Art as an Alternative Investment Asset I

Introduction

The role of art is changing. Art is no longer just appreciated for its aesthetic value and the expression of its lofty ideals but as an investment. Developments within the art market have been followed almost as closely as those within the stock market. Prices paid for pieces have gained international publicity and art as an object of investment has become particularly alluring. The art industry has really come of age: it is now worth over $3 trillion and has an annual turnover of $30 billion1. It has its own indexes for tracking performance (Mei Moses All Art Index, Art Market Research and artnet.com), showing that returns are just as attractive if not better in art than the stock market. Art has become the new hip must-have investment.

Indices tracking the performance of fine art have held up well in economic slowdown, with auction houses continuously reporting record prices. With uncertain stock market returns and high interest investors are now considering alternative investment avenues.

Art as an investment has an increasing demand coupled with an absolutely limited supply and the ability to survive the economic downturn. Traditionally, putting money into art has not been as straightforward as investing in bonds or equities, but the market has attracted increasing interest and new tools such as Artscoops.com have made it much easier to first-time collectors to invest in art. Art as an asset is in a class all of its own. Art is seen by many in the financial community and beyond as an attractive investment as it outperforms more conservative investments. It is an alternative investment earning capital gains rather than a dividend. Art does not behave in the same way as other assets such as real estate, or bonds. As investors take on a more hands-on approach to wealth management and portfolio diversification and with heightened exposure to alternative investments, the world’s wealthiest have been searching new investment territories.

Investing in art disregards the traditional benchmarks of financial analysis. Investing in art is a bet on the price appreciation of something whose values defies financial logic. Contemporary art has appreciated enormously in value over the last few years, and an informed choice often raises the chance of a good return on investment.  

The economics of art:

Art is a heterogeneous product, artworks are unique. Loyalty to an artist is low and the perceived value of the product very much depends on art dealer’s taste. There is a lot of competitive pressure in the industry and barriers to entry are high due to high fixed costs, these include the finding and commissioning of artists, advertising, insurance, and distribution. Costs of exiting the industry are also high as it is difficult to liquidate assets. There exists a clear mutual interdependency between firms, dealers, and art fund managers. The big three auction houses (Christies, Sotheby’s, Philips,) are said to be price-makers and not price-takers. The art industry tends to compete on uniqueness of artwork and not on price.

The relationship between supply and demand for art is very similar to luxury goods. To begin with, there is limited supply, giving art a higher value. Secondly, exclusivity that comes with art often leads to higher prices, thus having an effect on the demand curve. There are a number of indicators that point towards an inelastic demand curve, these include:
• Changes in taste
• Changes in income
• Pricing and accessibility
• Threat of substitutes

In the art market there are “numerous pricing strategies and commission packages” (Schweizer, 2008). Artists interested in maximizing their profits will set relatively high prices, which relates to quality and exclusivity like luxury goods, in turn decreasing accessibility. Art fairs that represent galleries and dealers represent the lower priced end of the market as they rely heavily on volume sales than charging customers premium prices.

Art prices can be assumed to be determined by supply and demand. However, there are many factors that affect the price of art within art markets, such as uniqueness of product and limited supply of works. Price is very much dependent on consumer preference and differentiation. There are two types of cost affecting the price: production costs and selling costs (Jyrämä, 1999). In art, as a rule, the price of the works of art consists of its production costs plus the aesthetic value of the piece. Selling costs is associated with the making of a new artist in terms of distribution and public relation efforts.

Factors affecting price are intertwined can be divided into four groups:
1. The work of art
2. The artist
3. The market
4. The macroeconomic environment

Factors relating to the work of art include the quality, content of the work, technique used, size and the authenticity of the artist. Artist’s fame and the valuation of previous works are important.

One key distinctive feature is the rarity of the works. Legitimization and reputation affect both the demand and supply side. Customers are reliant on the opinions of expert buyers to determine whether the price is correct or not. 

Macroeconomic factors include the state of the economy and economic upswings and downswings which the art market follows.

In practice, perfect knowledge of a market does not exist, and this is the case in the art industries. The market can be characterized as highly uncertain and knowledge is scarce. Thus the imperfection’s in the market becomes a tool of competition. In art markets, information on markets and products, including potential customers is a way to achieve a competitive edge. There is no substitute for art, art products are unique. Furthermore, benefits sought by customers are numerous and the motives for art purchasing is wide ranging.