illegal. Finally, the press is hardly investigative, instead following the "hot" artist and driving public fervor, which leads to higher prices, which increases the incentive for further collusion and market manipulation. These issues of inefficiency and unethical behavior, together with the opaque prices, low liquidity, and large information asymmetries, help to produce a market that is still in its infancy and is hardly attractive to investors.
It seems like present markets are catching up with these line of reasoning, and the bull market may be over for the time being. The above analysis and the quality of art as a product with low correlation to other asset classes suggests that art may work best as part of a diversified portfolio of assets, used as a hedge investment against other markets or recessions. Art differs from most investment products in that it does not carry inherent monetary value, has no easily agreed upon valuations due to concrete monetary cash flows and discounted cash flow analyses, and are traded in a market with sufficient liquidity to ensure resale and consumer confidence. Not only does art fail to satisfy these requirements, but its very value depends in its uniqueness and scarcity. If art investment ever succeeded in becoming mainstream and ubiquitous, the result will be the commercialization of art, the mass increase in its production to meet the rise in demand, and its eventual homogeneity as arbitrage and mass scrutiny eliminate inefficiences and equalize differences in value.
This seems like an unlikely result according to the current state of the market and the unethical practices described above, and art would need to become an accepted product that required government intervention and increased competition with other auction houses and middlemen entering the industry, and perhaps several established exchanges. However, the very process of commercialization would ultimately destroy the scarcity and uniqueness of art, and thus its value; as art investing introduces art to the greater global consumer base, demand would skyrocket, and there would be artist who would mass-produce supply to meet demand and capture profits. Art would become homogeneous, and thus diminish in value as a signal of prestige and an aesthetic decorative piece, and the very investment theses which seek to profit off art's value will ultimately destroy it. In short, the process of the commercialization of the art market can ultimately lead to its demise -- art cannot function as a consumer product, as it provides no cash flow and has no truly functional value.
The art market is a long way from maturity as an investment industry, but for it to maintain any value in the future, it needs to retain its scarcity and uniqueness, something that is categorically lost with its opening to the world as a commodity product, which seems a natural byproduct of its increased popularity and vitality as an investment. As a result I think there is a ceiling on the amount of speculation that can be weathered by the industry, and natural supply and demand factors should provide enough pressure on returns to maintain this equilibrium. However, in order to achieve that state, systemic change must take place in the art market to increase government oversight, remove conflicts of interest, increase ethical behavior, increase transparency and valuation techniques, and increase competition. For the time being, art as an investment is best served through efforts of diversification, and as a fraction of a greater portfolio.
For an interesting Intelligence Squared debate on ethics in the art world, please view the series below, available on youtube:
http://www.youtube.com/watch?v=xpsTNdYeG6U
Arguments and reasoning cited directly are linked in the above text, but other works and articles drawn from include:
http://artmarketmonitor.com/2011/02/07/mei-moses-art-beat-sp-500-in-2010/
http://www.bfletcher-associates.com/article_5.pdf
http://www.artbusiness.com/osoquspeccoll.html
http://college.holycross.edu/eej/Volume28/V28N4P443_463.pdf
http://www.caslon.com.au/artfundsnote.htm
http://artmarketmonitor.com/category/art-funds/
http://www.economist.com/node/16990811
http://www.slate.com/articles/business/moneybox/2006/06/painting_for_profit.html
1 Comment
user-5b6bf
Hi Cheryl,
I just realized that there is a change in time zone. All I day I was cognizant of the midnight deadline, and posted this at 11 pm my time (in California) without realizing that this is 2 am on the East Coast. I hope this isn't a problem, and I apologize for the mistake.
Evan