Art as an Asset Class

A few weeks back Barron's posted a short article on some of the issues of art becoming an asset class. The article notes some of the Deloitte report (I believe the new report should be available shortly, but I can only find the 2014 edition. I will post as soon as it is available) with the large number of HNWI investing in art.  It also notes investors in are now using art as collateral to invest in more art.  A risky proposition, especially if we are actually in a bubble market. The article also notes how some categories don not perform well in addition to high transaction costs.

Barron's reports

Should art be considered a new asset class? That’s a valid question according to a report from Deloitte and ArtTactic, which notes that half of the family office executives surveyed said “one of the most important motivations” for owning art and collectibles was to better diversify the portfolio. The survey also finds that 76% of art buyers and collectors are now snapping up art as an investment, up from 53% in 2012.

But should they be? It’s worth considering. Deloitte estimates that there are “at least 400,000 art collectors in the top wealth segments [high net worth and ultra-high net worth folks], with an estimated $1.5 trillion of wealth in art assets.”

Deloitte also notes that investors are doubling down. The survey finds that investors are increasingly taking out loans on their existing collections to buy yet more art. About 53% of collectors used their collections as collateral to buy new art; versus 38% investors who used the loans to fund “business activities”; and nine percent to refinance existing loans.

Private banks typically offer these loans to their clients at a rate of 2% to 3%, lending up to 50% of an artwork’s value. Last year, Northern Trust, for instance, approved $200 million in loans collateralized by art. (For investors desperate for liquidity, a cottage industry is emerging with firms like Borro, Right Capital and Art Capital offering nonrecourse loans at annual rates sometimes well above 20%.)

At 2% to 3%, that’s not a bad arbitrage but, from a pure investment standpoint, this added layer of complexity sets up a high hurdle for art investments. Art, as an asset class, has a questionable track record, with taxes and auction house fees chipping away at returns. A 2013 study found that, between 1900 and 2012, art, stamps, wine, diamonds and violins underperformed the equity markets. Stocks earned real returns of 5.2% annually versus between 2.4% and 2.8% for the range of collectibles. A key finding: During times of economic duress, artwork collapsed between 15% and 30%, as investors sold off their collections at fire-sale prices.

Another concern is transaction costs. The capital gains tax on collectibles, including the Medicare surtax, is 32%. Add on the auction house’s fee, of between 5% and 20% of the sale price, and that’s a tough threshold to clear. Juan Alonso, senior vice president at Northern Trust, notes that, after taxes and auction house fees, a seller could end up with just 52 cents on the dollar.

Undeterred? Art investors should also note that the market is built on an increasingly flimsy foundation. Based on 2014 total sales volumes, investors buying top-ranked artist, Andy Warhol, spent a whopping $653 million for the privilege. By comparison, the value at fine art sold at auction last year was $16.2 billion. The top ten artists in 2014 accounted for almost 20% of the art market’s entire value; back in 2005, the top ten accounted for just 13% of the total.

Penta cautioned about a bubble developing in the contemporary-art market in 2012. Collectors should let their passions guide them but, considering art’s track record and today’s frothy valuations, pure investors might be wise to wait for a downturn.

Source: Barron's