Art as investment

The Indian art market saw an unprecedented boom in prices between 2000 and 2007. As a result, it became fashionable to invest in art, art galleries mushroomed. Each auction set some new record and it seemed almost anyone could start an Indian art fund. But despite some recent gains, the 2008-09 melt down in the Indian art market has left many collectors asking: Is it a good investment?

There is a little need to pay attention to the spectacular success stories of a particular Tyeb Mehta or a Souza selling at more than a million dollars. Instead, it would be worth while to reflect on the characteristics of art as an investment vehicle and the empirical evidence comparing long term financial returns from art versus other asset classes. Why anyone would buy art given its poor financial performance?

Compared to other asset classes, art suffers from at least five drawbacks as an investment vehicle. If you suddenly need to sell the masterpiece that you happen to own, it will become apparent that the art market is not transparent because no two people agree on what the appropriate valuation is. Moreover it is an illiquid asset. The Indian art market is especially shallow with relatively few buyers. Furthermore high transaction costs can swallow as much as 30% of the sale price (at auctions) compared to selling stocks for a few pennies. And, all of this is before accounting for the fact that unlike property, stocks and bonds, there is no underlying income stream such as rentals, dividends or interest received whilst owning the masterpiece. On the top of that, the owner usually has to pay storage ad insurance costs.

Several academic studies have been conducted comparing the long team average financial returns of art versus more traditional investment vehicles. These studies usually compare the performance of an art index with returns from equities and bonds. The studies concentrate on paintings and the period of comparison is at least 25 years, with some studies tracking as much as 300 years of data. There are different ways of construction the art index, but the most popular is through repeat sales of the same painting at auctions, requiring at least two price observations per painting before it can be included in the database. This means that returns reported for art in these studies are upwardly biased for two reasons. First, the relatively substantial transaction costs are unaccounted for. Second, the method suffers from what is called survivor bias: many of the contemporary artist paintings old, which subsequently become worth less, never come up for a repeat sale. In other words, the returns reported for art rosier than reality.

The real annual returns (subtracting inflation) reported in the empirical studies range from 0.6-5.0%. Median returns are 2.6%. Even in the study by New York University professors Jian Ping Mei and Michael Moses, which is most popular with art professionals because it shows the highest annual real return to art of 4.9% per annum for the years 1875-2000, fails to outperform equities (the S&P 500 or Dow Jones industrial index). Vis-à-vis bonds the story is slightly more complex but art underperforms corporate bonds and only slightly outperform is the relatively risk free US government bonds. And, the result are even worse or masterpiece going against the conventional wisdom that argues for buying the best and most famous works as the path to highest returns.

Despite the underperformance it could be argued that art belongs in the investment portfolio if it has lower volatility or is not correlated with equities. The news on both these fronts is not encouraging. The volatility of art as measured by the variance of returns is at least twice that of equities or corporate bonds. And, art indices typically have a positive correlation with equities and negatives correlations with bonds or treasury bills. In financial theory terms, this means that an art index is dominated by other asset class in a portfolio that seeks to maximize returns and minimize vacancies.

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