Investing in art, is it worth the effort?

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Is art even a considerable asset class?

In 2020, the total value of global art auctions reached $50 billion, with the auction sector contributing 42% ($21 billion) and the remaining 58% ($29 billion) handled by dealers and galleries. Notably, digital sales accounted for approximately $12.5 billion, representing around one-fourth of the total art auction value. So, the art market is not small but, is it a worthwhile asset class to consider investing in? This article provides basic information about the art market in order to try to answer this question.

Why Invest in Art?

How to calculate the returns of Artworks?

The art market is an illiquid market, this refers to a market where there is a limited number of buyers and sellers, making it difficult to buy or sell assets without significantly impacting their prices. That is why art performance is typically measured using two methods: the repeat sales method (RSM) and the hedonic regression method (HRM). The RSM tracks the prices of artworks that have been sold multiple times, allowing for the calculation of price appreciation over time. The HRM, on the other hand, analyses the characteristics of artworks and their corresponding prices to estimate the value of specific attributes.

Diversification and Portfolio Enhancement

The Sharpe ratio measures the risk-adjusted return of an investment (subtracting a risk-free rate like US Treasury bills) divided by the standard deviation of the return, which represents the volatility of the portfolio’s value over time. A higher Sharpe ratio indicates a better risk-adjusted return, while a lower ratio suggests a worse performance. A ratio above 1 is generally considered good, but it should be compared to similar investments for a meaningful assessment.

When evaluating the investment performance of art in comparison to other asset classes such as gold, equities, and bonds using the Sharpe ratio (return/risk), it is evident that paintings have lower Sharpe ratios than gold, equities, and bonds. However, they outperform commodities and real estate in terms of risk-adjusted returns. Therefore, including investments in paintings can be considered beneficial for constructing an optimal investment portfolio.

Including art in a diversified portfolio can be advantageous due to the negative correlation between art returns and those of equities and bonds. This negative correlation implies that art prices tend to move in the opposite direction to the prices of equities and bonds, providing a potential hedge against market volatility. A suggested allocation for an optimal risk-adjusted portfolio consists of 50% Dow Jones corporate bonds, 25% S&P500 stocks, 15% gold, and 10% art. This allocation aims to balance risk and maximize potential returns by diversifying across different asset classes.

Potential for Capital Appreciation

According to the findings presented in ‘The Price of Art and the Art of Pricing,’ paintings and drawings have demonstrated an annual real return of 2.5% after adjusting for inflation. When transaction costs are excluded, the nominal return reaches 6.25%. Notably, higher returns are observed at the upper end of the price distribution (more expensive paintings tend to generate higher returns).

Key Drivers and Risks of Art Investment

Drivers of Artwork Returns

Influence of colour

The paper “Colors, Emotions, and the Auction Value of Paintings” (EER, 2022) conducted experiments using both field and auction data to investigate the impact of colours on the prices of paintings. The study analysed 12,906 art pieces sold between 1994 and 2017, focusing on 5,482 non-figurative abstract paintings by 66 artists to minimize contamination effects. The research found that a one standard deviation increases in the percentage of blue and red hues corresponded to premiums of 10.6% and 4.20%, respectively, in auction prices. Laboratory experiments with student participants from China, the Netherlands, and the United States confirmed that blue and red colours elicited higher bids and stronger intentions to purchase, with blue paintings commanding 18.6% premium and red paintings generating a 17.3% premium. Pleasure was found to be the dominant emotional response, increasing both bid amounts and purchase intentions across all three cultural contexts. Overall, the study concluded that colour attributes significantly influence the price of paintings, primarily through their ability to evoke specific emotions, and this effect is consistent across different cultures.

Gender

Female artists tend to sell their artwork at a discount compared to male artists, and this can be attributed to pricing bias rooted in gender culture. Analysing a dataset of 1.9 million auction transactions across 49 countries, the study finds that paintings by female artists sell at an unconditional discount of 42.1%. The gender discount is influenced by country-level gender inequality, indicating that more gender-equal cultures tend to exhibit less of a discount. Even when controlling for artist fixed effects, such as the UN gender inequality index and labour participation rate, the gender discount remains significant. The study also includes two experiments to further explore the issue. In the first experiment, participants were asked to guess the gender of the artist by looking at paintings, but the results showed that guessing correctly was no better than random chance. The second experiment focused on the effect of perceived gender on participants’ appreciation of artwork. The findings suggest that participants who more closely resemble typical art auction participants may value art by women 6% less. These analyses and experiments shed light on the gendered pricing disparities in the art market.

Death of a master

When a master artist dies, it has a positive impact on prices, returns, and turnover in the art market. The death of an artist represents a negative shock to their future production, resulting in a permanent decrease in their artistic output. Similar to the findings of Hong et al. (2006), where an increase in float reduces turnover and price, the premature death of an artist leads to an increase in both price and turnover. The death effect is more pronounced when the artist passes away at a young age (below age 65) and has achieved significant fame during their lifetime. The analysis, however, faces a challenge in that it lacks a counterfactual comparison (small dataset). To address this, the study matches each artist with a “counterfactual” artist who did not experience an early death.

Traumatic events during the lifetime of a master

This study explores whether creativity increases or decreases during the period of grief and mourning after the death of a loved one. The researchers collected information on the dates of death of 33 French artists and 15 American artists, as well as data on over 15,000 paintings from online sources.

The findings suggest that there is no evidence to support the idea that artists become more creative after the death of a friend or relative. However, the prices of paintings are found to be significantly lower during the first year following the death of a loved one. Additionally, paintings created during the bereavement period are less likely to be included in major museum collections.

It is important to note that there are limitations to this type of research, and the authors discuss the interpretation of the data.

Income and income inequality

In the paper “Art and Money” by Goetzmann, Renneboog, and Spaenjers (2011), the authors investigate the impact of equity markets and top income on art prices. They construct an art market index based on repeated sales data from Reitlinger (1961) and the Art Sales Index, focusing on London sales expressed in British pounds. The study finds a significant relationship between equity market returns and art prices over the past two centuries. Moreover, an increase in income inequality is associated with higher art prices. The authors also establish a long-run relation between top income and art prices. However, there are limitations to the dataset used, including a high concentration of sales from Christie’s London and potential biases related to artists famous in the 1960s. The study suggests that the money of wealthy individuals drives art prices, and rapid income inequality growth can lead to an art market boom. The findings support the notion that art prices are influenced by financial and economic factors.

Risks and Challenges in Art Investments

Trust, provenance and authenticity

In the study “In Art We Trust” by Li, Ma, and Renneboog (2021), the researchers explore the role of authenticity and provenance information in the art market. They investigate how information about an artwork’s history and certification affects its chances of being sold, its prices, and its returns.

To conduct their research, the researchers analyse auction catalogues from the online database Blouin Art Sales Index. They collect data on over 1.8 million transactions of paintings sold between 2007 and 2016. They focus on four dimensions of authenticity: pedigree (ownership history), exhibition history, literature coverage, and certification (artist’s testimonial or expert opinions).

Using textual analysis, the researchers examine the provenance text in the auction catalogues and identify 40 characteristics related to provenance information. They study the impact of providing detailed provenance information on the probability of sale, hammer prices (final bid prices), and returns for approximately two million artworks.

The study finds that trust, as indicated by provenance information, increases the likelihood of an artwork being sold by 2 to 4%. It also leads to price premiums of 14 to 54% and increases annualized returns by 5 to 16%. These findings hold true across different factors such as artist reputation, artistic style, auction house reputation, art market liquidity, and artist career timing.

In conclusion, the study highlights the importance of provenance information in establishing the authenticity of artworks and building trust in the art market. Detailed provenance information positively impacts the likelihood of sale, prices, and returns of artworks, contributing to a more reliable and trustworthy market.

Fake Artworks

In the paper “Discoveries of Fakes – Their Impact on the Art Market” by Bocart and Oosterlinck (2011), the authors study what happens when fake artworks are discovered in the art market. They find that a significant portion of high-end art may be fake, and when doubts arise about the authenticity of a painting, its price can drop by more than half.

The researchers look at how the discovery of fakes affects the selling of paintings and their prices. They analyse newspaper reports of fake discoveries and use a statistical model to understand the impact. Surprisingly, they find that the discovery of fakes does not greatly affect the chances of selling an artwork. Buyers seem to consider it irrelevant.

They also discover that prices of paintings do not immediately change when fakes are exposed. The first noticeable change in prices occurs about 136 days after the discovery. However, after about a year, prices start to increase again, suggesting that buyers regain confidence in the market. This means that while the impact on prices is not immediate, it has a medium effect in the long run.

The study also mentions that sellers may choose different ways to sell their paintings once fakes are known to exist. They may use auction houses that have stricter checks to ensure the authenticity of the artworks.

Overall, the research shows that the discovery of fake art has limited immediate impact on the probability of selling a painting and does not lead to immediate changes in prices. Over time, however, prices can recover as buyers regain trust in the market.

Strategies and Timing in Art Investment

Arbitrage

Arbitrage refers to the process of exploiting price differences in various markets by simultaneously buying and selling securities, currencies, or commodities. However, in the market for unique items such as paintings, sculptures, and prints, arbitrage is generally not theoretically possible due to the uniqueness of each piece. However, in the market for prints, where identical copies of the same item exist, arbitrage could occur in practice. Nevertheless, limitations may arise due to the condition of the prints and variations in transaction costs.

Navigating Market Conditions and Trends

Art in Times of Crises and Socio-political Turmoil

During World War II, art performed well relative to other main asset classes such as securities, bonds, and gold. While art returns initially declined at the onset of the war, they later became positive and outperformed equities. This suggests that art served as a hedge against political uncertainty during the war period.

In terms of specific returns during WWII (1939-1945), the arithmetic mean real return for art was 11.5% compared to 8.6% for equities. The geometric mean real return was 9.5% for art and 7.5% for equities. Over a longer-term period of 110 years, the art auction value demonstrated an arithmetic annual real return of 3.6%, with a risk amounting to 20.1%.

Art may have performed better during WWII due to its physical nature, allowing for the storage and transportation of value outside the country. Smaller, more portable paintings obtained higher returns during the war, partly because owning and trading gold was made illegal by the Nazi regime.

Overall, investing in art optimized the risk-return trade-off during both non-crisis periods and times of high uncertainty, such as political crises like wars. However, it is important to note that the largest declines in art returns occurred during the post-WWI period in 1931 (-63%) and the post-WWII period in 1991 (-37%) when significant art market bubbles burst.

Trends and Fads

In the paper “Sentiment and Art Prices” by Penasse, Renneboog, and Spaenjers (2014), the authors explore how people’s feelings and attitudes, known as sentiment, can affect short-term changes in art prices. They collect survey data from the art community, asking participants about their confidence in the future market for specific artists

The study finds that when sentiment is positive, it tends to predict higher art prices in the near future. This suggests that people’s positive outlook on the art market can influence the prices of artworks. However, it is important to note that the study focuses on short-term changes and does not analyze the long-term impact of sentiment on art prices.

The authors also discuss the boom-bust patterns observed in the art market, where prices can experience significant fluctuations over time. They suggest that traditional financial assets, like stocks, are valued based on their expected future earnings, while the value of art is influenced by factors such as market psychology and emotional appeal.

To measure sentiment, the authors use a dataset that includes survey responses from the art community, asking how participants feel about the future market for specific artists. The results indicate that when sentiment is high, it tends to be associated with positive short-term returns in the art market.

It is worth mentioning that the study does not thoroughly investigate whether extended periods of high sentiment can lead to lower long-term returns in the art market. The factors that drive trends and fads in the art market are still subjects for further research.

Overall, the findings of the study suggest that sentiment can play a role in shaping short-term changes in art prices. However, it is important to consider other factors and conduct more research to fully understand the dynamics of the art market.

Bubbles

In the paper “Speculative Trading and Bubbles” by Penasse and Renneboog (2020), the authors examine how people’s expectations and trading behaviors can lead to boom-bust cycles in the art market. They find that when investors believe that past returns indicate future returns, they tend to overbid during periods of high demand and underbid when demand is low. These patterns of behavior result in predictable market ups and downs.

The study also identifies certain characteristics of speculative bubbles in the art market. During boom periods, there is increased trading volume, a higher proportion of short-term trades, and more trading of artworks from the post-war period. The market also experiences higher volatility during these times. Interestingly, short-term trades tend to perform worse compared to long-term trades.

The findings of this study challenge traditional theories that suggest asset prices are based on expectations of future value. Instead, the authors find that price changes in the art market are influenced by current demand rather than future predictions. They argue that investors may have biased expectations, leading to these patterns in art prices.

The study highlights a particular period called “The Late 1980s Bubble,” which was a significant boom-bust cycle in the art market. This period coincided with the Japanese asset price bubble and involved many Japanese collectors in the market.

Overall, the study shows that art prices can be influenced by investor sentiment and expectations. It reveals that when investors become overly optimistic and base their decisions on past performance, it can lead to inflated prices followed by market downturns. Understanding these patterns can help us better understand how the art market behaves and why prices can fluctuate so dramatically.

Future: Technological Advancements and Digital Art; NFT’s

NFTs, or Non-Fungible Tokens, are unique digital items linked to an account through blockchain technology. They enable digital ownership, royalties, and cannot be replicated. NFTs can represent digital art, physical art, music, and more. Buyers and sellers of NFTs use digital wallets to store their cryptocurrency keys, which give them access to their online money. IPFS, or inter-planetary file system, is a decentralized storage system that prevents data loss in case of server crashes. The NFT market experienced a spike in volume due to speculative investment, leading to the sale of many useless NFTs. One potential application of NFTs is to create a transparent market that allows creators to receive fair compensation and royalties for their unique creations, such as shoes.

References

Goetzmann, W. N., Renneboog, L., & Spaenjers, C. (2011). Art and Money. The American Economic Review, 101(3), 222–226.
Li, Y., Ma, X., & Renneboog, L. (2021). In Art We Trust. (CentER Discussion Paper; Vol. 2021-016). CentER, Center for Economic Research.
Li, Y., Ma, X., & Renneboog, L. (2022). Pricing Art and the Art of Pricing: On Returns and risk in art auction markets. European Financial Management, 28(5), 1139–1198.
Penasse, J. N. G., Renneboog, L. D. R., & Spaenjers, C. (2014). Sentiment and art prices. Economics Letters, 112(3), 432-434. https://doi.org/10.1016/j.econlet.2014.01.008
Penasse, J. N. G., & Renneboog, L. (2022). Speculative trading and bubbles: Evidence from the art market. Management Science, 68(7), 4939-4963. https://doi.org/10.1287/mnsc.2021.4088
Ma, X., Noussair, C. N., & Renneboog, L. (2022). Colors, emotions, and the auction value of paintings. European Economic Review, 142, [104004]. https://doi.org/10.1016/j.euroecorev.2021.104004
Pénasse, Julien and Renneboog, Luc, Speculative Trading and Bubbles: Evidence from the Art Market (December 1, 2020). CentER Discussion Paper Series No. 2014-068, 7th Miami Behavioral Finance Conference 2016,
Kim Oosterlinck, 2017. “Art as a Wartime Investment: Conspicuous Consumption and Discretion,” Economic Journal, Royal Economic Society, vol. 127(607), pages 2665-2701, December.
Graddy, K., & Lieberman, C. (2018). Death, bereavement, and creativity. Management Science, 64(10), 4505–4514. https://doi.org/10.1287/mnsc.2017.2850
Renée B Adams and others, Gendered Prices, The Review of Financial Studies, Volume 34, Issue 8, August 2021, Pages 3789–3839, https://doi.org/10.1093/rfs/hhab046
Bocart, Fabian and Oosterlinck, Kim, Discoveries of Fakes: Their Impact on the Art Market (September 13, 2022). Economics Letters, Vol. 113, No. 2, 2011.
Renneboog, L. D. R., & Spaenjers, C. (2014). Investment Returns and Economic Fundamentals in International Art Markets. (CentER Discussion Paper; Vol. 2014-018). Finance.