Is art really a good investment

In her new book, London-based art market editor Melanie Gerlis argues that it's just about the riskiest thing there is. Like many other art world outsiders, when I began working in the art market in 2005, after a decade of working with investment banks, private equity firms, stock exchanges and hedge funds, I was convinced that the rules of these financial players could be applied fairly easily to art, to produce a more efficient system of trading. Why couldn't art be commoditised Nearly ten years later, I still hold true to some of my initial opinions: there is no reason for the art market to be as secretive and as distorting as a few controlling players would have it, and universally accepted practices-such as including the buyer's premium (up to 25%) in official auction results but not in the pre-sale estimates, and then comparing one with the other as a measure of success-are at best absurd, and at worst highly misleading to the uninitiated. I have also learned, however, that there is no universal “art market”: rather, there are several much smaller markets, each of which is comprised of an increasingly limited number of similar items, and which eventually drill down to one, unique object. Even when there are several items that are seemingly identical, such as editions of the same photograph or sculpture, each has a history of ownership, trading or exhibition that separates one ascribed value from another. Art is, quite possibly, the least commoditised asset in the investment universe, offering the potential for great returns but also-as is rarely explained by its market proponents-subject to enormous risk. Although most of the literature to date on art as an asset has promoted its status as a good investment-a view that is fuelled every time a record price is made at auction-the jury is still out. The lack of transparency on prices (particularly from art galleries, which account for a good 50% of the market's transactions, alongside auction houses) makes true comparisons to assets such as public equity, gold, property and wine very difficult. Even in the more opaque financial markets, such as private equity, there are considerably more data points from which to create indexes, assess risk and attempt to gauge returns. It seemed to me that the best way to understand art's distinct characteristics was through the prism of other such assets and industries, with which it is often compared, but rarely in depth. By looking at the characteristics that are shared and, more importantly, those that are different, this book aims to give a deeper understanding of a complicated and fascinating market. Art and stock markets If you are an institutional investor trying to work out whether or not to put money into art (or if you are the private bank manager trying to explain whether or not this is a good idea), there needs to be some way of pooling the available data to quantify the asset's performance. So, and despite all the essentially unmappable characteristics of art, market specialists have spent much time and effort creating indices that could (in theory) be compared with other markets. The main problem is that even these academically and mathematically conceived indices of art sales are built on data that is so limited and variable that they are like a tower built on very shaky foundations. In the continuing pursuit of liquidity in art, somewhat inevitably the idea has emerged of breaking up a painting into equal parts and selling each essentially de-risked part to investors while watching the value of the work go up or down, reflected by the supply and demand for each “share”. The aim is that these shares trade on an “exchange” for art that would provide daily prices of all constituent works and could eventually be a benchmark index for the value of all art-easy, right So far, such attempts have yet to succeed (or at least there is no measurable proof that they have succeeded). The biggest (logical) problem with such schemes is that they could only really work if a work of art could be seen, primarily, as an investment. A business needs to be profitable to exist, to employ its staff, to buy its machinery, to market itself, to grow; it therefore makes sense that people should want to invest in its possible growth through shares. A painting can exist perfectly easily without generating any profit at all. In fact, the primary reason for which the average work of art is bought (an emotional response to its visual qualities) is completely negated by trading the work on an exchange. The biggest (illogical) problem with such schemes is that the art market is rather elitist about applying financial metrics to works. Not because of concerns that would-be investors could be disappointed; simply because-like a designer clothes shop that doesn't display its prices-money somehow diminishes the greatness of art. Art and property Much like the relationship of a dividend to a share price, the value of a property includes a quantifiable premium for the regular income it can provide, in the case of property through rent. At the very top end of the luxury property market-a draughty castle or a 40,000 sq. ft property with only one bedroom-rental may be a more difficult income to guarantee, but on a like-for-like basis, a £5m apartment with views of Buckingham Palace or Hyde Park can generate considerably more income (around £3,000 a week) than, for example, a painting by Jean-Michel Basquiat, such as his 1983 Five Fish Species (which sold for £5m in February 2013). Others believe that art does provide a form of “rent” already-otherwise known as its “psychic benefit” or “psychic value”. This is, essentially, the pleasure that art brings, as both something lovely to look at and something prestigious to own. These qualities are summarised by the writer Malcolm Gladwell [in a 2011 article for Grantland]: “The best illustration of psychic benefits is the art market. Art collectors buy paintings for two reasons. They are interested in the painting as an investment-the same way they would view buying stock in General Motors. And they are interested in the painting as a painting-as a beautiful object.” There is consensus in the art world (including the art market) that art's “beautiful object” status is what should be deemed its most important feature anyway. While there is an element of posturing (or elitism) in cutting out the investment aspects of art, it cannot be ignored that art offers a very different type of reaction than a share certificate or gold bullion, and one that is potentially very rewarding. Gladwell points to an economic analysis that quantifies this reward as a “psychic return” of around 28%-extremely high when compared with, say, the average [long-term] financial returns for both art and property. Art and Gold One of the most interesting aspects of gold as an investment is how deeply it divides opinion. Those who are believers, known as “gold bugs”, define the metal as the purest, ultimate form of money. This is because individual currencies, known as “fiat money” (“fiat” being Latin for “let it be done”), are essentially IOUs. “I promise to pay the bearer on demand the sum of...” is printed on UK banknotes, “this note is legal tender for all debts, public and private” on US bills-both reminders that someone at some point might call in the debt. Gold is the only money without counterparty risk, emphasise its proponents. Others believe that gold's role as a financial asset should be limited to the history books, and that its perceived price is merely relative (it is easy to draw parallels with the more recent digital currency phenomenon, Bitcoin). Gold today has very little use. Many investors are “uncomfortable that gold is not 'consumed' like other commodities-it is not eaten or burned or forged, as food, energy or industrial metals would be”, explains Daniel Brebner, the former head of Metals Research at Deutsche Bank. In many ways, this is a wise way to think about art: not as an investment that can go up in value, but as a rainy-day security (that hopefully also looks good on the wall). However, the combination of the art market's illiquidity, opacity, lumpy supply and asymmetry of information undermines its security as an asset. This is underpinned by the unique qualities of each work, which can create enormous ranges of pricing and valuation, and open it up to greater manipulation. Although the pricing of gold is more subjective than for public equities, and its market's regulation less secure, it is still, however, a much safer bet than art, as well as being physically more secure. This is largely due to the size of the market, which enables gold to be traded as a liquid commodity, regardless of its essentially function free properties. Art and Wine Like the art market, wine investment has received a reviving boost in the form of demand from new markets, after the credit crunch dampened enthusiasm elsewhere. Countries with new wealth and a growing middle class (in particular China, Russia and Brazil) have proved one of the most significant sources of confidence, at least, in both markets. Until late 2011, Sotheby's had never had an unsold bottle of fine French wine in Hong Kong (where it began selling it two years previously), and in China, Lafite- known as “La Fei” in mainland China-soon became a brand associated with success. Helping the cause was a significant tax break: in 2008, Hong Kong cut its duty on wine from 80% to zero, making it one of the only places in the world where wine is untaxed (at the time of writing, the UK imposes a flat rate of £266.72 per 100 litres, for an alcohol-by-volume of between 5.5% and 15%, irrespective of value). Hong Kong also doesn't have any sales tax. That this came at the same time as the traditional wine markets of North America and Europe were wobbling from the effects of the longdrawn-out debt crisis gave some much-needed succour to the industry. A similar dynamic underpinned the art market between 2008 and 2011. The threat for the art market-that the arrival of new wealth meant it went up in value too fast and needed to correct itself-hit the wine market first (as can be expected where liquidity is better). Demand for Chateau Lafite-Rothschild, which singularly defined China's wine market, began to tail off in 2011. The Liv-ex Fine Wine 100 Index (which gives greater weighting to wines with the most supply on its exchange, so Lafite looms large) fell 4.1% in the nine months to 30 September 2011 and was down 6.4% for that month. Wine buyers in Asia are real, and have made a huge difference to the market, but they have their limits-and these seemed to be reached sooner than expected. The market began to mature fairly quickly after measured trading emerged. Art and private equity The most populous practitioners of the equivalent of an investment fund are, in fact, not the art funds that have based their business models on them, but rather the private dealers of art. The comparison is even more pertinent with primary market dealers, who “invest” in the artist and the production of his or her work. They grow profits not just through sourcing supply and stimulating demand, but by adding value to the artists they believe in. The daily business of primary-market dealers involves building the reputation of artists, their works and the gallery itself, as well as trading their works. These galleries can be seen as the equivalents of what are known as “incubator funds”-a subset of private equity's venture funds arena, designed to help businesses at an early stage develop their potential. Incubated companies rarely generate any revenue at all, but it is the funds' job to turn them into independent companies, just as primary-market dealers (generally) slowly turn artists and their work to secondary-market standards. Primary-market dealers have their own skin in the game, in much the same way as private equity's staff buy into their deals, reinvesting profits in the gallery but also keeping their own reputation intact (to attract both artists and collectors). The limited profitability of the primary market is one reason why dealers often also run a secondary-market business on the side. What is tricky for outside investors to get their heads around is not the way in which primary market dealers incubate their artists, but how they then manage their markets. First, there is only a handful of these “value creation” dealers, who control the primary art market (something that leads, understandably, to accusations of its manipulation). And then they don't always sell at the highest price, or indeed at a price that bears any relevance to even a loosely established level for the artist in question. Art and luxury goods The current generation of wealth, both elite and aspirational, responds strongly to brands. Whether Apple computers or Rolex watches, Manchester United or Damien Hirst, people are generally comfortable with being told what is of value. This is, in part, due to the shattering fragmentation and information overload that both globalisation and technology have brought to the world. The need for some sort of universal value system to rise-quickly, easily, recognisably-above the noise becomes greater each day. Luxury goods are now an area in which “product” almost ceases to be as “brand” begins to take over-a dominant force in today's global art market. Just as in luxury goods, whose proponents now say that “fashion isn't really about clothes”, a visit to an art fair (one of the most popular ways to see art thus far in the 21st century) seems to be about anything but the art. Like fashion weeks around the world, and other “to be seen at” events, the major international art fairs (Frieze and Art Basel) are more about people watching, celebrity-spotting and socialising (increasingly at events outside the fair), and can quite easily be experienced with a five second glance at some art. Yet in the luxury-goods market, while the underlying assets may not generate profits, the businesses that sell them do, and are highly cash-generative. Industry consolidation is a source of much debate among the fashionable, but has helped to keep costs down, while pushing the brands globally. Investor access to this market has mostly been made possible through public share offerings (most of the major luxury-goods companies are listed on stock exchanges globally, including LVMH, Kering and Richemont, the three biggest brand conglomerates). Perhaps to the surprise of many, an industry in which perception and marketing are the drivers of value has become one of the more successful sectors in recent years. To develop and meet a voluminous middle market, luxury businesses have had to bulk up and stamp their brands globally while cutting down on the associated costs. The contemporary-art world is still struggling to find this means of balancing investment and profitability. Art fairs, for example, have proved an effective umbrella organisation (although these often cost six-figure sums for galleries to attend). As the art market experiences the same dynamics as the luxury goods industry, such collaborations seem more likely in the future, although it would involve some swallowing of pride and ego for, for example, two struggling regional art fairs to join forces. Melanie Gerlis is The Art Newspaper's art market editor (Europe, Asia, Africa). The above article was published in India Inc′s print edition of the India Investment Journal launched in April 2014 in conjunction with the Global Wealth Management Conclave 2014.