ART AS INVESTMENT, INFLATION HEDGE
by David Shvartsman
December 21, 2004

The booming art market: it has been one of the year's sensations, at once both a cultural and financial phenomenon. A new generation of buyers has come into the market, driving up prices for modern and contemporary artwork while making headlines in the process. Accompanying the excitement and record prices is the burgeoning idea of art as a form of investment.

Private banking units have expanded their offerings to include art advisory services. Investment professionals and academics argue over the case for including art in investors� portfolios, citing potential benefits (diversification, price appreciation) and common pitfalls (illiquidity, high transaction costs). The promotion of art as a legitimate asset class seems a bold new element of this current boom phase. Regardless of whether or not these ideas are the product of a current mania, some investors may be asking themselves, �Is art a suitable investment or inflation hedge for me?�

This brings to mind another question; how does the specter of inflation affect decisions about asset allocation and investing? In past inflations, people have looked to gold, silver, or land as possible stores of value. But does inflation help fuel demand for collectibles and art? Apparently so, in the case of the 1970s collecting craze that found its way to stamps, numismatic coins, and Chinese ceramics. Will faltering stock markets and a rising public awareness of inflation create a modern parallel to our (U.S.) 1970s inflationary period, helping to sustain the current vogue for artworks?

This scenario may already be playing itself out in Russia, home to one of the art world's �hottest sectors�, where indices of works by leading Russian painters show price appreciation of 250% - 600% since 1997. [1] Journalist Mike Collett-White, anticipating the success of the recent Russian art sales held in London, attributed much of the demand to the cultural conscious of Russia's newly rich. [2] There may also be some inflationary psychology at work; Russia's annualized inflation is topping the 10% mark, according to news that appeared two weeks before the sale. [3]

The Growing Demand for Art

Earlier in the year, ARTnews magazine provided a gauge for the popularity of contemporary art by tracking �The Ten Most Expensive Living Artists�. Some of the artists mentioned in the article include: Lucian Freud, Jasper Johns, Jeff Koons, and Frank Stella. �All of them have achieved single-work sales of $5 million or more, while some have multiplied that figure many times over.� The article went on to note that records set at auction could be trumped by the prices fetched through private sales of an artist�s work. For example, Gerard Richter�s auction record is the $5.4 million paid for his �Three Candles�, but his 1960s paintings have since sold for $9 million - $10 million in the �secondary market�. [4] Personally, I am reminded of the fact that Richter�s painting, �Candle�, graced the cover of Sonic Youth�s �Daydream Nation� album back in 1988, his work having caught the group�s discerning eye. Indeed, it is a �swing to the trendy and modern by 30-40 year olds� that is largely responsible for the rise of modern and contemporary art, as one observer noted. [5]

This trend was further documented in a Barron's cover story, entitled �Cool Art, Hot Prices�. The article highlights the speculative frenzy that has hit the �red hot� contemporary art market, in contrast to the newer collectors� dismissal of works by Old Masters and French Impressionists. Capturing the mood of a soon-to-be period piece, the article reported that, �so many fans flocked to this spring�s annual Armory Show of contemporary art on a New York pier that the Coast Guard started turning people away, fearing the pier would give in�. [6] After looking over some of the article's (unintentionally?) humorous quotes from interviewees and viewing the works displayed (a $650,000 inflatable pool toy held up by chains, for example), I'm left to wonder if the article's subheading might have read, �Parlor Pieces for the Parvenus�. While the canny art collector may operate in this field with some success, it hardly seems an environment for prudent investment.

Still, with advisory services mushrooming, and price research becoming more available, art investment is a growing idea. What accounted for all this interest?

Changing Perceptions

In the 1989 edition of The Business of Art, art maven Jeffrey Deitch recalls his start in the art business and the prevailing views towards art at the time. Compared to today, the contemporary art world seemed cloistered, with relatively few buyers. �In the mid-1970s very few people thought of art as an investment.�[7] It would not be long, however, before demographic and economic trends joined to change the art world. Deitch pointed to the coming of age of the well-educated baby boom generation and America's increasing appetite for the finer things as catalysts. �However, it was the inflation panic of the late 1970s-early 1980s that was the real economic fuel behind the new vitality of the art market. This newly prosperous, aesthetically oriented generation, and their parents as well, saw their cash eroding in value and rushed to put their money into tangible assets such as art.�[8]

Meanwhile, overseas, The British Rail Pension Fund was setting the precedent for institutional art investing. During the 1970s it invested 2.9 % of its portfolio (about 40 million British pounds) into multiple categories of art. The fund sold most of its art portfolio in the late 1980s, and achieved �a return on its investment of 11.3% compound to December 1999.� [9] This success paved the way for such recent entrants as Philip Hoffman�s Fine Art Fund, a limited partnership designed to acquire an art portfolio that will be sold at a later date. The partnership successfully raised its target of $70 million towards that purpose last year. 70 percent of the partnership�s funds came from private investors. [10]

Looking to further the argument for art as an investment, professors Jiangping Mei and Michael Moses constructed the Mei/Moses All Art Index, an index of prices based on repeat sales of artwork at auction. Using this data, they hoped to overcome what they felt were �two major obstacles in analyzing the art market�heterogeneity of artworks and infrequency of trading.� [11] Moreover, this data would be used to compare price appreciation of artwork with the performance of stocks and bonds. They found that over the period of 1875-2000, art under performed equities but outperformed �some fixed-income securities�. [12]

Taking somewhat shorter views, the index shows a favorable performance picture for art versus stocks and bonds. Between the beginning of 1999 and end of 2003, the All Art Index rose at an annualized rate of over 8%. During the same period, Ten year Treasuries gained 6.7% a year and the S&P 500 declined 0.7 percent a year. Over a 20-year period ending March 31, 2004, stocks came out ahead, but art was shown to outperform both stocks and bonds again over a 50-year period. [13]

Mei & Moses further concluded that volatility of art prices was lower than previously reported, and that art�s correlation to stocks and bonds was lower as well. This information allowed the authors to suggest that art can provide a possible diversification benefit to investors. [14]

Weighing the Pros and Cons

Some investment professionals and academics are saying no to art as investment. Yale finance professor William Goetzmann has studied returns on art for over a decade and does not consider it to be a good investment. He considers art to be an unproven hedge against falling equity markets and says it offers �only moderate returns with substantial risk over the long term�. [15] Others have noted that art indexes are misleading because they fail to account for the high transaction costs at auction or from dealers. [16] The combined commissions paid at auction by both buyer and seller can total 25%, and dealer fees are often higher. [17] Also, art cannot be considered an investment in the sense of an income-producing asset. Unlike dividend paying stocks or interest paying bonds, art must be sold to yield gains.

Authors Luc Renneboog and Tom Van Houtte examined art�s investment merit in relation to stocks in a 1999 paper entitled, �The Monetary Appreciation of Paintings: From Realism to Magritte.� Using auction prices for Belgian art from the 1850s-1950s, they compared the returns a �well-diversified art portfolio� would bring an uninformed investor with returns from stocks over the period 1970-1997. They found that �risk adjusted buy-and-hold art returns generally under perform stock market returns� and that the diversification benefit of art was limited. Although some charts of the �hedonic art indices� showed periods of outpacing Belgian inflation, they concluded that overall, art is not a good inflation hedge. [18]

Possible Risks and Benefits of Art Investment.
Risks	Benefits
� Possibility of owning/selling frauds and fakes	� Possession of rare or one of a kind item.
� Illiquid auction/dealer markets.	� �Non paper� financial asset.
� Maintenance, restoration costs.	� Potential price appreciation.
� Artworks produce no income unless sold.	� May have limited correlation to other assets.
� High transaction fees.	� Possible diversification benefits.

As the table above shows, art ownership is not unlike other financial or life decisions. There are pros and cons that must be considered carefully, and weighed against our personal experiences and needs. While certain trends in the art business may remind us of those found in the financial markets, the debate continues as to whether or not artwork serves as a legitimate area for investment.

[1] Collett-White, Mike. �New Money in Russia Headed for Art World.� National Post November 29, 2004.

[2] Ibid.

[3] �Russian inflation to top 10% - World Bank�, Interfax, November 17, 2004. Retrieved December 18, 2004. < http://www.interfax.ru/e/B/0/26.html?id_issue=10721384>.

[4] Divine Thomas, Kelly. �The 10 Most Expensive Living Artists: Tracking the Highest Prices Paid for Contemporary Artworks.� ARTnews May 2004: 118-123.

[5] �Antique Market Shows Distinctive Trends: Buyers Rely on Websites to Track Prices, Items.� Edmonton Journal. June 12, 2004.

[6] McGee, Suzanne. �Cool Art, Hot Prices: Young Buyers Are Plunging Into the Market.� Barron's. May 10, 2004: 21-23.

[7] Caplin, Lee. The Business of Art. Englewood, New Jersey: Prentice Hall 1989.

[8] Ibid.

[9] �Finance and Economics: Betting on Genius; Art as Investment.� The Economist. Aug. 23, 2003: 60.

[10] Uhlfelder, Eric. �Performing Art�. Institutional Investor. Aug. 2004: 71-72.

[11] Mei, Jiangping and Moses, Michael. �Art as Investment and the Underperformance of Masterpieces.� February 2002. Research paper. < http://pages.stern.nyu.edu/~jmei/artgood.pdf >

[12] Ibid.

[13] Uhlfelder, Eric. �Performing Art�. Institutional Investor. Aug. 2004: 71-72.

[14] Mei, Jiangping and Moses, Michael. �Art as Investment and the Underperformance of Masterpieces.� February 2002. Research paper. < http://pages.stern.nyu.edu/~jmei/artgood.pdf >

[15] Uhlfelder, Eric. �Performing Art�. Institutional Investor. Aug. 2004: 71-72.

[16] Sullivan, Aline. �You Know What You Like, But What is it Worth? Investing in Art/Seeing Painting by Numbers;� International Herald Tribune. Aug. 21, 2004.

[17] �Finance and Economics: Betting on Genius; Art as Investment.� The Economist. Aug. 23, 2003: 60.

[18] Renneboog, Luc and Van Houtte, Tom. �The Monetary Appreciation of Paintings: From Realism to Magritte�. 1999. Research paper. < http://greywww.kub.nl:2080/greyfiles/center/1999/doc/62.pdf >

© 2004 David Shvartsman
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David Shvartsman
Finance Trends Matter
Chicago, IL USA
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