Art and Lots of Money: What to know

This past week NYC hosted the Antiques Fair at the 67th street armory and the Ceramics Fair at the National Academy of Design. There were also simultaneous high end sales at Christies and Sotheby’s to coincide. The events brought out not only art collectors, but also art advisors buying for their clients, some of which were high net worth individuals (HNWI). Art advisors buy art for HNWIs to smooth out the overall return of their investment portfolios within the ups and downs of specific categories in the art/luxury markets.

However, whether adding art as another asset class is beneficial to return is still a matter of speculation. The British Rail Fund (BRF) used art in its portfolio for 25 years and made an annualized return of 11.3%, which is perfectly respectable, but was not as high as the rest of the BRF’s portfolio.

Today, the BRF does not invest in art as an asset class. Its concerns could have included the cost of storage and insurance for the art or luxury item. In addition, this category has no dividends or income like stocks and bonds. Moreover, they cannot be disposed of rapidly. They are only worth what someone will pay for them and the market can be very thinly traded. Therefore, valuing art/luxury items can be speculation more than a solid determination.

A recent research paper by RFA Campbell, however, challenges this concept. It suggests that art is worth considering as an asset class in a HNWI’s investment portfolio. She looked at art as yet another alternative asset class and treated it like real estate, commodity futures, private equity and hedge funds. Each of these can be used to broaden diversification within an investment portfolio. She focused on bear markets because it is there that the benefit of diversification is most needed. The author used data from both the Art Market Research and Mei Moses All Art Index that compare repeat sales prices of particular items at auction.

She found that using a hypothetical fund (dates 1985-2006) consisting of 30% old masters, 15% European Impressionists, 15% Modern, and 40% contemporary, the average return would be 7.05% with an average annual standard deviation of 6.93. She also found low correlation with other asset classes. This lack of correlation between art and other asset classes offers attractive diversification for the HNWI. Campbell concludes: “Optimal portfolio allocations using historical returns make a case for investors to consider art as an attractive, albeit small addition to their investment strategy.”

This concept is expanded in a working paper by De Roon and colleagues entitled “Emotional Assets,” in which more than art is examined as an alternative asset class. They also include wine, stamps, watches and atlases. These were chosen because they make up more than 50% of the HNWI’s investment in the luxury sector.

The authors found that a diverse portfolio, which they termed emotional assets, could provide the investor with a positive and highly significant increase in the Sharpe ratio. The Sharpe ratio measures the risk-return profile of the investment portfolio. The authors conclude: “before advocating any investment into the emotional asset class arena we would suggest that a comprehensive study of the size of the market is undertaken for each alternative emotional asset class.” They also indicate that this is only likely to be of interest to HNWI’s for a small allocation of their portfolio.

These papers are just what HNWI’s and their art advisors are looking for. This is because a substantial proportion of this kind of client’s portfolio is often in unconventional investments. For example, a recent survey by IPI, the New York based Institute Private Investors, indicated that in 2005 their HNWI members had 40% in alternative investments versus 36% in long-only equity. This large proportion of alternatives indicates the value that the affluent families and their advisers put on this category. Art is one such alternative.

They are specifically mentioned as part of an effective diversifying strategy by Welch in his 2008 paper entitled, “Consulting to the Ultra Affluent.” In fact, he includes art advisory as one of the essential services that needs to be provided by financial advisors to their ultra wealthy clients.

Parts of this article were taken from Dr. Mueller’s recent chapter in a quantitative finance series book entitled Collectibles for the High Net Worth Investor (Elsevier, 2009).