Investors find safe haven in art investments

May 8, 2013

Investors are looking more and more for a save haven. There has been a continued growth in the demand for emotional assets, like art. "If society continues to treasure such objects with at least a certain level of intrinsic value then the downside value of holding such assets should not diminish completely", says Dr. Rachel Pownall.

Can you give an overview on how Art and Emotional investing has been affected by the turbulence in the market the past few years?
The turbulence in financial markets has driven many investors in search of other alternative asset classes. Not just into traditional forms of alternative investments, such as private equity, hedge funds, and ETF’s, but also into alternative investments such as emotional assets, or as they are sometimes termed, investments of passion or treasure assets. Investors are looking for a safe haven, and hence real assets are attractive as a store of value. Furthermore as financial markets become more integrated, more globalised and ultimately more in line with each other investors are looking for investments into assets, which do not move in sink with traditional financial markets. Investments in these types of assets offer investors these potential benefits. Also when markets decline, investors are looking for assets, which do not move to such a large extent when there is a large downside movement in financial markets. If society continues to treasure such objects with at least a certain level of intrinsic value then the downside value of holding such assets should not diminish completely.

Have the type of investors in this asset area changed?
Investors can either invest directly into these types of assets themselves, or they can invest indirectly via a fund which holds a wider more diversified number of artwork or pieces of treasure, and the investor holds a share in the diversified fund. The benefit of investing into a fund is that the idiosyncratic risk of the investment is reduced. For example if the fund holds a diversified mix of different genres of artworks or emotional assets, then the risk which is specific to the genre of art itself, or artist, or type of sculpture or photography, can be diversified away by holding a sufficiently diversified portfolio of pieces. In theory, if sufficient diversification takes place then this risk can also be reduced completely. However, in doing so, the aesthetic value is then lost, since the investor no longer holds the investment of passion directly him- or herself. He or she is no longer subject to the aesthetic dividend from viewing or treasuring the item or asset. Depending on his own tastes (or in economic parlance to the utility function of the investor) he can choose to what extent he is willing to give up the aesthetic dividend in order to obtain a less risky, in terms of less volatile fund from the perspective of price. By not owning the pieces directly or not being able to choose the constituents of the fund he also looses the ability to which his expectations about the future value of taste and fashion will influence subsequent prices, and this is given over to the fund manager. As is other operational aspects, such as the ability to detect fakes or forgeries, insurance premiums, transaction and commission fees etc. The diversification benefits compensate for the aesthetic or emotional value from the asset, and depending on the individual’s tastes the investor will choose to what extent he or she is willing to carry this diversifiable risk. For each person the trade off associated with the loss of aesthetic value and lack of involvement in the collection of items purchased will be different. For the true collector he will be unwilling to give up any aspect of this in order to obtain less risk in terms of market price risk. In this respect also the type of investor in the area of passion investing is changing. If the investor is driven more by the status element from holding the investment of passion, then he or she will be interested in an indirect investment only and not by the direct investment.

Can treasure asset funds create alpha or are these types of funds better used for capital appreciation and risk diversification?
There is little evidence that these types of asset funds outperform traditional assets in terms of alpha. Generally speaking assets, which generate positive alpha carry greater risk. Ex post greater alpha is oftentimes due to risks, which have not been factored in, or accounted for. With investments of passion there are many different types of risks involved, relating to the specific aspects of the investment, such that a fund that is able to consistently obtain positive alpha is highly likely to be carrying greater risk in terms of an unaccounted factor. This potential additional risk should be taken into consideration. Although there are opportunities from inefficiencies in the market which are likely to drive abnormal returns,

Valuations within ‘emotional’ asset funds can be difficult to standardise. What key evaluations should investors research before investing money?

Investors should be aware that the risk is largely operational, in addition to the risk of swings in the valuation of the objects. The competence of the fund manager is crucial. Furthermore, the market for emotional assets is currently attractive and the demand for such objects is high. These assets when used as a store of value over time reflect the high levels of status, wealth and income and not just cultural values in society that is put on these assets. There is also a risk that the demand across the board of treasure assets could fall. Particularly when financial markets start to show signs of recovery, there may be a move out of investments in real assets and back to equity. Unless you are willing to take a substantial loss in the value of the investment, or require a short-term rate of return on your investment, avoid this area of investment. Given the high commission costs and transaction costs, these types of investments should be considered more for their long-term value.

Is their growth in emotional asset investments and what is fueling it?

There has been a continued growth in the demand for emotional assets. The risk in high net worth individuals, and the rise in income levels globally. The demand for such assets and objects has grown at an unprecedented rate. As long as we as a society continue to value items of passion in such a passionate way then we will be willing to pay such high prices for them. If this changes, then the prices obtained for holding such pieces of treasure will not be maintained. There is an element in trust in our cultural value and heritage. For this reason contemporary art markets are more risky in nature and although high rates of return can be obtained, they also offer investors a more risky investment.

What needs to change for institutions to show more interest in this area of alternatives?

Currently Basel requires that institutional investors value assets ‘market-to-market’ on a daily basis. As there are no easy tools with which to currently value most emotional assets on a daily basis, this means that most institutional investors are not able to meet these requirements. The introduction of art indexes and /or a securitized market will relieve this issue. Moreover the limited size of the Art market and other markets for emotional assets is limited in size. The turnover on an annual basis is a fraction of the size of the turnover on mainstream financial assets. The market would be unable to cope with more mainstream type funds acting in these markets.

Private Banks have alluded to a potential increase in their willingness to provide Art loans but have you seen an increase in Art Funds?

There is currently a steady increase in the number of art funds created on a global basis. Whether all these funds manage to raise sufficient capital is another question. Some of the more established art funds are moving into new emerging markets. Those Private Banks who are willing to provide Art loans, as far as I know, is mainly down to the desire to help private clients with a particular funding issue rather than a more fundamental move towards greater loan provision on a more general basis.

What major risks are found in an art finance fund and how do these funds manage these risks?

There are three very important risks to consider when investing in a financial art fund. Firstly is the operation risk of the fund, secondly the market risk, and third is the liquidity risk. The operational risk can be high due to the lack of information and track record on the performance of the art fund manager and of the art fund in general. Further the lack of regulation and the opaque nature of the information and transparency of the investments can be cause for concern, and constitute to the operational risk of the fund. This risk can be mitigated by choosing to invest in art funds with both a sufficient track record and some evidence of the fund’s performance. With the recent emergence of many funds, this is more easily said than done. This type of risk also incorporates other operating risks such as the risk of buying fakes or forgeries. The ultimate risk is that that the fund can go under and that the initial capital is all but lost. Secondly the art price risk that the sale prices of the artworks in the art fund fall, or loose value. If the art market falls, then the value of the art fund will also tend to fall. This highlights the concept of liquidity risk. The third major risk to investing in funds of passion investments. If the fund is forced to sell artworks during such a period and liquidate its position then the fund carries a large risk due to liquidity risk and that the prices obtained during a quick sale are not as high as would be obtained normally with greater time to market the artworks. Only if the risks are bearable should you consider the investment. Either through the rate of expected return on the price of the investment or through the aesthetic return from enjoying the art itself!

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