Art as an Investment: a challenging, but potentially profitable market

ART AS AN INVESTMENT: a challenging, but potentially profitable market

Published as “Brush Strokes” (Investing in fine art), Wealth Magazine (London), September 2004.

by Brian Bloch

Particularly for high-net-wealth individuals, a prudent investment in fine art can constitute profitable and enjoyable diversification. Experts agree that an artistic investment of between 5% and 15% of one’s total portfolio may yield both profit and pleasure.

The results can be spectacular. A drawing by a minor Spanish master purchased for $26 000 in 1998 fetched $164 800 at Sotheby’s less than six years later. Such dramatic returns are the exception rather than the rule, but there is money to be made from art.

Some experts have calculated impressive art market returns over a period in which European and other stock markets went backwards in the short run and nowhere in the medium term. Michael Moses of the New York University’s Stern School of Business, argues that the art market has outperformed the S&P 500 by half a per cent over the last 50 years. Art Market Research in London claims that prices for the top 2% of contemporary artists have risen 72% over last three years.

With financial markets currently so volatile and inflation creeping upwards, there is a strong case for diversifying into hard assets and fine art. The low correlation with both equity and bond markets suggests that art can contribute substantially to constructing an optimal portfolio. The Wall Street Journal and a number of advisers and investors regard art as a legitimate asset class alongside bonds and hedge funds.

Admittedly, the last few decades have shown that, in comparison to most other markets, the art market develops with less regularity and predictability. However, this creates as many opportunities as it does risks. The art market bears a certain resemblance to volatile and unpredictable foreign equities. Yet, as with foreign shares and funds, these art investment risks can counter other risks in a portfolio, lowering overall volatility. This principle is, after all, the basis of optimal portfolio construction.

Enthusiasm for art investment is demonstrated by the existence of a London-based Fine Art Fund, and Fernwood Art Investments in the USA are also planning art funds. These remain exclusive investments and look likely to remain so for the time being, but they indicate a significant investment trend.

Some art works are relatively conservative investments. Really wealthy investors who want a relatively safe asset with an almost guaranteed rise in value can stick to the classics, both old and new. Monet, Dali and Picasso are almost always sound purchases. Even if the same money would buy a stately home or villa, if you already have these assets, why not diversify into some luxury paintings?

Furthermore, art investment can be particularly profitable for those with good negotiation skills. Some artists really are starving, others may still be happy to negotiate and some dealers really want to sell. This is potentially one of the greatest advantages over other more conventional asset classes. Prices are not fixed and it is possible to bargain prices down as much as 50 per cent below the asking price.

All the same, there is no denying that the art market is not a straightforward one. Its complexity and lack of transparency can be daunting. The market is unregulated and understanding quality and value is tricky.

Indeed, there is more than one kind of value. There is the trade value that a dealer will pay, an auction value or minimum price (generally 40-50% of the gallery value), and then there is an ideal or hypothetical value. The purpose generally determines the relevant value concept.

There are also strange “value hierarchies” in the art market. For instance, a Dutch expert explains that as far as animals are concerned, horses fetch more than dogs which, in turn, are better investments than sheep. Even the seasons have their relative values. Paintings of winter and autumn tend to fetch more than those of spring and summer. Perhaps more predictably, pictures of flowers and fruit are better investments than skulls and dead birds.

Art expert Peter Mellor warns of some common art market dangers. Insiders inflate prices at auctions, posters are sold as prints and there is the obvious danger of forgeries and fake signatures. Transaction costs are frequently high. As in the stock market, psychological effects and subjectivity may exert a strong influence. Also, sales cannot be made in a hurry and it is not uncommon to have to wait three to six months for an auction.

Partly because of such risks, art investors need to like what they buy, want to live with it, and study both the artistic and business aspects. The art market is one in which knowledge of various kinds is critical. German art historian Beate Kemfert points out that, far more so than with equities and bonds, people are not, and should not, be indifferent to their paintings and sculptures. She explains that “nobody should buy art purely as an investment, because unless people really enjoy it, they will not bother to find out what they really need to know”.

Informational asymmetry is as familiar as in the stock market. That is, the buyer tends to know a lot more than the seller or the other way round. Precisely for this reason, investors need to make sure that this asymmetry works in their favour.

Because of the difficulty of keeping informed, investors should limit their field. Sculptures from the 80’s, photographers of the 70’s or painters of a specific time, place or genre, constitute market segments in which informed specialisation is possible. Visits to galleries, exhibitions and art fairs are all forums for gathering data as well as having a good time. Networking with the right people at arty cocktail parties can also help.

Where and how does one buy and sell? There are established and trustworthy galleries and dealers in most larger regional centres. Some regions have a particularly high concentration. For instance, in Germany, Cologne is well known for its modern and contemporary art.

Regular art fairs offer yet another dimension to the market. Art Basel has been prominent since 1970 and there is the ARCO in Madrid, Arte Fiera in Bologna, Art Frankfurt and the Art Forum Berlin. Visiting these events is always worth while to get a feel for the market in all its facets.

Since the 80’s, auction houses have become increasingly popular, even for private buyers. Art historian Christel Sieling Klinger gives some tips. The European “auction season”, she explains, reaches its peak in Autumn and the New Year. There are mixed auctions and those dedicated to specialist areas.

Auction house catalogues are important sources of information in the art market. Together with lists of prices, they provide a realistic economic orientation as well as insight as to how auctions function.

Many countries and regions have well organised associations which offer lists of dealers and auction houses. It is not difficult to locate well-established and reputable outlets, although caution and information from objective third parties remain advisable.

Like other regional markets, those for art rise and fall over time. Until the 50’s, France was the world leader, but, with its current estimated world market share of 5.6%, has been superseded by London and even more so by New York. The UK as a whole accounts for 29% of world trade and the USA for 50%. It is important to monitor such trends over time.

Buyers can and should turn to independent experts and valuers such as the British David Freeman (http://www.freemanart.ca/atists.htm). Their main tasks are to determine if a work of art is genuine and if so, what constitutes fair value. Such individuals are widely used by banks and insurance companies, and increasingly by private individuals as well. Again, most European countries have well established bodies which accredit experts and provide relevant information about them and their services.

Books, magazines and the internet provide constant information on international and national art market developments. For instance, a report on Fine Art and Antiques Market in Switzerlandcan be obtained from http://www.internationalbusinessstrategies.com/ , a research organisation based in Maryland, USA. Sites like http://www.artnewsonline.com/ provide useful and valuable investment insights.

Insurance is yet another significant issue. Especially at the upper end of the market, it is essential to have works sufficiently and reliably covered for all relevant risks. Art displayed at home must also be protected by alarms and possibly other security measures.

There are unique legal dimensions to the art world. Ownership and transfer rights sometimes cause problems and it is worth ensuring that, for instance, the seller really owns the painting! Some lawyers even specialise in this area. In any event, insurance specialists generally know the right people.

Despite the above, the impression should not be created that art investment is only for the rich. Beate Kemfert regards an entry into the market with a couple of hundred pounds as quite possible. Indeed, part of the excitement, and of optimising investment potential is finding up and coming young artists whose popularity is set to rise. Regional art associations promote young artists. Buyers with a flair for such things are often surprised to find that their modest purchases are worth considerably more over a few years.

In summary, the art market resembles others in some respects, but has its own unique characteristics. If these are exploited, rather than their becoming pitfalls, art is a sound investment for those genuinely interested in both the aesthetic and financial aspects.

Considering the appalling scandals that have beset more conventional investment markets over the last few years, branching out into aesthetically pleasing and tangible assets that one can admire daily, can be more rewarding than a piece of paper signifying title to a bond or share.