Diversifying Investment Portfolios with Fine Art

U.S. News and World Report recently posted an interesting article about diversifying investment portfolios with fine art. I am recently back from the International Society of Appraisers annual conference and many of the topics discussed was the growing importance of fine art in financial investment strategies and the intersection of fine art and finance.

The topic is growing and more and more financial trade publications are devoting space and articles to investing in fine art.  Mike Moses, a speaker at the ISA conference is also mentioned in the U.S. News and World Report article, again showing how their Mei Moses art indexes are well respected and followed within the investment community.

The article also notes the enjoyment factor that also comes along with investing in art through viewing, display and exhibitions, which you do not typically get from a purely financial instrument.

U.S. News and World Reports state

For the vast majority of Americans, investments fall into broadly three categories: stocks, bonds and real estate, with the latter usually being the family home. Perhaps some people will own some commodities.

Basically, that's it. But it doesn't have to be.

For those willing to put in some effort to educated, the fine art market provides opportunities to add some return, while reducing overall risk in a portfolio. Still, it isn't without potential problems.

The returns can be surprisingly good. The broad art market has provided compound annual returns of 5.7 percent in the last 30 years and 8.8 percent for the last 60 years, says Michael Moses, founder of consulting firm Beautiful Asset Advisors.

Better still, the index of broad art market prices is uncorrelated with those of other asset classes, such as stocks or bonds.

"The stock markets went down in 2008 and our indexes were flat to a little up in 2008," he says. The art indices "dropped substantially in 2009," as the stock market rebounded. He pegs the long-term correlation at close to zero.

That lack of correlation reduces overall volatility when art is part of a larger portfolio. The lower the volatility, the lower the risk.

How much art should be in a portfolio? Moses says it depends on individual circumstances, but 10 to 20 percent is reasonable.

The category has been popular with institutions. "(The defunct state-owned railways operator) British Rail did invest in art; they put a large amount of money in and actually had a good return," says Andrew Milligan, head of global strategy at Standard Life Investments in Edinburgh.

Should you follow suit? Doing so won't be as simple as buying a stock index fund such as the SPDR S&P 500 (ticker: SPY) exchange-traded fund, which tracks the Standard & Poor's 500 index.

"If one is going to buy art, then are you sure you are going to catch the next big cycle?" Milligan says. It may make sense theoretically, but Milligan says the costs of buying and selling are steep, plus you need some expertise in the area to make sure you know what you are buying.

"Although investing in fine art is becoming very popular due to its return potential and low correlation with other asset classes, it also comes with significant asset specific risks that many investors are not equipped to identify and manage," says Bob Stammers, director of investor education at the CFA Institute in New York.

The sorts of risks are identifying forgeries – you might think you have a genuine Picasso but later find it was actually painted by an art student looking to make a quick buck on the side.

You might buy works that don't become popular with other collectors. The particular artist you have favored could go out of fashion for a while, which would be a problem if you were relying on the capital appreciation to fund your retirement.

Other potential problems include transactions costs of buying at auction, such as at auction houses Sotheby's (BID) and Christie's, or other similar operations. Plus, there are insurance and storage costs, as well.

It's not just for the rich. Still, it can be done and doesn't require boat loads of money. New York couple Herbert and Dorothy Vogel managed to amass a giant collection of art despite being modestly paid government workers.

They avoided the transaction fees by purchasing directly from the artists themselves. The 2008 documentary "Herb and Dorothy" details the couple and their amazing collection.

What it did require was a level of frugality on the part of the couple and a willingness to get educated on the subject. That can be as hard work as anything you learn in finance class or business school.

The advantage to art is that if you purchase something you like then you can hang it on your wall and get at least some pleasure from it. You can't do that with stocks.

That aesthetic satisfaction is one way that the expenditure is very different from other things you might buy for the home.

For instance, a washing machine wears out over time. A painting should not wear out. In fact, the amount of happiness you get from a work of art should not diminish the next owner's satisfaction from owning it.

A non-art alternative. If the thought of all that education and hassle of investing in art seems too daunting, then you could consider getting in on the art market action by buying shares in Sotheby's auction house. It makes money when sales volumes are high and when prices are high.

Source: U.S. News and World Report