The Art Alpha

As attendance fell to almost nonexistent during the coronavirus pandemic, famous museums around the world face destabilizing budget deficits. The Met museum in New York, whose finances rely on donations and revenue from its endowment instead of public funding, reported potential losses of up to $150 million and suffers still from the uncertainty shadowing the COVID-19 crisis, which is hopefully nearing its end. The museum has announced plans of putting artworks on sale from its collection to alleviate the budget deficit.

Usually, museums face strict restrictions about selling artworks from their collections. In the United States, collection policy guidelines are defined by the American Alliance of Museums and the Association of Art Museum Directors, which has held, for instance, that revenue from any sale of an artwork from the collection can only be used for future acquisitions of other artworks. This constraint has now been relaxed to help privately-funded museums in the US to sell works and use the revenue to pay bills, and survive the coronavirus crisis. The association also coordinates emergency funding resources for nonprofits.

Museums cannot freely sell their collections because of their very definition: “A museum is a non-profit, permanent institution in the service of society and its development, open to the public, which acquires, conserves, researches, communicates and exhibits the tangible and intangible heritage of humanity and its environment for the purposes of education, study and enjoyment.” This definition by ICOM formalizes the responsibility of conservation of cultural heritage, which is the basis of museums’ limited freedom to selling artworks. Obliged to guarantee the preservation of the artworks in their collection, museums cannot freely sell them to instances that do not adhere to these values.

Aside from the Met, other museums have deaccessioned during 2020, including important artworks such as Portrait of Sir David Webster (1971) by David Hockney from the Royal Opera House, Red Composition (1946) by Jackson Pollock from the Everson Museum collection and a couple of high-profile Old Masters. Now, concerning the Pollock, I am usually very supportive of museums selling ubiquitous male modernists that people can see in almost every museum in the world, because these resales can finance new acquisitions of works by female artists, artists of color, and other historically neglected artists to diversify the museum’s collections. Indeed, selling a single Matisse or a Picasso would provide museums with enough funds to acquire multiple artworks by undervalued artists of said demographics. While deaccessioning can be ethical and uplifting, sometimes (American) museums sell just to renovate. In that case, one understands the importance of government funding for museums.

The Old Masters I mentioned deserve a closer look. Old Master artworks are much rarer on the market than Modern, Impressionist or Contemporary art, because of the time-decay, disparition and material eroding of the artworks in the course of centuries, but also because most of the important Old Masters artworks in the world belong to museums. Museums do not usually sell them. This generates a very important scarcity effect on the market for Old Masters, and when one does surface the market, everybody knows. As per auction results in 2019, Arts Economics estimates Old Masters to account for merely 7% of total market share in value, 8% in volume:

As the world saw in 2017, the auction of Salvator Mundi, the “last Leonardo” on the art market fetched a record price of $450,3 million (net of fees), the highest price ever paid for an artwork and more than three times the previous record price. The hammer price was $400 million, which means that Christie’s revenue from that single sale was $50,3 million, or 12,58% of the hammer. The artwork was sold to Prince Bader bin Abdullah bin Mohammed bin Farhan al-Saud, a close contact of Saudi Arabia’s crown prince, Mohammed bin Salman. Later, it was revealed that Salvator Mundi was destined to be displayed at Louvre Abu Dhabi, as a fitting counterpart of the Mona Lisa. As of today, the exact whereabouts of Salvator Mundi are unknown.

After this, it is easy to understand why the opening of the Old Masters reserves in museum collections could make waves in the art market.

The Brooklyn Museum of art decided to sell Lucretia by Lucas Cranach the Elder, which had been in the museum’s collection since 1921. The work was estimated between $1,2 and $1,8 million, and sold at Christie’s Old Masters auction on October 15th, 2020. The realized amount net of fees was $5,070,000, with a hammer price of $4,200,000 as audible in the auction recording. This accounts for fees of 20,7%. A popular subject of Renaissance painting, the suicide of Lucretia evokes themes of sexuality, honor and morality, permitting artists to depict sexuality openly. The identity of the purchaser is unknown to the public. According to the details offered by Christie’s, the work was last exhibited at Brooklyn Museum in 1990, which provides some evidence that the selling decision is in line with the museum deaccessioning guidelines of mainly disposing of artworks that are rarely shown to the public.

Lucas Cranach the Elder, Lucretia, 1533. CHRISTIE’S IMAGES LTD. 2020

The Royal Academy in London is considering the sale of Taddei Tondo, a marble relief sculpture by Michelangelo, and the only Michelangelo sculpture in Britain. While the sale has not been confirmed, it is not the first time the RA plays with the idea of selling this particular piece since its valuation may well be in the range of (tens of) millions of pounds. Original Michelangelos are a very rare sight on the market. While the RA is not technically a museum, selling such a cornerstone of the collection is understandably a hot topic, especially since its donation to the RA was accompanied by the wish of its previous owner to “allow all artists to have free access to it”. This purpose would undoubtedly be compromised in case of a sale. Moreover, I think that sales of artworks from important institutional collections should resemble pruning a tree, as in tidying out by removing unnecessary parts, instead of cutting off the centerpiece.

An example of said wave was observed early this year, when Sandro Botticelli’s Young Man Holding a Roundel was offered at Sotheby’s Old Master Paintings and Sculpture auction on January 28th. The artwork is obviously exquisite. An enigmatic, androgynous portrait of a “renaissance man”, the identity of the subject is unknown. I think this is one of the best examples of the trendiness of Old Masters and the refinement of taste, to which the scarcity of works by artists such as Botticelli only adds. The work was sold for $92,2 million net, and while the estimate was only available upon request (adding to the mystery), the bidding started at $70 million, which suggests that the hammer price did not fall very far above the upper estimate. In comparison, the Salvator Mundi had an estimate of about $100 million, which was completely shattered by the bidding. Even still, the Young Man Holding a Roundel auction price was 9 times the previous record price for a Botticelli, and a record for an Old Master artwork ever sold at Sotheby’s. Judging from the elaborate promotion that Sotheby’s engineered for the artwork, notably calling it “The Ultimate Renaissance Portrait”, the painting gave high hopes for the auction house to rival Christie’s venerable success with Salvator Mundi.

The artwork is now the second-most-valuable Old Master painting ever sold at auction. However, this Botticelli did not come from museum deaccessioning, but from a late New York real estate developer Sheldon Solow. According to Barrons.com, the same painting had been previously sold at Christie’s in 1982 for around $1,3 million. Adjusting for inflation, the 1982 price in today’s dollars is around $2,3 million, which results in a price increase between the two auctions of 3908% for a holding period of 39 years. (It would be in 8th place on my price appreciation table).

We live in the age of billionaires, and museums do not have such funds. Museums of the world can no longer compete in the bidding for the most prestigious artworks sold at auction. Therefore, we witness a spilling of artworks from the public sphere to the private sphere. Whenever budget constraints force museums to sell artworks on the private market, the artworks arguably become investment vehicles, in the sense that their intrinsic value has increased during their stay at the museum. Famous Old Master artworks will fetch very high prices once let loose from the safety of museum vaults. However, it doesn’t necessarily mean that the artworks are lost from public view, since many collectors lend parts of their collection to exhibitions.

In this week’s The Gray Market, Tim Schneider writes about millennial stock traders and wonders why they are not investing in the art market. He discusses, expertly, some of the important elements that distinguish the stock market from the art market, but misses, for me, the key reason why most retail investors are not interested in entering the art market.

My blog is only a week old, but I’d like to properly introduce the topic of art market data to you. The actual reason the art market doesn’t attract investors is the sinister (and unbelievable, when you get deeper into it) lack of transaction data on the art market. Why? I’ll illustrate with a thought experiment:

You are familiar with the soaring equity markets and you’re thinking of purchasing a Tesla stock.

Now, let’s imagine we subtract most of the available transaction data from the financial markets. You can no longer look at daily transactions, you have no idea of the price level or volume (how many units were sold) of today’s trades of Tesla stock. Without datapoints, you have no graphics, no visual models showing the stark price evolution of Tesla over time (or maybe you craft yourself a measly, crude one with one datapoint per every 6 months).

You search the Internet and learn that a Tesla stock was sold last year once at XXX$. However, you don’t know how much of that sum were transaction costs.

Also, you no longer have any measure of price risk, or the volatility of the prices. You can’t see whether there have recently been sales at a lower level than the price you’re being asked. You hope that the price of your Tesla won’t go plunging down, yet, you have no way of computing the probability of it doing so.

Next, subtract instant market access. Your Robinhood platform now includes only the brokers’ phone numbers. You can inquire the price you would need to pay for that Tesla stock, and your broker can decide whether they care to sell the stock to you or to someone more influential.

Robinhood is popular because of the 0% trade fees. Oh, we can’t have that anymore. Slap 20% fees for your purchase.*

Last, subtract liquidity. Know that the buying process takes at least days, if not weeks or months. The price of the Tesla stock you’re in the process of acquiring might go down during that time, but you wouldn’t know, nor be able to resell before it drops too much. Also, you must either trust the documentation provided by the broker on the veracity of your Tesla stock, or hire an expert to make sure it’s the real deal.

Now, we have something of a proxy for today’s art market. How confident are you now in your initial idea to purchase Tesla stock and benefit from its future increase in value?

I think it is no wonder that investors avoid the art market. Unlike the financial markets, the art market does not have any objective price database that would track the price evolution of artworks sold in the world. As a rule, the transactions in the art market are not transparent, because the sellers and intermediaries do not publish the prices anywhere. They are not required to. As mostly private businesses, art galleries and dealers only report the overall turnover of their business to the tax authorities, because they are subjected to the regulation of private businesses. The important exception to this rule is auction sales. By law in many countries, auctions are public events and the prices are published by the auction houses. These prices, however, are most often net of fees, which means they include the fees charged from the buyer and the seller, obscuring the real hammer price.

Some data on the art market is offered by specialized data providers, who charge fees for access to their databases. I will discuss data providers separately in the future in order to give a full picture of the level of transparency we’re able to get. There are providers of different types, meaning that their data collecting / crunching / analyzing methodology is more or less public, and the source and completeness of their data vary not only from provider to provider, but also from year to year. Yep.

I hold that the problem with data is the source of an incredible degree of inefficiency, inequality and injustice in the art market, and it is something that ought to be corrected as soon as possible. I believe that we should look at the financial markets for solutions. Indeed, the financial markets have developed an outstanding body of data, which is by obligation transparent, because all of the market participants need to have access to the same information. The quantitative tools and actually the entire sciences of statistical calculation, machine learning and data processing have been developed because they are necessary to decipher the data in the financial markets.

The science of investment, as I have attempted to express, relies entirely on using data and information on the markets to calculate potential sources of plus-values for invested capital. This is finance. Finance cannot work without data! That data must imperatively be freely available, instantaneous, absolutely correct and regulated, I might add. Conversely, it is actually surprising that there is an art market at all, given its problems with data opacity.

Schneider contemplates the absence of derivative instruments on artworks. There are no derivative products on the art market because there is no way to price them. Pricing financial products, such as options or futures, requires information about the price of the underlying asset. Since we know the current price of a certain stock, say, Apple, and it’s entire price evolution history, it is possible to calculate the volatility of the stock (volatility is the measure of the price swings up and down, frequency and intensity of those swings), the sensitivity of the stock’s price in regards to the overall market (called its beta in the CAPM pricing model), the optimal stock price given multiple parameters of the company’s financial statements (methods such as DCF, discounted cash flows), and many more essential pricing parameters. Creating structured products reposes on a body of scientific methods of extracting information of the stock price. As we said, the art market disposes of none of that.

Even if we assume that we momentarily solve the problem of pricing correctly the artwork we would like to acquire (in an investment objective), the deal with data doesn’t end there. Say we have inside information which permits us to know the future price P, and are able to acquire it for less than that, R. We secure as capital gains the margin of P – R, since we only paid R and will be able to sell it for P in the future, and R < P. Even then, we suffer from the lack of efficiency of the markets because of the transaction costs C1 = 20% of R and C2 = 20% of P. Then, our gain must be higher than 0,2*(P + R) in order to make any profit. Then, our payoff writes G = (P – R) – 0,2*(P + R), which must be greater than 0 in order for us to go for that trade at all. In other words, the high transaction costs are likely to eat the gains we projected to make thanks to our insider information.

In the securities markets, transaction costs are a result of illiquidity, which in turn is a result of difficulties of selling and buying efficiently, hindered by lack of information. I don’t know yet whether we can argue that transaction costs are strictly caused by the lack of data and transparency in the art market, but for now I would incline towards claiming that they are, at least partially.

Now, if I were an investor interested in some price appreciation in the niche art market, I would be rather reluctant to send my money to a non-transparent and unpredictable market, when accessing it would require considerable effort and money. Any information about the correct prices would cost me money, and I wouldn’t be sure if the information would be good enough to build forecasts on.

In order to be clear with regards to my last post, it is not impossible to make gains in the art market (clearly). What is impossible, or at least very difficult given the current environment, is to make these gains systematically, to anticipate risk and returns, and adjust our investment strategy accordingly to the information. In other words, the systemic analysis of the art market’s movement is not feasible without data. The reason why art is not considered a real financial asset is because the structure of the art market defies any kind of systematic investment strategy. This structure, I believe, should be better regulated in terms of data transparency in order to put it into a financial framework that would improve the safety of art collectors’ capital. This, in turn, would arguably open up the market to people like you and me.

*I will later discuss Online art market platforms, which are already solving a part of the efficiency problem of the art market, as well as bypassing some traditional gatekeepers. They are even a potential solution to the price transparency problem and reducing transaction costs by a great deal.

If the art market is notoriously capricious and difficult to measure, why should investors be interested in entering such a perilous market?

Given that most art investors are actually avid art collectors, who collect art for many other reasons than for a pure investment purpose, one could say that art investment is really a niche, or just a byproduct of art collecting. This is a plausible statement: generally, collectors do seem to consider the aesthetic quality of the artwork as more important the investment potential. Or at least they claim so.

Nevertheless, some artworks have produced rather phenomenal financial gains for their holders. Artprice.com lists the largest plus-values generated in auction resales in the first half of 2019:

Notice that the price appreciation is in thousands of percents. Aside from certain exotic derivative products with very high leverage, no other investment vehicle produces that kind of yield. Of course, the holding periods are very long at more than 25 years on average. For most collectors, that kind of investment period isn’t out of the question, since it denotes the period they get to enjoy the artwork in the collection.

Artprice.com employs data from auction sales, which are public. The artworks selected here are the ten best price appreciations realized by subsequent sales in H1 2019 for singular works, therefore not representative of the market as a whole, not even of the market for these artists (even though you may notice that Jean-Michel Basquiat appears three times in the list). The prices are in nominal terms, but the price appreciation % has been adjusted for inflation by Artprice.com (supposedly, since I’ve no access to their specific methodology).

I’ve added another price appreciation measure normalized to a 10 year holding period. It represents relative yield supposing the holding period is only 10 years, given the accelerated pace of transactions in the market and the change of trends. A disclaimer must be made here; it is in no way evident that the increase in price is linear and therefore we could expect 3 297 % rises in prices every 10 years. More likely, the resale of these works has been timed to match a moment when the markets were very favorable to these specific artists.

The prices are net of fees, which can represent 18%-25% of the actual hammer price. Auction houses make their money from fees charged at the seller (“Vendor’s commission”) and the buyer (“Buyer’s premium”). Sadly, the prices that are published by the auction houses are always net, not gross prices (the so-called “Hammer price”), which makes the evaluation of exact gross returns impossible. The only way to know hammer prices is to sit at the auction.

The investor-collectors that hand-picked these artworks at the right time were very lucky. Or were they? Could it be possible to select promising artists before their prices skyrocket on the market? In equity markets, such practice is called “stock-picking” and it consists of studying, evaluating and scrutinizing promising entreprise stocks and assess the growth potential of their cash flows. It is also called fundamental analysis, a basic of portfolio management strategy.

Artworks do not produce cash flows other than the potential resale value. They pay no dividends. Instead, there are negative cash flows (ie. costs), such as insurance premium, transporting the work, storage, possible restoration, framing… Therefore, owning an artwork can be costly. If investment is the only reason an artwork is purchased, the investor needs to be very convinced that the artists’ works will rise in value.

Investment is usually not the only reason to purchase art. Collecting art is often a matter of passion for art and the willingness to contemplate artworks in the peace of one’s own home. Because of the taboo of money in the art world, many collectors would not be comfortable discussing financial aspects of their collection (in my experience, this is still very much the case).

According to this fantastic survey conducted by Deloitte Luxembourg in 2017, art collectors are most motivated by emotional and social values, closely followed by financial considerations, such as art providing a diversification to their investments, investment returns and even some inflation hedge. A hedge means reducing the risk of overall investments with another asset that isn’t subjected to the same risks.

This graphic proves that collectors actually consider the investment objective jointly with the collecting objective. The most prominent reason to buy art isn’t solely investment or collecting, but the two combined:

The investment aspect of art is becoming increasingly appealing to new collectors and investors alike. Especially millennial collectors are aware of the value gain potential and wish to gain access to the high end of the art market.

However, art investment remains an under-studied field, and it merits much more attention and theoretical analysis. Especially financial institutions have slowly started to pay attention to the art market. The systematic analysis and study of price movements should be more integrated to modern statistical and scientific information systems, just like the rest of global financial markets.

Below, I’ve included the full details of the Artprice.com 2019 H1 auction gains list.

Top 10 auction gains in H1 2019, in US dollars © artprice.com

1. Jean-Michel Basquiat: Apex (1986) +36,685% in 31 years $10,815,000 on 5 March 2019 – Sotheby’s London $29,400 on 30 June 1988 – Christie’s London

2. Daniel Buren: Peinture acrylique blanche (1968) +10,111% in 22 years    $357,400 on 8 March 2019 – Phillips London    $3,500 on 26 February 1997 – Libert-Castor Paris

3. Alexander Calder: Fish (1952) +8,752% in 32 years    $17,527,000 on 15 May 2019 – Christie’s New York   $198,000 on 4 November 1987 – Sotheby’s New York

4. Fengmian Lin: Wisteria +7,182% in 27 years   $1,321,700 on 2 April 2019 – Sotheby’s Hong Kong   $18,150 on 1 June 1992 – Sotheby’s New York

5. Yayoi Kusama: Midsummer (1983) +5,840% in 19 years   $427,700 on 6 March 2019 – Sotheby’s London    $7,200 on 30 June 2000 – Sotheby’s London

6. Fei’an Yu: Parrot (1945) +5,600% in 29 years   $786,600 on 2 April 2019 – Sotheby’s Hong Kong   $13,800 on 15 November 1990 – Sotheby’s Hong Kong

7. Jean-Michel Basquiat: Untitled (1987) +4,617% in 26 years   $1,321,000 on 5 March 2019 – Sotheby’s London    $28,000 on 25 March 1993 – Christie’s London

8. Pierre Soulages: Painting 130 x 89 cm, 2 March 1961 +3,402% in 32 years  $3,046,900 on 5 June 2019 – Sotheby’s Paris   $87,000 on 2 July 1987 – Sotheby’s London

9. Christopher Wool: Untitled (1986) +3,324% in 21 years   $630,000 on 27 June 2019 – Phillips London    $18,400 on 13 November 1998 – Christie’s New York

10. Jean-Michel Basquiat: Soothsayer (1983) +2,924% in 17 years   $998,000 on 5 March 2019 – Sotheby’s London    $33,000 on 28 June 2002 – Christie’s London

Source

The art market is a global marketplace for high-end artworks. Today, artworks go from collector to collector and dealer to dealer in a very fast pace. Traditionally, purchasing art at a market is considered as just a necessary step in collecting, which stems from pure love for art. However, those days are long past, since the market for artworks has become an arena for fast-paced trading, short-term collecting and even speculation. The global market for art has adapted itself to the new needs of the international (most often) wealthy people. Famous artworks have also seen phenomenal price developments in the last decades, with bidding rising to tens and even hundreds of millions.

As the amount of capital attached to artworks is growing and moving in a faster and faster pace, art has begun to be considered as a vehicle for investment. Any asset with rapid price development would attract new investors, and art is no exception. Is this bad? Does money erode the value of art? These questions are often asked, because art is deemed as fundamentally non-monetary, and money has been deemed too lowly a consideration to be associated with art ever since the times of Immanuel Kant (a German philosopher famous for his analysis of Aesthetic judgement).

I don’t think that money erodes the value of art or makes it “impure” in any way. When you think of art history, the production of art has rarely been completely dissociated from the artists’ getting by; it is a profession. It is more likely a romanticized idea of a starving artist, which certain famous artists (think of Van Gogh) made popular. To me, identifying exactly the function by which money ruins art seems difficult.

Investing is an exciting activity that combines financial risk with financial returns. The two aspects are contrary to each other, yet delicately intertwined. Indeed, they are two sides of the same coin: a low level of risk exposure entails safety, yet minimal plus-values for the investment, and vice versa. The best gains of invested capital come with high risk exposure.

In financial theory, investment returns are positively correlated with the level of risk: they get higher as the associated risks do. Yet, investors are always risk-averse. They seek the highest level of returns with the lowest possible risk. Nobody wants to risk their money for something that has low prospects of being profitable.

The art market is by no means an exception. In fact, art investment is considered particularly risky a type of financial venture. Why? Because the purpose of art investment is to unite art collecting with potential (and likely) financial price appreciation. The first part is easy, the second part isn’t. Price appreciation is very hard to predict even in the “real” financial markets, which possess all the tools that help investors make good guesses. In the case of the art market, where these tools do not exist or are way underdeveloped, the only way of making a guess is to be very good at anticipating trends in the art world.

There is granularity, though: the works by so-called “blue-chip” artists are the ones that have produced relatively stable gains. These are notably well-known Impressionist artists (such as Monet, Pissarro, Van Gogh, Renoir and Cézanne), household-name modernists (Picasso, Miró, Giacometti or Max Ernst), and established contemporary artists (Jeff Koons, Andy Warhol, Basquiat, Damien Hirst, and the like). The prices for these artists’ works have indeed increased strongly. How exactly, over which time period, in what kind of environment and why, we shall discuss later with more detailed examples. Now, it is enough to state that some artworks have attained pretty astronomical levels in the recent years.

Determining and quantifying risk and returns in the art market context is tricky. The data available is limited, and historical return analysis are difficult to establish. Due to lack of data, we cannot establish reliable calculations on risk level of various art assets, whereas for more common financial assets, like stocks and derivatives, the practice is already developed. There are risks which are particular to the art market, such as the physical risk of the work deteriorating, which financial assets of course do not suffer.

The number of transactions on the art market is much lower than on the financial markets, which touches the notion of illiquidity. The artworks sold are singular, heterogeneous works of varying quality, so generalisations about value gain on the market in general are problematic.

Moreover, an artwork is wholly comparable only to itself, and as the same work might not be resold for a long period (years), even two transactions of the same work might not be perfectly commensurate.

The inherent problems of market data availability and representativity are at the bottom of the great puzzle that can be formulated as follows:

How do we measure art investment returns and risk in an environment that does not easily give itself to statistical analysis, and with methods borrowed from the more quantifiable financial markets?

William Baumol argued in his paper “Unnatural Value, or Art Investment as Floating Crap Game”, published in 1986, that the prices of artworks are not grounded on or driven by “economic forces” in the classical sense, thus floating aimlessly and subject to “unpredictable oscillations”. Is this the whole story of the art market, or could it be possible to actually gain information from the price movements..?

Finally, the exchange of artworks is subject to the laws of supply and demand. 

With all these characteristics, I think that artworks can be defined as financial assets that are specified by a set of characteristics that only art (and occasionally luxury) objects possess. There are many theoretical frameworks in economics and finance that are applicable to the art market. We must nevertheless keep track of the many quirks of the art world which introduce deviations and exceptions to the rules. This is the objective of this blog.