The Art of Investing in Art
Art has long been considered an investment of passion, one that not only offers aesthetic pleasure but the potential for economic benefit. Only recently has art investing been viewed through the lens of modern portfolio theory and considered as a potential alternative investment in a portfolio of assets. Though research continues to shed more light on what has been historically an opaque market, studies show that art can offer long-term return potential that is uncorrelated with other asset classes.
Market paradigms have shifted dramatically over the last several decades, as newly created wealth in emerging markets such as China, Russia and the Middle East has increased the number of participants in the art trade, giving the market greater resiliency. Undeterred by a rough economic environment in recent years, collectors globally are paying record sums for top works. Despite art's attractive upside as an investment, the lack of market transparency, illiquidity and high object costs have generally limited participation to a select class of wealthy individuals, leaving most institutional investors on the sidelines.
Newly acquired wealth in emerging economies has globalized the art market in many ways, giving it much-needed depth and resiliency.
Global market overview
Given the murky nature of the art market, it is often misunderstood. Unlike traditional asset classes such as stocks or bonds, there is very little transparency associated with art trading. A large segment of the market is executed through private transactions, making it difficult for outsiders to gain insight. This overall lack of transparency also makes estimating the size of the market a true challenge.
According to The European Fine Art Foundation (TEFAF), the size of the global art market is roughly US$56 billion,1 which reflects public auction data and an estimate of art gallery and private art dealer sales during 2012. That total represents a six-fold increase in size over the last 20 years.
As wealth has grown exponentially beyond North America and Europe in the last several decades, the art market has become more globally influenced than ever before. According to the 2012 RBC/Capgemini World Wealth Report, which analyzes economic factors that drive wealth creation,2 Asia-Pacific surpassed North America in its high net worth individual (HNWI) population to become the largest HNWI region for the first time. With newly acquired wealth, the demand for luxury goods increases. Fueled by triple-digit growth in recent years, China (including Hong Kong) overtook the U.S. for the first time as the world's largest market for art and antiques in 2011. However, an economic slowdown in 2012 pared back art market participation, and China slipped to second place behind the U.S. in terms of global market share.
Performance and diversification potential
To understand what drives the art market, it is important to recognize the main motivations behind art buying. Art is unique as an investment in that there are many non-monetary investment reasons behind collecting. Surveys have shown on average only 10 percent of HNWIs own fine art and paintings purely as a financial investment, though other surveys suggest a much higher percentage.3 Regardless, the actual non-financial value, though difficult to extract from overall value, shouldn't be ignored.
First, there are intangible values associated with having and enjoying a piece of art. Art provides collectors with social status and prestige— an outlet to signal their wealth or lifestyle to others. There are also the philanthropic benefits of purchasing art, from financing up-and-coming artists to building a collection to preserve cultural heritage. Chinese buyers, for example, have been repatriating cultural assets that have been in the hands of Western owners, which has contributed to a rise in values of Chinese works in recent years.4 The obvious monetary benefit is the opportunity to gain a return on investment, though investors also recognize art as a way to store value, to hedge inflation and to diversify their portfolio allocation.
Several studies have been conducted to measure the historical returns of art investments. The two main approaches involve analyzing repeat sales of the same object at auction and developing a hedonistic model, which takes into account characteristics and qualities of the individual works. Though calculation methodologies, sample data and time periods vary, most studies show that over long periods of time art prices have trended upwards, kept pace with inflation and, in several studies, have outperformed more traditional asset classes such as equities and bonds over certain time periods.5
There are, however, several limitations in measuring art performance. Typically, only auction records are used. Though auction data is large and represents a wide range of price points and collecting categories, much of the turnover in the market (i.e., private sales) is not captured. In addition, transaction costs and other fees are not fully reflected. Auction fees for the buyer can exceed 10 to 20 percent of the hammer price. Other ongoing expenses such as storage, insurance, advisory and appraisal costs may also eat into returns.
The Mei Moses® World All Art Index,6 which is calculated annually and based on resale values of paintings sold multiple times at auction, shows positive returns over the last 50 years, albeit mixed relative to other asset classes. Figure 2 illustrates that annualized returns on art as measured by the Index have done particularly well in recent years, outperforming U.S. equities and fixed income over the last 10 years and outpacing U.S. and international equities over the past 15 years. This is due in part to a relatively softer correction during the 2008 recession and a quicker recovery.
Volatility (standard deviation of annual returns) of art was lower than U.S. and international equities as well as commodities during the last 25 years. Art tends to move in slow and long-term cycles. The data show that when considering performance on a risk-adjusted basis (returns divided by standard deviation) over the last 50years, art (0.51) looked comparable toU.S. equities (0.58). On a 20-year basis,art (0.51) looked relatively strong,outpacing international equities (0.32)as well as U.S. equities (0.44).
Figure 3 shows that in the last 25 years,art had almost no correlation with U.S.equities and was negatively correlatedwith fixed income and REITs. Theanalysis suggests that art may adddiversification benefits within thecontext of an investment portfolioof assets.
Selectivity a factor
It is worth noting that certain art genres do better than others for a number of reasons. Art can be an unpredictable investment in which returns may be heavily influenced by not only a number of macro-factors, such as economic growth and inflation, but also micro-factors unique to the market, such as global interest in certain genres and changes in trends, tastes and culture.
As figure 4 shows, the Mei Moses World Post-War Contemporary Index has greatly outperformed the Mei Moses World Impressionist Modern Index, particularly over the last 10 years. As with other asset classes, investors should look to diversify their holdings to manage their exposure across different genres, artists or types of work.
Hedging against inflation
As a store of value, art has shown to be an effective hedge against increasing prices when inflation rises. Figure 5 shows the average yearly return for years when inflation (as measured by the Consumer Price Index) is higher or lower than the 40-year median (3.3 percent) and rising or falling from one year prior. On average, art has performed significantly better over the last 40 years during periods when inflation is rising, particularly high and rising. Returns on art appear weakest when inflation is falling. The analysis of art performance in various environments suggests that art can be used as an effective store of value in prolonged periods of rising prices.
As emerging markets become wealthier, the art market is likely to continue to be comprised of a much more diverse set of art buyers. This is generally good news. When investors are concentrated in one geographic region, the art market as a whole is very sensitive to that region's economic environment. For example, a steep decline in the art market in the early 1990s was in part attributable to the decline in the Japanese economy. During the highly inflationary 1980s, Japanese investors were investing heavily in art. As the Japanese real estate market started to collapse in the early 1990s, investors there pulled back and many segments of the art market crashed. In theory, a more global market is more resilient. As figure 6 shows, art prices took almost a decade to recover from that slump when the market was more concentrated geographically in a small number of wealthy countries, while the downturn during 2008 was short-lived incomparison.
An alternative for the institutional investor?
Studies have shown relatively strong returns for art over extended periods of time, and recent risk-adjusted performance looks comparable to other traditional asset classes. Low and even negative correlations with equities and fixed income suggest an allocation to art can potentiallydiversify one's portfolio.
Despite the return potential, institutional investors, such as pensions and endowments, have historically been reluctant to invest in art or art funds. The British Rail Pension Fund (Railpen) is widely considered one of the first institutional investors to allocate money to a fund of art works. In the mid 1970s, about US$70 million, or roughly three percent of Railpen's capital, was invested in approximately 2,500 works of art. This collection included a wide range of works including paintings, manuscripts, furniture and ceramics. Railpen was reportedly able to deliver an annualized return of 11.3 percent in its art allocation from 1974 to 1999. Critics, however, were quick to point out that most of the returns came from just a few works that were sold at a very good time in the market.
It is worth noting, however, that views on alternatives have evolved significantly over the last several decades and will continue to evolve. What most fiduciaries today consider mainstream alternatives—namely, hedge funds, private equity and real estate—were not always considered so. Today, more than 22 percent of institutional investors' portfolios are allocated to such investments, a significant increase from just a few years ago.7 Whether or not art will be accepted as a viable alternative asset remains to be seen. However, given a low interest rate environment, unease about the global equity and bond markets and chronic pension funding shortfalls, less mainstream assets such as art may draw more attention among institutional investors seeking greater return and diversification potential.
The JPMorgan Chase Art Collection
Established by David Rockefeller more than fifty years ago, the JPMorgan Chase Art Collection is one of the world's most celebrated corporate collections. Over 450 locations display pieces from the collection, true to Rockefeller's original vision of "art at work." Today, Lisa K. Erf, Director and Chief Curator, JPMorgan Chase Art Program, oversees the collection as director and chief curator.
Thought: What is your role as director and chief curator?
LE: My job is to manage a collection of around 30,000 pieces in 450 corporate locations worldwide. The firm sees this collection primarily as a cultural investment, not a financial one. When Rockefeller started the collection, he envisioned it as a way of bringing art and creativity to the workplace. We seek out works that are high quality, innovative and inspirational, and ultimately contribute to our corporate culture. We also look for good value.
Thought: Can the public view the collection?
LE: The JPMorgan Chase Art Program curates travelling public exhibitions as an ongoing component of its dedication to share the collection with audiences and communities around the world. From 2007 to 2009, Collected Visions: Modern and Contemporary Works from the JPMorgan Chase Art Collection, an exhibition of more than 70 highlights, travelled to Istanbul, Dubai and New York City. Other exhibitions have toured Argentina, Brazil, Chile, Japan, France, Venezuela and throughout the United States. We also have a full agenda of loans with many museums all over the world—an average of 12 works are on loan to different museums every year.
Thought: What types of works are included in the collection?
LE: The collection has a variety of art forms and styles. It includes paintings, photographs, prints, sculptures, indigenous objects, textiles, such as African cloths and American quilts, and even utilitarian objects, such as maps and weathervanes. More than 8,000 artists and 100 nationalities are represented.
Thought: What are some of your favorite pieces?
LE: I love some of our earliest acquisitions—a mobile by Alexander Calder, a mural by Sam Francis and a 1959 oil painting by Joan Mitchell. I love them because they're magnificent works that are highly collectible and museum quality now, but at the time they were acquired, the artists were relatively unknown. Part of our vision is to discover original and innovative artists and their works to inspire future generations, not necessarily to follow current trends.
Thought: Do you work much with clients who may be interested in collecting or investing?
LE: We share our passion, exchange information and network with clients, but my department does not work directly with clients to buy or sell their art.
Thought: To which artists are you looking with interest at the moment?
LE: Latin-American artists, particularly those from Colombia, Argentina, Peru and Brazil, are interesting. Miguel Angel Rojas and Oscar Munoz are two examples of mature artists whose art is still undervalued, in my opinion.
Special thanks to Michael Moses, co-founder of the Mei Moses family of fine art indexes and Beautiful Asset AdvisorsLLC, for his contributions to this article.
3 In the 2011 RBC/Capgemini Global Wealth Management Financial Advisor Survey, 42 percent of advisors believe their HNW clients invest in art primarily for its potential to gain in value.
4 Patrick Mathurin, "Gold feels weight of Paulson Curse," Financial Times, 8 January, 2012, www.ft.com.
5 Orley Ashenfelter and Kathryn Graddy, "Auctions and the Price of Art," Journal of Economic Literature, Volume 41, Issue 3, September 2003, www.aeaweb.org/jel.
6 Used with permission; more information about the Mei Moses Art Indexes may be found at www.artasanasset.com.
7 2012 Russell Investments' global survey of 144 large institutions, cited by Mark Cobley in "Pension Funds Embrace Alternatives,"www.efinancialnews.com.