Suffering for your art?

Thursday, 01 May 2014
Dr Ariel Sergio Goekmen outlines the risks associated with alternative investments.

The current supply of liquidity is already the stuff of legend: monetary sluice gates remain wide open as the authorities attempt to head off serious problems in the major economic regions. Companies are hoarding money. Rather than investing in new equipment or employees, they prefer to buy back equities in order to push up their share prices. Employees who receive share options as part of their compensation are benefiting from this too. Value might not be created in the real business sense, but there is a promise of greater financial remuneration when year-end comes.

The same can be said of private investors. They can use their money to consume, and the spending secretly boosts the economy, but it empties their wallets. Private investors can also think about protecting their wealth from what the future might bring – specifically, what might happen when the central banks switch off the flow of liquidity, which many forecasters think will happen soon.

One option is to invest money in the equity markets, which are still in a bull phase. But a lot of private investors feel uncomfortable about the constant fluctuations. Gold met its Waterloo last year, and, since then, wealthy people have been on the lookout for other investments that seem safe. Many are succumbing to the temptation to invest in physical assets, especially those that don’t seem to suffer from price fluctuations – assets that have less liquid markets and don’t therefore generate statements that reflect shifts in supply and demand in real time. This includes property, which is much in demand among investors from China and other foreign countries.

The search for alternatives

Alternative investments that could be used to diversify a portfolio include investments in the art market, in wine or in Swiss watches. The problem with these markets is their lack of transparency and the herd behaviour of investors. How can investors make proper comparisons and find an investment that suits them? There are very few opportunities to make comparisons at the level of securitised investments. Economist Clare McAndrew produced a study in collaboration with The European Fine Art Foundation (TEFAF) in 2011.1  According to her report, the global art market is worth around USD61 billion. This is negligible compared with the global capital market, which encompasses investments of around USD212 trillion, of which around 75 per cent are in bonds.2  In simple value terms, the global capital market is four times as big as global GDP. 

According to the study, half of this USD61 billion goes through auction houses and private dealers. With 37 million transactions around the world, the average size of a deal is very low, at about USD1,600. The great majority of transactions involve artworks created after 1875. More than half of them are conducted through New York and London. Approximately one-third of all auction transactions are handled by Sotheby’s and Christie’s, and over 40 per cent of auction sales, worth more than USD13 billion, are accounted for by Chinese investors. Worldwide, however, Europeans are the biggest investors, followed by Americans and then, not far behind, the Chinese. 

Altogether, the world’s art market is worth 0.03 per cent of global securitised investments. Any investor thinking of diversifying into this market today needs to consider that there is an almost immeasurable quantity of liquidity out there in the form of worldwide bonds and shares, which theoretically could be sold at any time and moved into the art market. This could catapult art prices into the stratosphere. So the message coming from the TEFAF Art Market Report 2013 may come as a surprise: the global art market actually shrank by 7 per cent in EUR terms in 2012. This may have something to do with exchange rate fluctuations, but statistically the collapse can be attributed to the current decline in the value of Chinese art. For investors, the trend is clear: the art market is not a one-way street, even if artworks are not valued on a daily basis. 

From record to record

How can the market be shrinking, one may wonder, at a time when we always seem to be hearing about a record sale at Christie’s or Sotheby’s? Take, for example ‘Dustheads’ (1982) by the Afro-American painter Jean-Michel Basquiat (1960-1988). Christie’s put it up for auction in New York in May 2013 with an estimate of USD30 million, but it sold for USD48.8 million. On 2 May 2012, a world record was set when Sotheby’s sold ‘The Scream’ (1895) by Edvard Munch (1863-1944) for more than USD119 million. To understand what is going on here, we need to get to grips with the inner workings of the art market.

Let us assume that a wealthy investor likes the paintings of Norwegian expressionist Munch. This investor could just as easily be a group of like-minded individuals or a gallery owner. First, they buy a painting, then some drawings, and soon they have a rather nice collection. So why would they now be inclined to pay significantly more than the estimated value for another Munch piece? Simple: the number of works by a dead artist is limited, give or take the odd contemporary forgery – not like the countless number of shares available – shares that can also be diluted by rights issues. If a painting is purchased, it is withdrawn from the global interplay of supply and demand until it is put up for sale again. As a consequence, the excessive price that a collector of Munch, for example, pays for another work by the same artist also increases the value of their existing Munches. In fact, it is exactly the same principle at work as when, as mentioned at the outset, companies buy back their own shares.

Individual prospects

Having taken on-board these sobering thoughts, let us return to the art market itself. If an investor wants to go into the art market, but, rather than investing directly, would like to rely on the knowledge of others and, perhaps even more importantly, select a more liquid form of investment, then investment funds should be the first option on the radar. Deloitte and ArtTactic have published a study on this type of investment, estimating the size of the global art investment fund market at USD1.6 billion.3 This is a very small amount when we consider the value of Munch’s ‘Scream’: 13 Screams would take care of the whole market, which is worth less than 3 per cent of the art market as a whole.

One example of this type of fund is the US-based Collectors Fund, established in 2007. Its own figures show that it has attracted investments of more than USD20 million, and that it achieves an annual internal rate of return of 28.5 per cent.4  This is impressive. Interested investors will want to know how the fund calculates its net asset value. As with real estate, the artworks held by the fund are either entered in the books at their purchase price and left unchanged, or they are regularly valued by independent experts to produce an accountable value. In simple terms, this means that the final return achieved by such a fund will only be known when all the artworks are sold. In the case of the Collectors Fund, this will be in 2017.

The central question

This brings us to the problem of any investments in the art market, wine market or any other ‘securitised’ market: returns are only determined when all the assets are completely liquidated. In the case of the Collectors Fund, an expiry date has been set in advance, and there is a residual risk that it won’t be possible to sell certain assets. An external event could also affect values. Artworks could be stolen, or one of the artists in the collection could suddenly fall out of favour. This happened to Damien Hirst: in 2008, many of his works were sold for record prices at a widely publicised auction, but press reports suggest these prices have now dropped by up to 30 per cent, while no purchaser at all can be found for about a third of his works.5

When considering returns, investors often forget to factor in the cost of holding the works of arts, framing, repairs (in the case of watches), maintenance considerations (for example, climate-control systems and storage rooms), insurance and so on. And, if auction houses are involved, they tend to take a commission of around 20 per cent on sales. As a result, a work of art that increases in value by 50 per cent on its original sale price may be worth exactly 0 per cent more once all the costs have been deducted.

Alternative investments – in art, wine, watches and the like – are en vogue. But these are investments for the big boys. Anyone else would be wise to stick to the rule that you should only invest directly in art, wine or watches that you personally love. There are, of course, many renowned experts who can help a novice to build up a collection. These include specialist auctioneers, well-known collectors and other respectable figures. In our view, wealthy investors who have more than USD100 million dollars to diversify should not put more than 10 per cent of their money into such assets. These are ‘aficionado investments’ in which the investor should be deeply interested, and which will produce a supplementary return in the form of the pleasure derived from looking at, consuming or exhibiting the item in question. Such investments must be categorised as illiquid and long-term. The bottom line is that they should be welcomed as a hedonistic lifestyle enhancer. Any gains made after costs should be seen as a bonus.

  • 1The International Art Market in 2011: Observations on the Art Trade over 25 Years
  • 2McKinsey, Mapping global capital markets 2011 
  • 3Art & Finance Report 2013
  • 4Art Market Monitor, ‘Collector’s Fund Launches Second American Investment’
  • 5‘Works by Damien Hirst lose 30 per cent of their value, while one third fail to sell at all’, The Telegraph
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Dr Ariel Sergio Goekmen

Dr Ariel Sergio Goekmen TEP is a Partner at Kaiser Partner

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