Wealth Reports - Volume 15

Wealth-X Bolsters Global Data Assets by More than 15%

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Gaining access to the market for collectibles, or treasure assets, is now easier than ever. The Internet has opened up the auction process, enabling collectors more easily to bid for and acquire objects anywhere in the world. Collectibles now increasingly share the characteristics of broader financial markets.

Introduction

There are market indices and specialist funds, which enable individuals to invest in art, wine or other treasure assets indirectly. There are even asset-backed financing products that enable collectors to borrow against their treasure assets. This combination of increased investor interest and more robust market infrastructure has led to a surge in activity across a wide range of different treasure assets. According to Art price, was the best ever year forsakes of art at auction.

Boom times for auction houses however do not automatically translate into strong returns for investors. Collectibles markets are riddled with inefficiencies, are frequently opaque and illiquid, and are extremely volatile and risky. They involve high transaction, storage, insurance and appraisal costs. Appreciation in value can also incur a higher tax burden in some jurisdictions, such as the U.

Of course, for many collectors the cost and financial risk of treasure are irrelevant given the intellectual stimulation and aesthetic pleasure it brings to them. But when acquiring such assets primarily for their financial benefits, extreme caution is essential.

It has long been known that investors in equities and other financial asset classes can be susceptible to a host of cognitive biases that make it difficult for them to make rational decisions. With art, wine and other treasure assets, these biases can be even more pronounced. When buying a painting, for example, collectors can all too easily let their heart rule their head. The emotional and social attachment to treasure means that investors are extremely likely to make sub-optimal decisions about when to buy, sell or how much to pay.

We look at recent trends in key collectibles markets, and assess the risks and behavioural biases associated with holding treasure as part of a broader financial portfolio. Although media reports tend to focus on the blockbuster auctions where everything massively exceeded its reserve, there are many items that fail to sell and many that auction houses will not be prepared to put forward at all.

Art is typically an illiquid investment, which means that sellers cannot always offload it in times of need.

Treasure trends

This does vary from one category of treasure to another, however. Chris Smith, an Investment Manager for the Wine Investment Fund, points out that wine is easier to value and sell than, say, art, because many bottles of wine are made at a single chateau each year, whereas every painting is unique. Even within wine, however, there are differences. Valuation is another key challenge, despite the emergence of indices for some types of treasure and an increase in publically available price information.

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In the art world, trading volumes are extremely thin, which makes it very difficult to arrive at an objective valuation. The length of time that elapses between a single work coming for auction for a second time can be enormous. Research by Clare McAndrew, founder of Arts Economics, a consulting firm, found that it takes on average about 30 years for the same work of art to appear on the market again The prices achieved at auction for similar works can vary enormously, and be influenced by a range of factors, including the skill of the auctioneer, the interaction between bidders and the sale price of previous lots.

Even the weather on the day can make a difference. Professor Pownall has conducted research that compares repeat sales in the London market with the weather on the days when auctions took place The transaction costs associated with investing in treasure can be high, and many investors omit to factor these into their overall financial planning. There are also ongoing costs to consider, including insurance, storage and maintenance. Certain pieces may require storage in climate-controlled units with consistent temperature and humidity. Although investing in art and other treasures is often cited as an effective means of diversifying a portfolio, simply holding a proportion of wealth in art, for example, is not enough even if that were the case.

Investors must also diversify within a single category, because the sub-categories can have very different dynamics, risks and returns. Contemporary Chinese art, for example, will behave very differently from the market for Old Masters. Diversifying properly therefore requires very deep pockets, because of the need to hold a variety of items with different characteristics. You can then sell at auction or at retail and the margins can be enormous. Finally, there can be problems with authenticity. In , the Knoedler Gallery closed after a controversy involving a painting purported to be by Jackson Pollock but now believed to be a forgery.

Some scholars have been reluctant to authenticate works because they fear lawsuits should they make the wrong call. With most scholars offering their opinions for free or at minimal cost, there is therefore little incentive for them to make pronouncements on a work that could later prove controversial. Of course, investors may also benefit from these inefficiencies in the art market. Many individuals can and do make large sums of money from investing in art and other treasure assets.

The relatively small size of the art market means that there are more opportunities to create and move markets than in, say, equities or currencies. Even something as simple as exhibiting a work can enhance its value. But creating consistently positive returns requires a high degree of expertise, time and contacts, which very few casual collectors will possess. Funds can be one way of accessing this expertise but, as with funds in traditional financial markets, finding the right ones can be challenging. When an individual invests in any financial asset — whether a stock, bond or real estate fund — their reasons for doing so will typically combine both financial and emotional motivations.

As well as thinking about the potential financial returns from investing in a hedge fund, for example, an individual may also derive a benefit from the status that being a sophisticated investor brings, while an investor in bonds may derive comfort from their perceived safety. Treasure investments are no different. Although some individuals may acquire treasure primarily for financial reasons, a greater proportion of the benefits can be derived from the emotional aspects, such as enjoyment, status, sharing with friends or bequeathing to dependents.

The fact that treasure has such a large emotional component to it means that collectors can be particularly susceptible to behavioural biases and heuristics. The availability bias, a mental shortcut whereby investors will draw conclusions from information and examples that are readily at hand, can skew decision making. Because media reports on art sales tend to focus on the spectacular gains and the record-breaking hammer prices, investors may falsely believe that these are representative of broader trends in the market.

Emotional attachment to an object can exacerbate this phenomenon, causing the affect bias.

The previous price paid for a similar item can also have an impact on price expectations in a bias known as anchoring. Bidders can also anchor their valuation to the estimate given by the auction house at the time of sale. Treasure can be susceptible to some strange inversions of traditional economic theory. With most consumption goods, increased scarcity leads to higher prices but with art, the opposite sometimes seems to be true. It is striking that, of the artists that achieve the highest prices at auction, many are highly prolific.

Damien Hirst and Andy Warhol, for example, have produced countless artworks yet, rather than reduce prices, their familiarity and exposure have helped to raise them. Some collectors will ascribe different motivations for their investment depending on its performance over time. For example, if the value of an item increases, they are more likely to ascribe this to their shrewd financial judgement, but if it falls, they may focus more on the emotional benefits.

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