Investors are looking increasingly at the tactics and strategy of investing in art amid fears about the inflationary impact of rising government debt, argues Randall Willette of Fine Art Wealth Management.

Recently we have seen a portrait of Pablo Picasso’s mistress entitled “Nude, Green Leaves, and Bust” sell for $106.5 million at Christie’s in New York - making it the most expensive painting ever sold at auction.  As investors shift their concern from weathering the financial crisis to anticipating the inflationary effects of rising government spending and debt, they are turning to art for tactical and strategic investment.   

Investors are expected to increasingly explore the role that real assets like art can play in their portfolios in 2010 through opportunistic, tactical or strategic investment.  While many investment professionals agree that real assets provide diversification benefits, there has been surprisingly little research into the appropriate allocation in an investment portfolio.

Art used in the right way can enable investors to better tailor their investment strategies to address specific financial and investment concerns (for example, controlling volatility, boosting returns, or hedging against inflation). 

Diversification within alternatives

Many of the gains realised by high net worth individuals in recent years have been a result of strategic diversification of their holdings by moving into a broad range of asset classes.

Increasingly, sophisticated investors are looking to protect themselves from losses by emphasising diversification within their alternative portfolios among various established and new types of strategies.  Art, like gold, is classed as a “real asset” and has proven in the past as a natural hedge against inflation.

Additionally, we have seen the emergence of a number of art funds and the growth of private art investment clubs for wealthy individuals looking to put a portion of their wealth into selected sectors of the art market as a safe-haven. 

Strategic management of an art porfolio

Art is increasingly becoming a small part of the portfolios of wealthy investors who are searching for alternative assets with two distinct strategies emerging.  The first strategy is designed to emulate the world’s top collectors who tend to focus on specific sectors of the broader art market. Collectors pursuing a sector allocation strategy seek to obtain their investment objective of medium to long term capital appreciation through the active management of a broadly diversified portfolio of art across the most established sectors such as Old Masters, Impressionist, Modern and Contemporary.

These sectors are identified for having significant size and maturity of collector base; independent market behaviour (including price performance and volatility); and a long transaction history allowing greater predictability. The second strategy is pursued by the leading art dealers and auction houses that successfully identify financial transactions and direct art investments that can result in superior shorter-term returns. Transactions of this nature may be viewed as a higher risk/return proposition and often include trading opportunities to buy and sell works quickly to achieve an immediate return.

Sector allocation

A critical element in the success of any collector is his or her ability to find attractive investment opportunities on favourable terms. Opportunity can be further managed through a combination of economic and behavioural research and access to market intelligence.  To enhance the value of each individual art asset in a portfolio, investors should consider employing the same curatorial and marketing activities commonly practiced by successful collectors and dealers through strategic promotion and exhibition.

For example, successful collectors will often seek appropriate public venues for the exhibition of their collection and inclusion in an important show or at a respected institution.  Equally important, assembling a group of works into a cohesive collection with a singular focus can result in significantly higher prices than the amount each work might command on its own.  Finally, investment in art involves a substantial risk of loss.

Precipitous art market declines such as the one we have just experienced in the Contemporary art market are often the result of bursting bubbles within geographic regions or market sectors. As with any alternative investment strategy, investors must carefully consider the data and market intelligence where such activity appears to be building.  Sophisticated investors will also employ non-concentration strategies to mitigate the risk of exposure to a single opportunity or sector of the art market.

Investment process

An investment approach to managing an art portfolio cannot be static and should aim to combine traditional portfolio management with art world “best practices” by drawing on a combination of research, expertise and market intelligence.  The process of determining where assets should be allocated should include a thorough assessment of art market conditions, global economic conditions, the availability of attractive investment opportunities, and suitability of investments to the risk/return profile of the investor.

Similar to industry analysis in traditional fund management, the investment process should include a curatorial review of sectors, genres and artists within each sector to determine how trends in those sectors would influence the future performance and risk management benefits of the portfolio.

Art price indices

What is relatively new about art investment is the preponderance of recent data that for the first time is providing investors with an understanding of the risk/return potential inherent in this unique asset class. Established techniques and discipline common to the management of every asset class can now be employed allowing investors to incorporate art into their alternative investment strategy.

Over the last several years we have seen the development of art price indices which have aided the comparison of art to other assets such as equities, bonds and gold.  There are a number of methodologies for producing art price indices however all are reliant on data from the sales at the main auction houses given the absence of obtainable data from the dealer market and private treaty sales.

Boutique art investment clubs

A new and interesting development in art investment has been the emergence of small and very private art funds and/or clubs formed by high net worth investors looking to integrate art into their alternative investment strategy.  The desire to establish an art investment club or private fund has grown particularly among friends and family wishing to co-invest in a particular sector of the art or collectibles market.

This type of arrangement is typically self-managed and no third party investment manager is engaged.  In fact, the trend towards “Do-It-Yourself” investing is thought to have intensified since the crisis, because many high net worth investors currently see direct investment as the most palatable alternative to counterparty risk and “black box” solutions such as hedge funds and structured products. 

Establishing an art investment club is a unique way to pool investment capital from a group of like minded investors. By clubbing together with other investors private clients may not only benefit from a more diversified art portfolio but also from a lower dealing cost than if they invested  in art themselves.  Another scenario is a family office which will engage a professional third party fund manager to invest and manage the art assets of the scheme. 

Given their limited size (there are normally no more than 10-15 investors), these boutique investment clubs require much lighter regulation and reporting and as such are less costly to set up and administer.  They are also a good way for a start-up art fund to establish a track of performance before going public. 

They are able to offer members a network of privileged resources and access to tailor-made services ideal for a family office.  Most of all, investing members are able to make better informed decisions about art purchases from the knowledge gained through participation in a club before going solo.

About Fine Art Wealth Management

Fine Art Wealth Management Ltd first began studying art as an alternative asset class in 2003 to fill the void of useful information available to wealth managers and their private clients. Since this time we have grown to become the leading provider of intelligence on art investment funds and clubs through our quarterly publication Art Fund Tracker (click here) and consult on integrating art into overall wealth management strategy. 

(Randall Willette is a member of WealthBriefing's editorial advisory board).