Art as investment and investment as art

Good morning. Will turmoil between Iran and Israel send stocks south? Our view is that it probably won't happen, simply because geopolitical turmoil doesn't usually matter. As we said last October, markets don't understand war any better than we do. Is this time different? Email us: robert.armstrong@ft.com and ethan.wu@ft.com.

Art is not an investment, but investment is an art, unfortunately

Someone from the art world or the financial world, or both, is always emphasizing that art is an investment, not just a decoration. It is not just a store of value; They say it creates wealth over time. The Sotheby's Fine Art Index pegs the compound annual growth in nominal art prices between 1950 and 2021 at 8.5 percent, well ahead of inflation. Banks and consulting firms issue reports tracking the growth of the art market and discussing its beneficial contributions to a diversified portfolio. In short, art is best categorized as an esoteric asset class, a group that includes wine, stamps, handbags, sneakers, and so on.

These offers are generally treated with the skepticism they deserve. Talk face to face with someone who is in the art game – someone who is not trying to sell you something – and they are very likely to impress upon you the folly of buying art with the expectation of gain, and that only the work of the best artists of all time can be relied upon to retain the value paid for it. .

Academic studies on the subject broadly agree with skeptics. Few, if any, large, high-quality studies have found that the art market, however you slice it, can provide returns as high as stocks. One large study, which attempted to expand beyond the standard technique of tracking repeat sales of the same works of art, found annual real returns of just under 4 percent between 1957 and 2007, on par with corporate bonds, but with much higher volatility. Another author surveyed 13 studies on drawing and prints and found annual returns of between 1 and 5 percent. One study, which covered only Picasso, found returns of 8 percent. Once again, author Benjamin Mandel found that:

In terms of volatility, art unequivocally has the highest variance of all assets, at up to two or three times that of the Dow Jones Industrial Average or corporate bonds. Thus, due to low average real returns, art is often a dominant asset [eg an asset that will always provide a worse return than some alternative] In a portfolio that seeks to maximize returns and minimize variance.

The debate about the returns and benefits to an art portfolio is far from closed. The measurement problems in this area are too great for that. The intervals between price observations are often many years apart, the recurring sales methodology is limited, different submarkets behave very differently, and so on.

For example, on the key question of whether the highest quality—that is, the most expensive—artworks generate the highest returns, studies disagree. Renebaugh and Spengers found that “the annualized real return at the 95th day [price] The percentile is about five percentage points higher than the return at the 5th percentile. On the other hand, May and Moussa's much-followed work on art prices from 1875 to 2000 found that:

Our king. . . American Art Business estimates that a 10 percent increase in purchase price is expected to reduce future annual returns by 0.1 percent. Moreover, our results are robust to whether nominal prices or real prices are used in the regressions. Thus, our study seems to suggest that art investors should buy less expensive artworks at auctions.

Mee and Moses clearly link their findings of outperformance by cheap artifacts with the “small firm effect” in stock markets.

However, given what we know, there seems to be no compelling reason for wealthy families to add works of art to their portfolios of stocks, bonds and real estate, unless they also enjoy looking at them, or use them to impress their friends and enemies. . The best thing to say, of course, is that owning fine art may not be a big financial mistake.

But the interesting question is not to what degree works of art can serve as a financial asset. It is the degree to which financial assets, especially stocks, function like works of art.

Don't make fun. One might insist that the future value of works of art is essentially ambiguous. For example, buyers of contemporary art cannot know who will be the Warhol or Basquiat of the future, and who will also be forgotten. Remember the bad reviews of Monet and Degas in the early 1870s (“a chaos of indecipherable scraps of color”). However, let us remember Hendrik Bessembinder's work on stock markets. Over time, a small number of blue-chip stocks account for the majority of stock market returns. Collectors, like art investors, hope to find Basquiat – that is, Apple – in time. It is true that the problem in stock markets can be solved through diversification and indexing, but perhaps not in art (although some are trying). The point is that the uncertainty we all attribute to the future of art prices is a feature of stock prices as well.

Surely stocks have a key component to which their share prices can return – dividends, or free cash flow, should that fail? The same problems apply. Collectively, stock markets are going back to basics. However, these indices contain a lot of large stocks whose prices are loosely linked to fundamentals, or not at all.

More importantly, there is a very strong argument that stock prices, like the prices of works of art, respond primarily to changes in wealth – or liquidity if you prefer – and in particular to the wealth or liquidity possessed by the richest decile. In any study that has explored the relationship between art and stock prices, Goetzman, Renneboog, and Spengers find that stock returns, especially capital appreciation (as opposed to dividends) have a significant impact on art prices, and that widening wealth inequality supports art prices as well. they write:

The price of an art piece is limited only by how much the collector is willing and able to pay for it. It is expected that rising income will lead to higher art consumption, and thus to higher price levels in the art market. However, given the relatively limited supply of high-quality artwork, average purchasing power may be less important in determining prices for fine art than the amount of money the wealthiest members of society can spend.

It's interesting to replace, say, “Nvidia sharing” with “art object” in that paragraph. One might rephrase the first sentence with 2001 and 2007 in mind: “The price of a stock market is limited only by how much investors are willing and able to pay for it,” and continues from there.

More seriously, Goetzman and others argue that changes in art prices are largely a function of wealth concentration. This is not far from saying, like Mian, Stroop, and Sophie, that inequality between people has contributed to the rise in the values ​​of financial assets that are mostly owned by the rich (and thus debts that are mostly owned by the poor). It is also not far off to say, as many have done in recent years, that the Fed artificially inflated asset prices by forcing more money on investors' balance sheets than investors wanted, forcing them out of the risk curve (perhaps as much as art… ). market).

The stock market and the art market are not the same thing. The stock market is the best bet. But despite all that, there is a lot more ambiguity, irrationality, and inequality in the art market than we like to admit.

One good read

Some very good news.

FT Podcast is not protected

Can't get enough of Unhedged? Listen to our new podcast, hosted by Ethan Wu and Katie Martin, for a 15-minute dive into the latest markets news and financial headlines, twice a week. Catch up on previous editions of the newsletter here.