Deloitte released the fourth edition of its report on the state of art and finance earlier this month. The 2016 Art & Finance Report comes at a time when investors and art market players alike are experiencing a softening in the markets. Yet several indicators show that we can remain bullish about the future of art as a viable asset class. Here’s what you need to know.
Current macroeconomic uncertainty is leading an increase in the extent to which collectors view art from an investment perspective
Analysts suggest that we could currently be at a low point in the down cycle of asset performance, with volatility ebbing in the second half of the year. Global GDP is estimated to increase at a rate of 3.2% this year, which is slightly lower than what was predicted at the end of last year, when the Fed increased interest rates for the first time since 2006. While economic down cycles have some impact on the art market, they also spur increased investor interest in alternative asset classes as a means of risk and portfolio diversification.
Two factors are of greatest interest to wealth managers when considering an increase in client wealth allocation towards art. For one, art, especially at the high and ultra-high end of the spectrum, can be non-correlated in nature or at the very least less dramatically affected by macroeconomic swings and geopolitical uncertainty. While we saw a dramatic contraction in the gross value of art sold during New York’s spring auction season, the prices achieved were generally within expectations. Thus, wealth managers hold a view that art is well used as a store of value, rather than as a yield-oriented investment vehicle. An all-time high of 51% of wealth managers hold this view, up from 35% in 2014. Another key factor for including art in investors’ portfolios is inflation protection. Thirty percent of the wealth managers surveyed held the view that art could provide a buffer against inflation, doubling the 15% of those surveyed who held the same view in 2014.
The focus of art investment has shifted as a result
Two years ago, the art world was caught up in a flurry of speculation around emerging artists. Prices famously rose at astronomical rates (3,000% in just a few years for artists like Oscar Murillo and Lucien Smith). Things have since calmed down significantly. And the notorious “art flippers,” as they were called, have fallen out of the limelight as their headlining profit opportunities have largely disappeared. This means that investment-oriented art purchasing is also less visible to those working in the art trade.
However, collectors’ concerns about the potential return on investment when buying art has increased significantly in the past two years—from 47% of collectors citing this as a significant factor when buying in 2014, to 64% in 2016. The vast majority of collectors (72%) say their purchases are passion-led and investment-informed, while only 6% said they’re buying art purely as an investment. Wealth managers’ interest in art as a store of value can also be seen in the extent to which more consistently performing sectors of the market, like the Impressionist and modern segment, have grown in overall market share (33% in 2015 over 27% in 2014), while the contemporary market has stagnated at an overall higher 45%. The greater provenance and proven price track record for works in the Impressionist and modern sector make for lower, more predictable risk and thus a more palatable investment in less-certain times, macroeconomically-speaking.
Though the art market is currently down, certain sectors of the market continue to outperform key economic indicators
As with much of the investment landscape, the biggest returns when investing in art are at the very top of the spectrum. The Mei Moses World All Art Index (a somewhat controversial but widely cited market indicator) was down 3.1% in 2015, while the S&P was up 7.14%. However, works sold for over $10 million have generated a 27% compound annual growth rate, or a 1,000+% return over 10 years. Deloitte highlights that this return more than doubles that of gold and other frequently cited commodities. Looking at a 20-year spread, the Mei Moses’s compound annual return of 5.26% was below the 8.33% of the S&P500. However, if you segment out post-war and contemporary art or traditional Chinese art, Mei Moses beats the S&P at 10.71% and 9.13%, respectively. A similar picture is painted when looking at a 50-year spread, with art returning 7.89% annually against the S&P’s 9.17%, but post-war and contemporary delivering 10.85%.
Significant growth in the art-secured lending space is allowing those with assets allocated to art to access the value of those works without selling them
In the past, a major hesitance among wealth managers with regard to their clients including art and collectables among in their portfolios has been that art—often even more so than real estate or private market equities—is a relatively illiquid asset. To achieve maximum return, resales must be timed precisely. And even then, if we’re talking about a truly significant piece, there are only major sales in New York (the most business-friendly city for art dealing) twice per year. However, art-secured lending has grown rapidly in recent years to fill this gap. (Deloitte estimates 15–20% annual growth in the sector over the past five years.) Now only 62% of wealth managers cite liquidity as a major concern for clients with art in their portfolios, down from 83% just two years ago.
According to the survey, two major use cases have come to the fore for art-secured loans that have surprised some in the space: collectors who are entrepreneurs (or gallerists) leveraging their art holdings to obtain short-term liquidity when a significant business opportunity presents itself; and the elderly, who are using art-secured loans as a sort of reverse mortgage on their collections. The arrangement allows for collectors to get cash out of their art without paying the capital gains taxes that would be associated with a sale. And, at least in the U.S., it also allows them to keep the art hanging on their walls. In Europe, regulations are stricter and force any art loaned against to be handed over for the duration of the loan, hindering growth in the sector.
Investment vehicles tied to art remain relatively far off and wealth managers are generally bearish on art funds
With such significant growth in art-secured lending, one might expect that securities built around these debt obligations would be near on the horizon. Not so, says Deloitte. Art Collateralized Debt Obligations (ACDO) and Art Credit-Default Swaps (ACDS) remain a ways off, despite the fact that they could enable current debt holders to hedge risk. The central mitigating factor here is the liquidity risk on ACDOs being too high. In other words, the current risk analysis suggests that the securities may not be able to generate sufficient income for their cost and/or that those leveraging art holdings may default at too high a rate. More nimble hedge funds may, however, be able to enter into custom arrangements with auction houses and other major market players in the short term.
Wealth managers also currently have a declining interest in art funds. Only 10% said that the sector will expand in the next two to three years. That’s down from 20% in 2014, and understandably so, given that the market has contracted from a high of $2.13 billion in 2012 to $1.2 billion in 2015. The art fund market is also heavily concentrated among very few players, most notably The Fine Art Fund Group. The typical concerns around the art market—lacking ability to conduct pre-investment due diligence or track current valuations while invested, and the unregulated and non-transparent nature of the market—are amplified when wealth managers look at art funds, according to the report, with all three issues being cited as a major concern by over three-quarters of those surveyed. This also suggests that more traditional exchange traded funds (ETF) based on an art index remain a relatively distant prospect.
There has been one interesting, late-breaking development in the art investment space, however. London’s Passion investment eXchange (Pi-eX Ltd.) received regulatory approval in February of this year to begin offering a new instrument called Contracts on Future Sales (CFS). CFS is essentially a derivative based on an upcoming lot set to come up for auction. It should allow both art buyers and sellers to hedge their risk when selling a particularly major piece, something that could, if adopted successfully, have interesting implications for the auctions business and the guarantees houses currently use to help consignors mitigate their risk exposure. It also means that interested fund managers may be able to begin trading art futures in the same way they trade other commodities.