Fine Art Investing- a New Asset Class
Outside the aesthetic return created by art, there are excellent reasons people are utilizing art as a new asset class. Art is attractive from a financial investment point of view over the long run as it is a store of value that generates moderate positive real return. Art has minimal correlation with stocks and bonds which offer diversification possibilities over time and across the business cycle.
More and more, there's a strong momentum recognizing art by investors as an investment asset class, not to mention almost anyone with an art budget. Society becomes more educated in their estate and financial planning and they begin to view art as a sophisticated investment. Many take on a deeper and measured approach to portfolio management and are willing to consider diverse strategies that encompass more realistic and possible investment classes, such as art and other collectible assets.
Notably, the current socio-economic context creates a demand for ‘real assets’ because many lost a lot of money in the financial crisis by investing in products they did not understand and are turning back to things that are closer to their heart and which, at the same time, offer protection and a return on investment.
With financial markets still in flux (as will usually be the case as there are no guarantees), some High Net Worth Individuals (HNWIs) indicated they are approaching their passion investments as ‘investor-collectors’, seeking out those items that are perceived to have a tangible long-term value. The two categories that are the most attractive to these ‘investor-collectors’ are art and other collectibles (coins, antiques, wines, etc.) (source-World Wealth Report 2017).
The fine art industries are complex and it is recommended to work with a professional to secure works based on knowledge and research. It allows those with great inside knowledge to make substantial benefits. Therefore, it is not surprising to notice that the art investment funds set up so far are generally organized for individuals who spent a significant amount of time in the art markets and are able to negotiate key agreements to lower transaction costs.
Conditions such as these, it is most likely that they could deliver announced targeted annual return by profiting from market inefficiencies in order to buy and sell advantageously, by finding compelling opportunities when objects are sold, such as: death, discretion, debt or divorce and by anticipating trends, with substantially less transaction costs.
Finally, besides a potential increase in value, art provides additional financial benefits:
-Art has no geographical risk and can be moved easily
-Art provides a hedge against inflation and currency devaluation
-There is little risk of losing your principal if you purchase wisely
-No minimum investment is required
-Art investments enjoy favorable tax treatment
-Reduction of risk because of its low correlation with other financial assets
-Possibility of earning extra revenue by lending out the work or of participating in events, such as exhibitions and meetings of experts
-Art can be insured against calamity risk
Art advisory services, the most common in the financial sector, tend to complement the traditional range of private banking services to provide ‘non- financial lifestyle services’ in order to offer a holistic approach to wealth management.
Generally, art advisory services include:
-Art research: authenticity, art historical analyses, information on art market, price research
-Art transactions: purchase and sale, representation of interests
-Art management: evaluation, insurance, storage, transportation, collection advisory and management
-Structured solutions: inheritance planning, art foundations and trusts, philanthropy
-Art lending: organize lending portions of private or corporate collections
Art lending, not very developed by the financial sector and mainly supported by specialised boutiques and art consulting, seek to turn art into a working asset. The main services include:
-Term loan: borrow against art
-Revolving lines of credit
-Dealer inventory financing
-Bridging loans, advances and auction guarantees
-Arranging loans to museums and exhibitions
Final category, art investment services, is still in its early development (comparatively speaking). It finds its source in the growing recognition of fine art as a new alternative asset class and supports the evolution of art investment products, the role of art to positively diversify investment portfolios and the integration of art into wealth portfolio analysis. Initiatives mainly come from the academic world and from individuals or groups of individuals that combine a strong expertise in art and finance such as art brokers, art designers, and art appraisers. Main art investment services are:
-Art investment research
-Monitoring and selection of art funds
-Structuring of art investment funds, funds of art funds and art investment clubs
It is interesting to note that today art markets have substantial press coverage and are covered by nearly all main financial newspapers such as The Economist, CNBC, Financial Times, New York Times, Bloomberg, and Wall Street Journal.
When we're looking at the historical evolution of fine art markets, we can observe that they have been in continuous evolution expanding to new countries and new customers worldwide. Today they have reached a global impact in the sense that nearly everywhere on earth people are buying and selling artwork every day and are moving around the world to find the desired piece for their collection, business, or investment.
According to the World Wealth Report, art markets are global, large and growing. It is estimated that the outstanding value of artwork is in excess of "US $3 trillion with annual sales of the art and antiques market in the range of US $50 billion, with its peak of US $65 billion in 2007". After the triangulation of data, we estimated that the art markets experienced a compounded annual market growth of between 8% and 9% for the period 1993-2009. The conjunction of economic, social and technological factors supports the view of a continuous growth of fine art markets. They note the key economic macro trends are as follows:
"1. There is a world wide increase in prosperity especially in emerging countries. Once a nation grows richer and its citizens reach a certain level of affluence, they start to buy art. This has been the general financial trend since the beginning of the industrial age. China is now third in term of sales of fine arts at auctions after the U.S. and the UK.
2. Art markets become more transparent due to research in finance and economics as well as data dissemination
3. As more and more countries are becoming wealthier, there are more artists and an increased interest in art from a larger community
4. The proportion of all luxury spending on art will continue to increase as investors look for assets that would retain their value in the longer term especially in a period of economic uncertainty".
We live in a time greatly characterized by the globalization of cultural activities, which creates an interest in art to unparalleled levels. So, social macro trends will highly support the expansion of the art markets. All societies and cultures seek to reinforce their national and/or individual identities through the acquisition of artwork of their own place and time and new museums will continue to be built: more than 100 museums over the last 25 years. Branding and art acquisition goes hand in hand, so it's evident art budgets are being applied from everything to businesses, personal identity, national identity, and education.
Deloitte with art and finance states technological evolutions strongly support the positioning of art as a new asset class. It increases transparency as new market opportunities and business models in an internet and digital world emerge, such as online auction houses, online databases, online and real time market data dissemination, online catalogues and fairs, artist websites and new communication channels through art designers and art consultants. More people are discovering that acquiring paintings, prints, sculptures and valuable collectibles is now within their reach. And not only is it in their reach, it especially serves as an asset for buyers for corporate or local business spaces, where that investment can do wonders for their brand, and serve as an investment for future renovations.
So how do we value fine art? Valuation is one of the most critical points when offering investment pieces in works of art, which can be tricky if aesthetics need to play a role in a collectors decision as well. Questions such as- how can investors trust the performance announced when there is no transparent art pricing mechanism commonly accepted, is fair and common. Well, in finance, the price of a financial asset is determined by the market, an index and some specific factors. So, not as ambiguous as one would believe. However, today there is no forced standardized art valuation methodology and there is no guarantee that the fair price of a work of art is the result of an independent quantitative analysis. The fair price of a work of art is usually the result of a qualitative analysis provided by expert appraisers and art designers using relative valuation, i.e. by looking at how similar assets are priced in the market and at a combination of qualitative aspects of the work of art, the scarcity of supply relative to demand, consumption utility and individual perceptions. That's why it's imperative to work with someone who knows what they're looking at, and can properly assess the work and it's place in the market.
One resolve to such predicaments, comes by a suggestion made by Professor Moses, is to clearly describe a methodology that combines a qualitative and quantitative approach. This methodology includes the expert appraiser’s valuation to cover the subjective if not emotional part embedded in the art price, the auction house appraisal to have a sense of the market and to market the work of art using an index. Moses and similar researchers indicates that the single strongest independent explanatory variable of the future price at auction of a work of art is the prior sale price inflated by an appropriate art market index. Their research indicates that art indices can explain 80% of the variability of the price and if you add the hedonic variables you can explain up to 88% of the variability of the price.
By recognizing an index, the art markets can structure themselves in a transparent and fair way. Such as the S&P/Case-Shiller price indices created 20+ years ago, and a commonly accepted transparent valuation methodology. As the research on indices progresses and more compelling databases are developed, it is likely that soon a family of indices will be used as recognised benchmarks which will ease and increase the use of art as an asset class. And we agree, the art world is due.
Baird asset management (2009) defined three types of collectible buyers- the pure collectors, collector/investors and investors for whom buying collectible assets is a pure financial game. In their report, they assume that the last two categories own 1/3 of the total collectibles valued around US $4.3 trillion. This estimation of direct investment into collectibles puts the value of collectibles viewed as financial assets on par with the US $1.9 trillion invested in hedge funds and the US $2.5 trillion invested in private equity funds (Deloitte).
Art and collectible assets represent sizable assets for many HNWIs currently served by financial institutions. There is an opportunity for banks, hospitals, restaurants, hotels, family offices, etc to integrate the concept of collectible assets into the overall asset allocation strategy to assure adequate liquidity, avoid over-exposure to risk, minimise income taxes and organise appropriate transmission to heirs or donation to charity. This is a very big deal for all businesses that acquire work for their space. Also the gap between the estimated amount invested directly by collectors/investors in art and the existing offering of art financial products is impressive. Most likely we will see more new financial products offering opportunities to invest in this asset class and services to support customers such as advisory, legal, tax, wealth structuring and insurance.
Last but not least, external forces, such as globalization, knowledge sharing, democratization, increased cultural interest or new communication channels, development, growth, and education of the fine art markets, transform it and push for its ‘ financialization’. This era provides room for innovation. New business opportunities are created and some art professionals have already embraced them, which is where the development of Ipseity comes from . Several new different initiatives search to securitize several billion of US dollars of artwork, such as art investment funds, tradable artworks and services or dedicated art trading exchanges. Provided that they are successful, they will substantially increase the market size of art available for indirect investment by monetizing a percentage of the outstanding volume.
It's an exciting enterprise when dealing with assets both tangible, educational, emotional, provocative, and lucrative. Having the ability to develop these financial opportunities will have a domino effect on multiple areas of the economy. This evolution should create a new era and environment for the art markets and for the benefit of society as a whole by fostering culture, knowledge and creativity.