It’s no secret that a well-diversified portfolio is crucial for accumulating long-term wealth. Stocks, bonds and mutual funds can provide variety, but some of today’s savvy investors are probing beyond these conventional asset classes and looking at alternatives.
Increasing competition in the wealth management industry has created demand for new wealth management models, and one of the ways firms are meeting their clients’ need for diversification is by incorporating art-related investments into their asset mix.
The 2010 World Wealth Report noted a rise in “passion investments” such as art, luxury yachts, wine, antiques, coins, cars, memorabilia, jewelry, gems and vintage watches. Of these, art was seen as the most probable of all such investments to be acquired for its potential to gain value over time.
Let’s have a look at the pros and cons of art as an investment.
Less volatility, good returns
Artprice, a leading online art price database, reports that the average return for art is 7.6%.1 In comparison, the S&P 500 has historically produced an average annual return of 9.8% over the past 90 years.2 Though stock market returns may be greater, those higher returns come with higher risk due to stock volatility and the fact that a bull market can quickly transition into a bear market. This is where the value of investing in art shines through, since it offers more insulation against factors that directly affect stock prices, such as shifts in global economic conditions or political turmoil. Art prices can be fast to rise but slow to fall.
Scarcity equals value
Art investments offer simplicity and clarity. When stocks plunged during the 2008 recession, most investors didn’t really understand what had happened to all the money they’d lost. The impact of the recession on the art market was negligible,3 though, because art has a limited supply. This scarcity can make the value of art more stable during economic recessions.
In the 2001 recession, art outperformed the stock market.4 This demonstrates how art, unlike typical investment vehicles, has a strong negative correlation with the stock market. It can go up in value even when the market crashes, making it a good candidate for portfolio diversification. As art is an alternative investment, it also lets you earn capital gains the way conventional stocks do, which provides some relief with taxation.
A mature and viable asset class
The role of art in society continues to change as investors take a different approach to wealth management, increasing their exposure to alternative investments. The art industry is currently worth over $3 trillion,5 showing that art is no longer merely appreciated for its aesthetic value, but also for its viability as an alternative asset class.
A case in point is the British Rail Pension Fund. In the 1970s and 80s, it invested in art under the guidance of Sotheby’s, an auction house, purchasing old masters, impressionist paintings, Chinese porcelain and medieval works. The pension fund later sold the art for $300 million, resulting in a compounded annual return of 11.3%.
Art fund instead of collecting
The growing number of high-net-worth individuals looking to diversify their portfolios has led to the creation of several art-based investment funds. The Fine Art Fund, launched in 2004, specializes in western art from 1500 to the present, with emphasis on impressionism, surrealism, modern and contemporary art.
A 2012 study conducted by Tilburg University analyzed data from $1.2 million worth of auction sales of paintings, drawings and prints. The study concluded that art, on average, appreciated at a yearly rate of 3.97% between 1957 and 2007. Over the quarter century leading up to 2007, the yearly return was 5.19%, which is higher than many traditional investments (see Figure 1).6
Source: Buying Beauty: On Prices and Returns in the Art Market by Luc Renneboog and Christophe Spaenjers – April 2012
Knowing if the price is right
Putting a monetary value on a work of art can be an opaque process. Galleries and dealers are sometimes secretive when it comes to pricing art for a first-time sale, or even on the secondary market. There are some research tools available, and auction results are a good indicator of value.
In the pursuit of beauty, it truly is buyer beware as there are numerous hidden costs that can reduce the return on your investment. You’ll need to consider various expenses such as framing and display costs, appraisal fees, sales tax, auction fees, insurance premiums and storage fees.
It’s an actual object
Storing, displaying or shipping often fragile works of art can be challenging and is always expensive. Rare artifacts are finicky about things like lighting, humidity and temperature swings. Your investment is a physical, often unique object, not just an arrangement of pixels on the computer screen that displays your investment account.
The majority of art investments are held for the long term. This means your money is locked up, which creates liquidity issues. And when you want to sell your investment, you’ll need to find a potential buyer in what is often a small marketplace. Buying art is easy, but selling is hard.
Also keep in mind that galleries may be reluctant to resell contemporary art they’ve already sold once, because they stand to make more money selling newer work by the same artist. Top auction houses want to sell proven names and will not sell emerging or declining artists. Like many talent markets, the art market is characterized by a winner-takes-all dynamic, where the top names reap most of the rewards while the remaining ones are unable to sell.
Before committing any serious capital, you need to understand and embrace the challenges that exist in the art market. So do your research, and speak with an investment advisor about how to include art and other passion purchases in your portfolio.
T.E. Wealth, Toronto
3 & 5 https://www.researchgate.net/publication/228225215_Art_as_an_Alternative_Investment_Asset
6 Buying Beauty – https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1352363
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