By: Jacinta Sherris
With advantages such as the low risk and disadvantages in liquidity, the art investment market is growing with a complicated fortune.
This past November, Salvator Mundi (Latin for Savior of the World), a painting of Jesus Christ, by Leonardo da Vinci, was up for bid at the renowned Christie’s auction house in New York. Despite disputes over its authenticity and undergoing restoration, the painting sold for a whopping $400 million in less than 20 minutes, making it the world record for the most expensive work of art ever sold. In 2004, a dead shark preserved in formaldehyde solution within a glass container, a piece called The Physical Impossibility of Death in the Mind of Someone Living by Damien Hirst, sold for $12 million making it the most expensive artwork sold for its time by a living artist.
The reasons some pieces of art can sell for such exorbitant prices has to do with cultural significance, limited supply (especially if the artist is deceased), artistic trends, branding, and ultimately the super wealthy driving prices upward as they compete for the most valuable in auctions. The artist’s reputation, the size and genre of the artwork, the prices of similar pieces, and the locations of the artists exhibitions all play incremental roles in creating the sense of urgency and competition that drive bidders to pay far beyond what many would believe for a painting or sculpture. Ultimately, according to Clare McAndrew, founder of Art Economics, the reason that art can be so expensive is due to its scarcity, and how everyone is chasing the same few artistic names. Works of art do have creative, aesthetic, historical and cultural values, but it is often the vying for a few top name brand pieces that can drive up prices to astronomical amounts. The price tag of a painting or sculpture resembling the value of luxury real estate might receive eye rolls from the public, but high figures have caught the attention of economists, investors, and bankers. Nowadays, about three-quarters of art buyers are acquiring art for investment purposes. Many have begun to explore the benefits of protection that art as an asset class can offer a portfolio, but investors are still wary of the various perils associated with this type of diversification.
Artwork is categorized as a low-risk asset because it generally does not lose its principal value. This is due to artworks’ behavior as a luxury good and thereby having a high-income elasticity of demand. Artwork also shares features of many positional goods in that its value is a function of its desirability and its supply is inherently scarce (even in the short run for a living artist’s pieces). Characteristic of most luxury, positional, and even collectible goods, the value of artwork tends to appreciate over time and rarely loses principal value as its supply is inherently limited. Investors have begun to utilize these features that categorize art assets to guard their portfolios against inflation and currency devaluation. Artwork is also likely to retain value during turbulent macroeconomic conditions, though the extent of this durability is often of much debate between financial experts.
Some further advantages that come with purchasing art for investment purchases include certain tax benefits, and although artwork does not generate a discounted cash flow similar to a bond’s coupon or a stock’s dividend, some artwork can be lent out in return for a rental fee. There are also numerous financial institutions and even art funds that allow artwork to be put up as leverage for loans which could be used by an institution or an individual to refinance, raise liquidity, or fund new investments. Art markets are also known to be less volatile than other asset markets, primarily due to illiquidity constituting a primary characteristic of this asset class. Many investors and art industry experts also assert that the art market is negatively correlated with other financial assets, making it an ideal candidate for diversification. However, the extent of this is often debated and has not always proven to be true.
Like any asset class, artwork is not without its shortcomings that investors need to be aware of. Art is incredibly illiquid which makes speculative, short-term investments enormously risky and unattractive. One of the major issues with artwork is the opaqueness surrounding pricing and prevalent lack of transparency in the art market. Most investment decisions are based off an asset’s worth in relation to its price, but neither can be pinned down in an elusive art market as many transactions happen behind closed doors, and the parties involved are usually incredibly secretive about pricing. Art galleries and art dealers rarely reveal prices to the public, making past auction prices the best place to start in determining the value or potential future value of a piece. A couple of indexes attempt to report on values of the art market including Art Market Research and Mei Moses, though they are unable to capture the entirety of the market.
Issues such as these make it imperative for those looking to purchase art as an investment to consult with an appraiser. Because art assets tend to turn over relatively slowly and trade thinly, they must be assessed and analyzed with human expertise and subjectivity in order to gauge possible returns on investments. Hiring such experts can be costly, however, and increases the transaction costs of investing in this asset class. Nowadays, art investment funds are making it easier for prospective investors to diversify their assets into the art industry while simultaneously reducing the cost of acquiring the information needed to make such decisions.
Art investment funds operate much like private equity firms. They combine art industry expertise coupled with opportunities for returns on investment. Well-managed, knowledgeable art funds generally generate returns between 6-8%, while returns from 10-15% are considered extremely lucky and require increased risk. The Fine Art Fund is one such example that boosts an average return of 9% on investments before 1% to 3% in management fees and 20% of profits made (only after a 6% return) are taken into account. Still, such firms have limited opportunities for investments that often depend on the duration of their funds as well as how much money is being offered for deposit.
Art funds are offering investors the promise of the benefits of low-risk returns that come with investing in art, and have succeeded in lowering transaction costs for prospective investors. However, they are not without their shortcomings and do not entirely wipe out the issues facing art investors, primarily the lack of transparency central to the art market. After the recession of 2008, many investors were eager to diversify into less volatile markets. Whether art markets will remain a viable option for investors depends on how willing the industry is to accommodate to the needs of investors in terms of regulation and transparency.
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