Art Market: Past Results Are No Guarantee Of Future Performance

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Volatility is an intrinsic part of any financial market. It can negatively affect investors’ confidence. It can also be a positive phenomenon because it provides arbitrage opportunities for those in the know.

The highly inefficient art market, estimated by Clare McAndrew at c. USD 63 billion (globally, 2014), has seen a remarkable increase in volatility in certain sectors, particularly contemporary. The historical notion that art is an ever-appreciating asset, is slowly disappearing. These days a 17th Century Old Master can go for less than a painting by an artist straight out of college.

Art Market: Supply And Demand

Any market is a function of supply and demand. Limiting supply means price control. Looking at contemporary art, for example, artists tend to overprice their work. They also price inconsistently. Therefore, one of the main functions of the gallery that represents them is to control the artist’s prices and inventory. The price level for an emerging artist is low. It is gradually increased by the gallery as the artist establishes himself, resulting in - by control rather than the market - an upward price trajectory over the course of the artist’s career.

RELATED: The Challenges Of Art Wealth Management

Shift In Drivers Of Value

That said, the nature of the art market has changed significantly over the last 10 to 20 years: from a small number of highly informed art connoisseurs to a global, homogenized audience that buys brands and household names. The drivers of value in the art market have to some extent shifted from deep subject knowledge to effective branding and marketing, which artists like Hirst and Koons understand so well.

Different Distribution Model

Furthermore, the art distribution model has changed ever since Hirst bypassed his gallery, White Cube, to sell directly through Sotheby’s in 2008. Normally the artist’s gallery carefully places works with trusted and well-known collectors in order to build the artist’s resume. Selling at auction has the potential to speed up this process but at the same time an unsold work has a detrimental effect on the artist’s prices. This increased volatility is a direct result of the gallery’s diminished price and inventory control during the early years of an artist’s career.


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Are Quality And Volatility Related?

So what does this mean? Does increased volatility say anything about the underlying quality of the art? Not necessarily. There is just a lot more noise because the art market is in flux: more and different buyers, shifting distribution channels and less control of pricing and supply. You can still do really well in the art market if you have a good advisor who gives you access to great opportunities and facts you need to know in order to make an informed purchase decision. Just remember that art does not always go up in value, it moves in cycles, like any other market.

Correlation With The Financial Markets

Proponents of art investment often claim that the art market is uncorrelated to the financial markets. Therefore, they argue, art is an excellent portfolio diversifier and a certain percentage of your wealth should be invested in art. At the same time, clients and their wealth advisors question whether volatility in the global economy affects the art market. Conveniently left out of the argument are notions such as the specific artwork to invest in and whether this artwork is likely to go up in value or is already at the top of its market cycle.

What Is Correlation?

Without getting too technical, let’s briefly examine what correlation actually is. Correlation is a key concept used in portfolio management to manage risk. The premise is certain investment assets move in tandem with each other and others move in the opposite direction. Uncorrelated assets however, move completely independently from each other. Claiming that the art market is uncorrelated to the financial markets therefore suggests that the art market operates in a vacuum. Although I imagine that art is more closely correlated to certain assets than to others, to suggest that there is no correlation to any financial asset does not make sense.

The Global Economy

In today’s global economy everything is connected, from the price of cocoa in Ghana to the UK’s threat to leave the European Union. Similarly, today’s art market is global, with an ever-growing number of buyers who are increasingly well-informed about art prices. Art buying itself has changed from a pastime by elite collectors with deep art-historical knowledge to investor-collectors, who view art as a financial tool and who buy easily recognizable brand names such as Picasso or Warhol, turning these investment-grade works into currency. These buyers use the high end auctions in London and New York, held at set times during the year, as indicators of how the overall art market is doing.

Crash Of The Art Market

In 1990 the art market crashed spectacularly. Throughout most of the 1980’s prices had been driven up by the Japanese buying impressionist and modern works, including van Gogh’s Sunflowers (1988) which became the most expensive painting sold at the time, when bought for $39.9 million by Yasuda Marine and the Fire Insurance Company.

When the Japanese economy tanked, the art market followed. Similarly, in the aftermath of the financial crisis in 2008, many collectors had to part with their art assets at discounted prices because they needed the cash. I am not an economist but there seems to be somewhat of a cause and effect thing going on here. To my mind, the correlation between art and other (financial) assets can probably be described as varying degrees of low (whether positively or negatively) rather than non-existent.

Art Is A Luxury Good

Let’s not forget that art is firstly a luxury good and secondly, a moderately desirable investment asset at most. The advantages, such as low correlation to the financial markets and the potential of being an inflation hedge, need to be offset against the fact that art, unlike real estate, does not generate an income; it is highly illiquid; it has exorbitant transaction and ownership costs; and successful trading requires deep insider knowledge. As an example of the latter, the record prices achieved at Sotheby’s, Christie’s and Phillips are often used as examples of why one should invest in art but these high end auctions are not necessarily representative of the dynamics of the underlying middle and lower art markets.

Key Take-Away

The art market tends to lag the wider economy. Generally speaking, if the economy expands, investors perceive art to be a good opportunity to park excess cash. Conversely, if the economy contracts, art will be a less attractive asset to most. Less buyers means that sellers are now reluctant to put their art up for sale at public auction. If the artwork does not sell this will damage its future earnings potential, a real risk. Whatever the degree of correlation, investor confidence is as important to the art market as it is to the financial markets.

To find out more about correlation, read the article written by Rob Russell for Forbes, "The ABC's of Investing: Alpha, Beta And Correlation".  To learn more about the art market crash in 1990, read the editorial by Alexander Forbes for Artsy, "Can China Avoid a Japan-Style Art Market Meltdown?".

The content of this article is for informational purposes only and does not constitute legal, tax or investment advice. It should also not be interpreted as advice arguing for or against buying art for investment or enjoyment.