OF THE MARKET FOR
2          S K AT E ’ S A R T I N V E S T M E N T H A N D B O O K

Table 1-1           Top 10 Investment Returns Achiev...

   asset—each work of art—is unique. Complicating matt...
4   S K AT E ’ S A R T I N V E S T M E N T H A N D B O O K

                              museum and collecting communi...

    then, they take place only when market conditions ...
6   S K AT E ’ S A R T I N V E S T M E N T H A N D B O O K


    auctions conducted by Christie’s, Sotheby’s, and o...
8   S K AT E ’ S A R T I N V E S T M E N T H A N D B O O K

                       as something that modern collectors ...

     As a starting point, and subject to refinements t...
10   S K AT E ’ S A R T I N V E S T M E N T H A N D B O O K

                        around the world, as irrational as...

thus forming one part of the definition of investment...
12   S K AT E ’ S A R T I N V E S T M E N T H A N D B O O K

                        conducted research into the works ...

volume as the entire Ph...
14   S K AT E ’ S A R T I N V E S T M E N T H A N D B O O K

                             No truly reliable art market ...

 Table 1-3        Allocation of Skate's Top 1000 Artw...
16   S K AT E ’ S A R T I N V E S T M E N T H A N D B O O K

                        Supply and Demand

occasionally a source of su...
18      S K AT E ’ S A R T I N V E S T M E N T H A N D B O O K

Figure 1-1
THE INFRASTRUCTURE OF THE MARKET FOR INVESTMENT-QUALITY ART                                             19

20          S K AT E ’ S A R T I N V E S T M E N T H A N D B O O K

Table 1-5            Art Market Versus Capital Mark...

“irrational joy of ownership” factor plays a far more...
22   S K AT E ’ S A R T I N V E S T M E N T H A N D B O O K

                          3. Minimize ownership and transa...
Available everywhere books are sold.

Special discounts are available for bulk purchases through McGraw-Hill Profession...
Skate's Art Investment Handbook: The Comprehensive Guide to Investing in the Global Art and Art Services Market
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Skate's Art Investment Handbook: The Comprehensive Guide to Investing in the Global Art and Art Services Market


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The most comprehensive how-to guide of its kind, Skate’s Art Investment Handbook demystifies art investing. It provides a detailed, dispassionate look at the global art market and outlines an original analytical model and rational strategies for profiting from this alternative asset class.

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Skate's Art Investment Handbook: The Comprehensive Guide to Investing in the Global Art and Art Services Market

  1. 1. THE INFRASTRUCTURE OF THE MARKET FOR INVESTMENT-QUALITY ART 1 s an alternative investment, how should art be valued, and how A does the valuation process work? How can the investment perform- ance of art be measured? These are just a few of the questions addressed in this opening chapter. Art can be an extraordinarily attractive investment. Tales of astonish- ing financial returns abound, adding some merit to the argument that in- vestors who move part of their funds into art can improve the risk-return profile of their portfolios and achieve optimal diversification (see Table 1-1). However, art investments are also distinguished by a number of less quantifiable benefits. Investing in art is arguably more intellectually, aes- thetically, and socially rewarding than investing in other asset classes. Owning important art has a significant “hands-off” element, meaning that investors do not need to worry unduly about whether their assets will be- come embarrassing liabilities as a result of poor management, adverse market conditions, or other events outside their control. A cherished work of art may decline in value, but the public will be unaware of this unless the work is brought to market. If a negative return does occur, the joy of ownership can compensate for the financial loss. These less tangible at- tributes of art investment do not apply to other asset classes, aside from residential property and flagship commercial real estate. 1
  2. 2. 2 S K AT E ’ S A R T I N V E S T M E N T H A N D B O O K Table 1-1 Top 10 Investment Returns Achieved on Repeat Sales of Artworks from Skate’s Top 1000 Initial Holding Exit Year of Investment, Period Price,3 ERR1 Rank2 Artist Title Creation ($) (Years) ($) 86.29% 77 Francis Bacon Three Studies 1976 5,168,000 3 25,000,893 for Self-Portrait 42.09% 982 Jean-Michel Untitled (Head) 1981 1,799,500 3 5,097,092 Basquiat 40.09% 297 Joan Miró Le Coq 1940 2,996,415 4 11,662,114 39.01% 874 Gerhard Richter Abstraktes Bild 1992 467,175 7 5,500,000 33.95% 108 Andy Warhol Liz 1963 3,580,750 6 21,000,893 30.60% 249 Gerhard Richter Abstraktes 1987 3,367,500 5 13,000,893 Bild 625 30.11% 594 Roy Lichtenstein Still Life with 1972 640,500 9 7,148,265 Stretcher, Mirror, Bowl of Fruit 28.15% 556 Andy Warhol Campbell’s Soup Can 1962 2, 415, 500 5 7,500,893 (Pepper Pot) 27.75% 833 Paul Cézanne Carrière de Bibemus 1898 3,190,000 3 6,000,000 1 Effective rate of return, calculated on an annualized basis with all transaction values (if not in dollars) converted to dollars as of the transaction date, with the buyer’s premium paid capitalized as part of the initial investment and the seller’s commission deducted from the proceeds to the investor, all in nominal dollar terms, before ownership costs and taxes. 2 Artwork’s rank in Skate’s Top 1000 as of April 30, 2009. 3 Hammer price before seller’s commission. Source: Art differs considerably from most other investment classes in that the valuation methods and investment strategies employed are fundamentally different from those used for traditional investments. The investor who can recognize and adjust to this reality will be well positioned to consider investing in art. There are five key reasons why art is such a special alter- native investment: 1. No standardization of product. From a financial point of view, it would be ideal if major artists produced artworks in standard series. Stan- dardization would make pricing and performance measurement far easier. Unfortunately for financial minds, art is generally not created in standard product series the way bonds or equities are, although there are certain exceptions to this, such as prints, sculptures, and photo- graphs.1 Generally speaking, in the fine art segment, each individual
  3. 3. THE INFRASTRUCTURE OF THE MARKET FOR INVESTMENT-QUALITY ART 3 asset—each work of art—is unique. Complicating matters even more is the fact that value drivers such as provenance, cultural relevance, aesthetic preferences, and the emotional context of art transactions have significant influence on the value of art, further limiting a buyer’s ability to apply universal, quantifiable rules to art investment (see Chapter 4 for a thorough discussion of valuation drivers). These valu- ation drivers diminish the accuracy and reliability of any benchmark- ing, indexing, or price research for artworks. This lack of reliable benchmarks is something for investors to bear in mind when they are confronted with upbeat statements from art funds and auctioneers boasting of skyrocketing prices. At certain times, prices in general may seem to be rising, but for individual artworks, performance varies con- siderably over time. No index-tracking investment strategy is possible, as mimicking the performance of an index requires the ability to allo- cate capital to the constituents of that index. 2. Lack of sufficient price data for art transactions. Even though it is esti- mated that the auction houses’ share of the art market is no more than 50 percent, auction results and catalogue listings—being publicly available and readily assembled—continue to be the principal sources of data on art sales.2 Art transactions other than these are generally handled privately, and as a result, no price records are publicly avail- able. Museum acquisition reports and financial statements from art funds are becoming increasingly important and interesting sources of price data, but this emerging information flow remains minor in the overall scheme of things. Thus, price transparency is fleeting, since a significant share of price information for art sales remains inaccessible to the greater market community. 3. Unequal access to information. As in any public investment market, knowledge is the cornerstone and the foundation of a profitable art in- vestment. Most important are the knowledge of a work’s ownership history, price data, historical facts and cultural connections, authenti- cation standards, and collecting habits and preferences, or what Wall Street would call buyers’ investment policies. In short, such knowledge and related data allow a person to value an investment target or design an optimal exit strategy (generally referred to as deaccessioning in the
  4. 4. 4 S K AT E ’ S A R T I N V E S T M E N T H A N D B O O K museum and collecting communities). In the conventional public in- vestment market, the equivalent fundamental valuation elements are available to investors through channels born out of laws and standards imposed by governments and regulatory agencies. By contrast, in the art market, accurate and complete information, which is key to deter- mining profit potential in any marketplace, remains private and is closely guarded by market professionals such as collectors, dealers, galleries, and auction houses. In these secretive and private domains, knowledge often varies among parties to a significant degree. The un- willingness to share knowledge and the emphasis on secrecy are not merely benign idiosyncrasies of the art world; rather, this control of in- formation is more sinister, for it is the means by which market pro- fessionals gain and retain an advantage over other market players. Without access to key information, market newcomers and investors struggle under a handicap that will limit their investment returns and profitability ranges. 4. No recurring cash-generating capability and high ownership costs. Unlike equities, which may pay dividends, bonds, which pay interest, and real estate that produces rental income, art does not generate cash. While a few innovative ventures and some art funds do rent artworks from their portfolios, the rental market remains limited. At the same time, there are unique and sizable ownership costs involved in art invest- ments. Insurance, security, climate control, restoration, and access management, which means viewing and travel, are examples of own- ership costs that result in an artwork’s consuming cash rather than generating it.3 This is an unfortunate quality for an investment asset to have. Although restoration and access management costs are tradi- tionally considered to be ownership costs, they can be treated as value- enhancement expenses that can be capitalized in a work’s valuation step-up as a part of a rational art investment process. (See Chapter 5 for a more detailed discussion of this topic.) 5. Significant transaction costs and low liquidity. The art market is gener- ally illiquid. This means that owners of high-value works cannot ex- pect to dispose of them in a few days or even weeks. Lead times for significant disposals often have to be measured in months, and even
  5. 5. THE INFRASTRUCTURE OF THE MARKET FOR INVESTMENT-QUALITY ART 5 then, they take place only when market conditions permit. Further- more, liquidity in the art market is not localized to any continuously functioning exchange such as a national stock exchange; instead, it floats among major trading outlets such as the annual European Fine Art Fair (TEFAF) in Maastricht, the Art Basel fairs in Switzerland and Miami, and fine art auctions conducted chiefly in New York and Lon- don at set times during the year. While individual dealers and auction houses may sometimes provide limited liquidity, such as advances on future sales, there is no assurance that a work of art can be sold quickly at “market price.” Moreover, although auction houses offer the opti- mal price discovery process, this avenue comes with a hefty transac- tion cost (see Chapter 2 for a detailed discussion of transaction costs). Sale and price guarantees, in which a percentage of the expected sale price is advanced to the seller prior to the auction’s taking place, are generally offered only for exceptional works of art in an environment of market growth. Before they commit funds to art, investors should be mindful of the potential handicap that can result from a lack of full knowledge of both price data and meaningful comparisons. Generally speaking, market pro- fessionals value art on an analogue basis, that is, by building groups of comparable transactions to justify the market value of a particular work of art. Investors should keep in mind that the actual return on an art in- vestment is simply the capital gain (or loss) achieved on the work less its ownership and transaction costs. Thus, achieving a suitable return on a special alternative investment such as a work of art requires knowledge and experience. Not only must the right investment choice be made at the right time, but the entire investment cycle must be carefully planned to achieve positive returns after taking into account cash-consuming ownership costs, prohibitively expensive transaction fees, and sporadic liquidity. Suitable re- turns such as those listed in Table 1-1 should compare favorably with the returns on publicly traded securities or relatively liquid debt instruments to compensate for the specific risks related to art assets. The next logical step involves determining how investment-quality art can be selected from the enormous pool of artists and genres present in to- day’s market.
  6. 6. 6 S K AT E ’ S A R T I N V E S T M E N T H A N D B O O K INVESTMENT-QUALITY ART The investor will find that there is a large supply of high-quality art on the market, with the quantity of available work increasing daily. Unlike the sit- uation with oil and certain precious metals, there is no dearth on the hori- zon, and so no alternative needs to be found. In fact, the opposite is the case. Once rather limited, the sources of art are now manifold and in- creasingly global. Given the sheer wealth of human creativity over the centuries and the continuing desire for creative expression, the supply of art is unlikely to dry up. As the auction house Sotheby’s states in its annual report: “It is not possible to measure with any particular accuracy the en- tire international art market or to reach any conclusions regarding overall competition because dealers and auction firms frequently do not publicly report annual totals for auction sales, revenues or profits, and the amounts reported may not be verifiable.”4 While accurate measurements are indeed difficult to make as a result of the vast number of artworks and the contin- uous flow of new material, an attempt can be made to estimate the size of the market’s free float, defined as works of art that are available for purchase.5 Sources of Purchasable Art The five main sources of purchasable art are as follows: 1. The world’s museums hold well over 100 million works of art. Of this figure, some 100,000 works can be expected to come to the market each year through a process of deaccessioning—those exceptional cir- cumstances in which a museum sells selected works from its collec- tion for fund-raising or curatorial purposes.6 2. There are at least 10 million unique artworks for which historical price records are stored in the world’s major price databases (discussed later in Chapter 2). These works make up the bulk of the free float. 3. At least 1 million unique works of art come to market and are added to these databases every year. Approximately 400,000 of these newly added artworks are sold through nearly 1,000 annual international
  7. 7. THE INFRASTRUCTURE OF THE MARKET FOR INVESTMENT-QUALITY ART 7 auctions conducted by Christie’s, Sotheby’s, and other major auction houses.7 4. Approximately 1 million individuals and estates (personal investment vehicles), more than 50 art funds (collective investment vehicles), and at least 500 museums purchase art on a regular basis. Galleries, deal- ers, and other intermediaries are excluded from this count,8 but to put the trade activity into perspective, it is worth noting that there were 4,658 galleries present at 51 major international art fairs throughout the 2007–2008 art market season.9 5. At least 350,000 artists are listed in various directories, catalogues, and encyclopedias. Of these, 13,900 have a public auction history, that is, auction price records are accessible to individual collectors and art market investors.10 Thousands of new names are added annually.11 A single artist can produce anywhere from a hundred to several thou- sand works of art during his or her lifetime. In total, based on these data, it can be assumed that there are between 70 million and 150 million works of art in circulation on the market. Of these, roughly 10 to 15 percent are included in free float. Each year, the number of artworks in circulation grows by about 500,000, measured by items that are newly produced and sold. Most of these new additions enter into free float. The actual market for several thousand artists exceeds 1 mil- lion transactions per year, resulting in an art market turnover ratio of less than 1 percent. In addition, the percentage of total transaction volume rep- resented by contemporary art is constantly growing.12 These estimates should be read as a broad-brush attempt to sketch the size of the art market rather than as a scientific definition of its exact boundaries and true depth. They are also grounded in contemporary per- ceptions of what constitutes a work of art. As Arthur Danto wrote in his seminal philosophical text inspired by Warhol’s Brillo box: “Until the twen- tieth century it was tacitly believed that works of art were always identifi- able as such. The philosophical problem now is to explain why they are works of art. With Warhol it becomes clear that there is no special way a work of art must be—it can look like a Brillo box, or it can look like a soup can.”13 In the context of this book, an artwork might be defined simply
  8. 8. 8 S K AT E ’ S A R T I N V E S T M E N T H A N D B O O K as something that modern collectors and investors are prepared to pay money for. The millions of investment opportunities open to today’s buyers range in market value from several thousand dollars to tens of millions of dol- lars. Furthermore, each artwork must be treated as a unique object of in- vestment because of its individual physical and aesthetic aspects, as well as the specific art valuation drivers such as provenance and the personal sentiments brought by individual buyers. While most market professionals recognize the need for a unified ap- proach to art valuation, there is currently no single standard system for classifying the millions of available artworks. Christie’s and Sotheby’s each have between 10 and 15 different departments into which they classify art assets, and auctions are conducted within those categories, such as Contemporary, Impressionist & Modern, Nineteenth-Century European, Russian, and so on. On the other hand, both Kusin & Co., an independent economic research firm that focuses on the art market, and the U.S. Library of Congress use a broader system that provides separate classes for Fine Art, Sculpture, Prints & Printmaking, and other categories. Finally, perhaps the most interesting classifications are offered by Gurr Johns, a global art appraisal specialist, and Artfact, an online art auction service provider. Both firms use several hundred classes for art and accordingly of- fer highly detailed and specific approaches to art asset classification. Even with this level of detail, however, certain overlaps and “hard to classify” challenges do occur. Since 2004, Skate’s has collected data on the world’s 1,000 most ex- pensive artworks based on auction prices from 1985 through to the pres- ent, which we refer to as Skate’s Top 1000 (Chapter 2 covers this topic in greater detail). Skate’s Top 1000 is composed entirely of investment-quality art produced by 183 artists, collectively valued at $13.185 billion as of April 30, 2009. As of this date, the threshold sale price for inclusion in Skate’s Top 1000 was $5.6 million, although an investor does not need to spend $5.6 million to ensure a solid investment return. Investment-quality art is not solely defined by price, and Skate’s Top 1000 does not embrace every known example of investment-quality art. So what else defines investment-quality art?
  9. 9. THE INFRASTRUCTURE OF THE MARKET FOR INVESTMENT-QUALITY ART 9 As a starting point, and subject to refinements that we will consider later, artworks that have the potential to attract another buyer who would be willing to pay a price equal to or in excess of the original purchase price would be considered investment-quality art. In Chapters 3 and 4, we will see that a significant capital gain on art investments requires a 30 to 35 per- cent annualized pretax effective rate of return (ERR) to compensate for poor liquidity, ownership and transaction costs, and “opportunity cost.” This is the cost of forgoing the alternative return that would have been received had the capital expended in acquiring the work been directed toward an- other investment opportunity. This definition assumes, naturally, that ir- rational factors such as the joy of ownership and social recognition are excluded as valuation drivers that compensate for an otherwise lower fi- nancial ERR. In terms of returns, this 30 to 35 percent requirement puts art investments squarely on a par with the stated target for private equity investments. In addition, investment-quality art should be defined as works produced by an artist who is already known to the public or who can be “brought pub- lic” as a result of intrinsic features of his or her charisma or persona, the ability to connect with a broad group of prospective buyers. We call this the “equity story,” since it is not unlike the pitch given in conventional markets to sell a stock or equity. There are two arguments supporting such a defi- nition. The first is a comparison of investment-quality art with collectibles, and the second is a statistical analysis of the chances of finding a new buyer for a work of art while enjoying a significant return on such a sale. Comparisons with Collectibles Researchers, journalists, publishers, and collectors often group works of fine art with collectibles. The common denominator in this analysis is the passion brought to the process of acquisition in contrast to a return- focused investment. Passion implies a love of the subject at hand, an emo- tional attachment to similar objects already in one’s possession, and a zeal for “the hunt.” In this model of acquisition, the rational mind is always pre- pared to accept financial loss or inadequate returns as a trade-off for the joy experienced through collecting. It is no wonder, then, that most collectors
  10. 10. 10 S K AT E ’ S A R T I N V E S T M E N T H A N D B O O K around the world, as irrational as they may be, are rational enough not to bet their entire fortunes on their collections. Many limit their exposure by focusing on lower-end collectibles, such as sports memorabilia, coins, stamps, and so forth. Collecting art is usually significantly more expensive. It takes more time and knowledge, per unit prices are considerably higher, the subject matter is generally more complex, and, as we have seen, transaction and ownership costs are greater. When they are carried away by their passion for collecting, investors in fine art tend to comfort themselves with the belief that art, relative to sports memorabilia and other collectibles, has a greater chance of increasing significantly in value. The opportunity for greater returns is the reward, or at least the justification, for risking much larger amounts of capital. The reason why art can experience massive valuation step-ups, while antique cars, stamps, or coins generally do not, has to do with the following unique characteristics pertaining to fine art objects: 1. Art is not a standard product, and it exists in an environment of inad- equate disclosure and dissemination of information. Limited access to information and the irrationality of buyers can be exploited to extract high prices at exit. In contrast, coins, stamps, and baseball cards come in series, with more efficient pricing and more readily and equally ac- cessible information. 2. Buyers are more likely to form a personal attachment to art, since in most cases it is unique and handmade, whereas collectibles tend to be standardized and mechanically produced. The very personal connec- tion between art and its buyers flows from the psychological con- nection of the single human being to the many, mediated through the projection of the artist’s creativity manifested in the artwork. The buyer’s attempt to map himself or herself onto a timeline, onto an art- work’s ownership history, and perhaps even onto the current celebrity status of the artist can also contribute to the personal connection pe- culiar to fine art ownership. The key takeaway from this discussion is that art is made by a person with a story. This factor is an important source of capital gain for artworks,
  11. 11. THE INFRASTRUCTURE OF THE MARKET FOR INVESTMENT-QUALITY ART 11 thus forming one part of the definition of investment-quality art presented earlier. Increased Chances of Achieving Capital Gain The chances of finding a buyer for an artwork that is in one’s possession and getting this person to pay a hefty premium on top of the original pur- chase price increase as 1. A work of art begins to appeal to a broader audience within the target price category. 2. The artwork’s “story” gains credibility in the eyes of market profes- sionals such as museum curators, professional intermediaries, art ad- visors, and specialized media outlets. This professional endorsement is critical to marketing the artwork to a wider audience. Exiting successfully from an art investment is in many ways similar to the process of prepping a private company for an initial public offering (IPO) of its securities. These similarities are covered in detail in Chapter 5, which also discusses successful art promotion tactics. The central idea in- volves making art suitable for a broad spectrum of prospective investors in the same way that preparation for an IPO makes a company attractive to securities investors. The willingness of dealers, galleries, auction houses, museums, the media, and other industry professionals to support the story of an artwork is essential for building and grooming potential buyers. It also increases the seller’s chances of exiting the investment with an acceptable return. Despite their value in other investment contexts, contrarian approaches rarely make sense in the world of art investments. Going with the crowd is absolutely necessary when dealing with investment-quality art. Investing in “no-name” artists who have no resources in place dedicated to “taking them public” is not a return-focused investment strategy. Fortunes in art are made in the spotlight of publicity, not outside of it. Any estimate of the size of the investment-quality art market must in- clude artworks sold at major auctions and through the world’s largest gal- leries. These catalogued sales, with proven transaction records and duly
  12. 12. 12 S K AT E ’ S A R T I N V E S T M E N T H A N D B O O K conducted research into the works in question, are the equivalent of listed equities—securities that trade on a public exchange and thus possess a level of marketability far in excess of that of the securities of privately held companies. The power of well-branded auction houses and dealers rests firmly on their ability to label art as investment quality and to provide pub- lic access to it. Purchasing art outside of auctions and major galleries makes it harder to find buyers for the assets once the decision to exit is made. While established auction houses and dealers may not be able to give sell- ers a firm bid or price guarantee for an artwork, the chances of a successful exit on agreeable terms are significantly higher. THE ART MARKET VERSUS OTHER A LT E R N AT I V E I N V E S T M E N T M A R K E T S Defining the investment-quality art market as the market commanded by well-established dealers and auction houses allows us to make a fairly ac- curate measurement of the size of the market and its trading volumes. The European Fine Art Foundation (TEFAF) is best known for its an- nual art fair in Maastricht, one of the most respected and well-attended events in the art market calendar. Since 2002, TEFAF has published an an- nual survey of the international art market. The most recent study—“Glob- alisation and the Art Market: Emerging Economies and the Art Trade in 2008,” an illuminating research guide written by Dr. Clare McAndrew and published in 2009—estimated that the total size of the global art market trade was €48.1 billion (approximately $66 billion) in 2007. Art trading vol- umes are almost equally shared between auctions and dealers, with 52 per- cent and 48 percent, respectively. The United States held 41 percent of the global art trade and the European Union accounted for 41 percent, of which the United Kingdom was the greatest contributor, with 30 percent of global trade. China accounted for 8 percent of the global art market.14 To put these figures in perspective, the volume of trades throughout the entire art market corresponds to roughly twice the annual trading vol- ume of Microchip Technologies, a leading producer of microcontrollers, which, at the time this was written, had an annual volume on the Nasdaq exchange of approximately $30 billion. This is also approximately the same
  13. 13. THE INFRASTRUCTURE OF THE MARKET FOR INVESTMENT-QUALITY ART 13 volume as the entire Philippine Stock Table 1-2 Trading Volumes by Auction House in 2007* Exchange. 1. Christie’s $6.3 billion The financial reports published by 2. Sotheby’s $6.184 billion Sotheby’s, one of two major auction 3. Phillips de Pury $600 million houses listed publicly and the world’s 4. Bonhams $307.7 million largest listed art business in general, 5. China Guardian $239.45 million provide another helpful source for 6. Beijing Poly International $220.5 million monitoring the size of the art market. According to Sotheby’s annual report, *Auctions with over $100 million in annual turnover based on publicly stated volumes. Source: Sotheby’s and Christie’s together com- manded approximately $12.5 billion in auction sales in 2007 (see Table 1-2). Sotheby’s was responsible for about 48 percent of the total aggregate auction sales of the two major auction houses.15 Overall, Sotheby’s repre- sents close to 23 percent of the global art trade, with the rest of the market share belonging to Christie’s, smaller auction houses, and private sales by dealers, individuals, and art galleries. Art is fairly illiquid, with less than 1 percent of art assets changing hands each year. Thus, we can estimate that the size of the entire art mar- ket fell somewhere in the range of $4 to $6 trillion as of the end of 2008. About $400 billion of this amount is in free float, with the rest being closely held by museums around the world. Finally, in terms of value distribution, there are thousands of artworks valued in excess of $1 million. In 2007, there were 1,254 works sold at pub- lic auction for more than $1 million, and in 2006, there were 810 works sold. Since 1985, there have been 416 works sold at public auction for more than $10 million. To put these figures in perspective, more than 90 percent of auction sales and perhaps an even larger percentage of gallery and dealer transactions are below $15,000.16 When we compare the art market with other investment markets, it bears a number of similarities to a large emerging-market economy in which the ownership of most valuable assets is in state, or quasi-state, hands. In- deed, many national museums look a lot like national champions and sov- ereign wealth funds. With two notable exceptions, no single publicly disclosed art transaction has exceeded $100 million, and most deals are on the micro level. By way of comparison, this is similar to the Philippine Stock Market activity report in terms of trading volumes and liquidity.
  14. 14. 14 S K AT E ’ S A R T I N V E S T M E N T H A N D B O O K No truly reliable art market performance benchmark exists today for an art investor or collector to reference. Since every artwork is unique and the art market offers discrete rather than continuous liquidity, averaging and indexing are of limited practical use. There is no way to invest in the underlying assets of an art market index. (A more detailed discussion of available art market indexes is included in Chapter 2.) Despite the problematic nature of art-market indexing, scholars and practitioners seem to have reached a consensus in recent years favoring the use of data on repeat sales to measure performance. We have been early supporters and advocates of this approach, publishing the first edition of Skate’s Art Investment Handbook in 2006. Repeat sales data are based on transactions for the same artwork appearing at auction more than once. This allows multiple price records to be fixed and facilitates the calculation of effective rates of return between such sales. Although these data do not represent the entire market for investment-quality art, the focus on repeat sales permits us to measure accurately the performance of a series of art investments made in the auction market. According to auction records, no more than 20 percent of art deals each year qualify as repeat sales. The re- maining 80 percent of transactions either take place privately or involve works of art with no prior public price record. Chapter 5 provides a detailed analysis of investment returns based on repeat sales, and Appendix C con- tains a complete record of repeat sales for artworks that are currently listed in Skate’s Top 1000. Unlike other mainstream investment markets, or even the real estate market, the world of art investment is largely unregulated. In most juris- dictions, the art trade is governed by laws and regulations that are not specific to art, including import and export regulations and regulations concerning cultural property, ownership, data protection, privacy, and money laundering. Depending upon the place in which a transaction oc- curs, there may also be the issue of VAT or sales tax. In some jurisdictions, auction businesses are regulated, the New York City Auction Regulations being one such example.17 A very important feature of the art market is its significant counter- party risk. Counterparty risk can be defined as the risk that the other party in an agreement or transaction will default on its obligations. The presence of auction houses as intermediaries does not remove these risks, but it
  15. 15. THE INFRASTRUCTURE OF THE MARKET FOR INVESTMENT-QUALITY ART 15 Table 1-3 Allocation of Skate's Top 1000 Artworks by Auction House Auction House Number of Works Total Value ($) Christie’s 506 6,555,300,719 Sotheby’s 467 6,302,893,946 Phillips de Pury 18 197,044,055 Binoche & Godeau 2 61,895,900 Aguttes 2 25,536,730 Ader Picard Tajan 2 20,563,290 Piasa 2 15,823,354 Deutscher-Menzies 1 6,498,420 Source: significantly reduces them. Most auction houses and virtually all art dealers however, are small businesses that publish no financial statements and that fall outside any significant regulatory requirements concerning trade standards. Moreover, the art industry is governed more by reputation and trust than by laws and regulations. Coupled with unequal access to infor- mation and poor price transparency, counterparty risk creates a fertile breeding ground for price manipulation, fraud, other questionable market practices, and outright criminal activity. These risks are explored further in Chapter 2, and a discussion of risks involving the purchase of stolen art is included in Chapter 8. The art market’s poorly regulated trading environment, abundant with counterparty risk, makes established auction houses and dealers valuable as intermediaries (see Table 1-3). Established auction houses and dealers endorse the market for investment-quality art by filtering the flow of art- works and removing as many counterparty and asset-specific risks as pos- sible. This is clearly a very important service. THE COMPONENTS OF THE MARKET FOR INVESTMENT-QUALITY ART An easy way to visualize the art market is to imagine the two pillars of sup- ply and demand supporting a large area filled by the art industry. The art industry is composed of trade, services, and media companies.
  16. 16. 16 S K AT E ’ S A R T I N V E S T M E N T H A N D B O O K Supply and Demand The supply and demand sides together comprise five classes of investors: 1. Old money: individuals and their estates who historically have allocated capital to art, thereby establishing collecting traditions 2. New money: individuals and their estates with no family collecting tra- dition 3. Professional art dealers and galleries: market movers who purchase art- works on their own account 4. Museums and affiliated pools of capital: individuals, such as “friends of the museum” and patrons, who sponsor museum purchases and di- vestitures 5. Professional asset managers: traditional asset managers who allocate capital to art and managers of collective investment schemes focused on art, such as art funds and segregated art capital pools Needless to say, the supply and demand sides are further segmented by geography (see Table 1-4) and by the amount of capital allocated to or in- vested in art. The involvement of these investor classes in the supply and demand structure obviously varies over time, but they are key drivers of market ac- tivity. Their involvement is reflected in shifts in value for particular styles, genres, and periods as fashion and tastes change and fortunes wax and wane. For example, at times of economic growth and bullish art market per- formance, new money and professional art dealers become dominant among buyers, with old money and museums being most active as sellers. Conversely, during economic downturns, old money and museums tend to migrate toward and become dominant among the buyers, while on such oc- casions the sellers are represented mostly by more speculative new money and professional art dealers, who operate with a shorter time horizon. While museums contain predominantly investment-quality art, these works are never likely to be traded. New money, along with professional art dealers and galleries, provides the majority of the free float in the market for investment-quality art. Old money is a consistent source of demand and
  17. 17. THE INFRASTRUCTURE OF THE MARKET FOR INVESTMENT-QUALITY ART 17 occasionally a source of supply, as de- Table 1-4 Geographic Distribution of Auction Trading* fined by Sotheby’s “4D” concept: Death, Country Volume Value Divorce, Debt, and Discretion, which Austria 1.6% 0.6% are equally applicable to the new money Belgium 4.1% 0.4% investor class (see Figure 1-1). Denmark 1.2% 0.4% Despite the emergence of well over Finland 0.6% 0.1% 50 art funds over the last five years, pro- France 18.1% 6.4% fessional asset managers, including art Germany 12.8% 2.9% funds, remain the smallest and least Ireland 1.1% 0.5% important investor class. Somewhere Italy 5.5% 2.8% in the region of $250 million has been Netherlands 2.4% 1.1% committed to art funds thus far (see Portugal 0.2% 0.0% Chapter 7 for a detailed discussion of Spain 3.5% 0.8% art funds). Because of factors such as Sweden 3.6% 1.0% the joy of ownership, low price trans- United Kingdom 14.5% 26.8% parency, and social prestige, investors EU 27 70.9% 44.4% generally prefer to purchase art directly Switzerland 3.5% 1.9% from dealers or at auctions rather than Other extra-EU 0.4% 0.3% through collective investment vehicles. United States 17.2% 45.7% One of the few forms of institutional China 1.9% 5.0% art investing to have blossomed over Rest of the world 6.1% 2.7% the years is the pools of capital built Total 100.0% 100.0% around well-established museums, in- cluding both contributions from donors * For those who are interested in aggregate market statistics, regardless of how accurate the data are, Dr. Clare McAndrew’s book The Art Economy: An In- for new acquisitions and single-owner- vestor’s Guide to the Art Market (Dublin: Liffey Press, 2007) is highly recom- funded capital pools for the creation mended. This book has actually used a lot of the original Skate’s Art Investment Handbook methodologies for art asset pricing and market definitions. Another of private museums such as the Guggen- valuable source is Contemporary Art Market 2007/2008 Report, by Artprice, FIAC, and Axa Art. heim in Abu Dhabi and the Pinchuk Source: Arts Economics (2007)/Artprice (2007). Art Center in Ukraine. The various cap- ital pools built around museums hold over $3 billion in capital commitments and are growing at a faster pace than stand-alone art funds.18 High-net-worth individuals (HNWIs) remain the backbone of supply and demand for the art market worldwide, and it is largely the dynamics of wealth distribution that determine the price and liquidity trends for in- vestment-quality art.
  18. 18. 18 S K AT E ’ S A R T I N V E S T M E N T H A N D B O O K Figure 1-1 Corporations Relationships—Converting Private Auction Opportunities Individuals clients Estates Sources of Dealers business Museums Institutions The 4Ds Principal reasons for sale Death Divorce Discretion Debt Changes in taste or Strong Redecorating collection focus market Source: Sotheby’s 2007 Annual Report The annual “World Wealth Report” published by Capgemini and Mer- rill Lynch is perhaps the most authoritative source of information on trends in high-net-worth wealth. Its 2007 findings provide a clear explana- tion of why major auction houses and dealers have gone to such lengths in recent years to access the new emerging markets in China, India, and the Middle East (see Figure 1-2). More than 10 million individuals worldwide have financial assets in excess of $1 million and are thus classified as HNWIs. On average, each HNWI had slightly more than $4 million in assets in early 2008, prior to the market crash. In total, they controlled $40.7 trillion in assets.19 Our es- timated free float of investment-quality art is less than 1 percent of the total financial assets held by HNWIs. The annual volume of the art trade is just 0.15 percent of the total financial assets controlled by HNWIs. Private bankers and investment advisors tend to classify art pur- chases as investments of passion (see Figure 1-3). More often than not, the
  19. 19. THE INFRASTRUCTURE OF THE MARKET FOR INVESTMENT-QUALITY ART 19 CAGR Annual Growth Figure 1-2 HNWI Wealth 2005–2007 2006–2007 Distribution, 2005–2007 10.4% 9.4% (trillions of dollars) $33.5 $37.2 $40.7 45 trillion trillion trillion 1 40 0.9 1.7 35 1.4 6.2 0.8 1.3 5.1 % Change Total HNWI Wealth, by Global 30 4.2 Region, 2006–2007 HNWI 9.5 Wealth 25 8.4 (in $ 7.6 trillions) 20 10.6 Africa 14.9% 10.1 15 9.4 Middle East 17.5% Latin America 20.4% 10 Asia-Pacific 12.5% 5 10.2 11.3 11.7 Europe 5.3% North America 4.4% 0 2005 2006 2007 Source: Capgemini and Merrill Lynch, “World Wealth Report, 2008.” 100% 2% Figure 1-3 Investments 5.5% 7% 6% 4% 8% 8% 90% 5% 3% 6% 6% 5% of Passion and Portfolio 6% 8% 10% 80% 9% 14% 7% 6% Structure (in % of dollar 10% 7% 7% 11% 13% volume, 2007) 70% 12% 9% 15% 9% 60% 13% 14% 12% 12% 14% 13% 50% 17% 13% 12% 12% 40% 14% 19% 11% 15% 30% 22% 21% 16% 11% 20% 13% 10% 10% 16% 17% 17% 18% 16% 14% 0% Global North America Europe Asia-Pacific Latin America Middle East Miscellaneous Wellness Jewelry, gems, and watches Sports investments Luxury consumables Art collections Other collectibles Luxury/experiential travel Luxury collectibles Source: Capgemini and Merrill Lynch, “World Wealth Report, 2008.”
  20. 20. 20 S K AT E ’ S A R T I N V E S T M E N T H A N D B O O K Table 1-5 Art Market Versus Capital Market Infrastructure Segment Art Market Capital Markets Data Four professional players plus specialized Market dominated by duopoly of Thomson Reuters departments of large auction houses; combined and Bloomberg, with dozens of international and data sales of less than $150 million per annum national companies that are well established and profitable; combined revenues in tens of billons of dollars Media Very diverse market, although largely dominated by Market run by dozens of global and regional the print media and a limited number of quality specialized media groups with all possible distribution online media outlets. Combined advertising, channels employed, including television and radio. subscription, and copy sales less than $0.1 billion Global sales of financial media companies in per annum excess of $50 billion Vetting aids Cottage industry of experts helping to determine Enormous industry ensuring the compliance of authenticity and other art asset–specific risks and publicly traded securities and their issuers with to ensure compliance with droit de suite* rules in market regulation; government agencies, law and applicable jurisdictions audit firms, corporate departments, and multiple professionals involved Trading, auctions Auctions represent about half of the trading Almost all institutional securities trading is handled volumes. About 60% of those volumes are online on either stock exchanges or electronic trading dominated by Christie’s and Sotheby’s, with the platforms. Over-the-counter deals are mostly limited balance going to more than 3,000 smaller and to securities that meet no listing requirements or have mostly national/regional auctions limited liquidity Trading, dealers About half of the trading volume occurs in Individual/retail trading is largely conducted online unrecorded private deals in all price categories, and is “plugged” into institutional trading platforms including widespread barter practice. with well-regulated price transparency and dealing Intermediaries are largely a cottage industry with rules.The industry is well consolidated globally, and a few large name dealers, all of whom have limited in developed markets intermediaries are always international representation nationally regulated institutions Ownership services No significant specialized art insurers (industry is Enormous industry, with trillions of dollars in (finance) operated by art insurance departments of large collective investment, lending, and insurance insurance companies).Tiny art banking with no premiums worldwide. Industry includes global, more than $500 million in annual art lending national, and midsize regional companies volume. Small but growing collective investment of all sorts industry (with less than $1 billion in funds under management), only five or six large players in this segment worldwide Ownership services Fragmented cottage industry of small businesses, Specialized audit, legal, and computer/IT services (other) including restoration, advisory, software, security, represent a massive industry operated by global firms transportation, materials, education, appraisal, and others. Almost every segment has one or two national leaders in major markets *See Chapter 2 for a detailed discussion of royalties paid to artists’ families and the droit de suite (DDS) regulations.
  21. 21. THE INFRASTRUCTURE OF THE MARKET FOR INVESTMENT-QUALITY ART 21 “irrational joy of ownership” factor plays a far more important role in the decision process than the quest for adequate investment returns. Globally, art is the second most important investment of passion, after private jets and other so-called luxury collectibles, which also includes rare automo- biles and yachts.20 The Art Industry The infrastructure of the art industry comprises three principal segments, each with various subsegments. The principal segments are 1. Trading: auctions, dealers, and specialty stores, including e-commerce retailers 2. Services: investment decision and ownership services, including advi- sory, financial, security, and collection management services 3. Media: publications, art fairs, education, and databases Within these principal segments, four primary types of investment aids that support art buyers and sellers in the investment and divestment processes can be identified: trade decision aids, or information; vetting aids; trading channels; and ownership services. When discussing the infrastructure of the art market and art invest- ment, it is useful to discuss these four types of investment aids in terms of how they compare to their peers in the capital markets (see Table 1-5). A more detailed discussion of the art industry can be found in Chapter 7, in- cluding a discussion of several of the most interesting business models. CHAPTER SUMMARY A successful art investment strategy requires the ability to 1. Focus on investment-quality art 2. Mitigate the downside risk of art investment, specifically, the risk of purchasing artworks with compromised ownership titles or question- able authenticity
  22. 22. 22 S K AT E ’ S A R T I N V E S T M E N T H A N D B O O K 3. Minimize ownership and transaction costs by engaging in transac- tions outside expensive auction houses, and by minimizing per unit ownership costs by spreading them across larger collections and us- ing shorter holding periods 4. Sell to the next buyer at an acceptable profit, despite the relatively illiq- uid environment and uneven information access This model for art investments is very different indeed from applying financial equivalents, such as the capital asset pricing model (CAPM) and earnings models, used in equity investing, fixed income, and derivatives math. It also differs from other rules-based approaches to successful in- vestment strategies for mainstream assets. The key to creating a sizable capital gain on an art investment lies in exploiting irrationality and using hands-on tactics to build the appeal of one’s portfolio in the eyes of a greater number of potential buyers. In the following pages, we suggest a number of ways to use this approach and other strategies to conceive and pursue successful art investments.
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