Especially in the new millennia, we have seen a small barrage of new “investment” venues for art.  After the British Railroad Pension fund had a moderately successful run in art investment between the mid-1970’s and the end of the century, just under twelve per cent per annum, others contrived to make investment in art available to a target audience, through art investment funds and art stocks.  While that might seem unnatural or unnerving to those of us who are interested in art for art’s sake, it is simply standard practice in the investment business.  After all, most of the investment business is dedicated to marketing, and designing new investment vehicles that fill certain niches that those in that business perceive as ripe for the eager and uninformed public to be lured into.  Thus, in order to discuss these new art investment venues, properly, we need, first, to put them in context with both the art market and the investment market.

As I look back over the three decades that I have been a professional investor, I recall early lessons that I learned after landing a job as a securities analyst on Wall Street.   First, most of the investment business is really involved in marketing, with the objective of earning riskless commission or management fee dollars.  The second thing that I learned is the low regard in which Wall Street, the “sell side” of securities, holds the “buy side”, fund managers and advisors.  Although the buy side has made some progress in enticing some of the talent away from the sell side, over the years, the sell side remains dominant, peopled by the more talented players.  Indeed, even as I teach university finance, today, I am amused to see academic “proofs” of market efficiency, i.e., that one cannot “beat the market”, using the returns of fund managers, whom the dominant side of the investment business look down upon for the very same reason.

When the sell side invests, through its proprietary trading businesses, it invests in arbitrage and other ways to take advantage of market inefficiencies.  Indeed, the mushrooming growth of so-called hedge funds, over the last several decades was an attempt to take that sell side investment expertise into the realm of the buy side.  The hedge fund business, as a result, became cluttered with marginal players and with hedge funds that were hedge funds, in name only.  A hedge, after all, means to limit risk, and hedge funds, originally, employed true hedging techniques, in arbitrage businesses where they could earn high returns, especially with the leverage that is allowed for broker dealers on hedged positions.  However, as the media and the public became aware of the opportunities offered to professionals, in certain arbitrage markets, funds arose, in response, heralding themselves as hedge funds or funds of absolute return because that is what the ravenous public demanded.  In particular, as my original business of merger arbitrage became overrun by an explosion of new funds, many Wall Street firms began to ease out of the business and move into selling advise and recommendations to all of the nouveau hedge funds and retail investors who, through their inexpertise in the business, destroyed returns, pushing them from triple-digits, in the 1980’s, to single-digits, by the end of the century.

Of course, that example is but one of all that have occurred in the reinvention cycles of the investment business since it was originally invented in Italy, in the 1300’s.  Professional investors constantly find and take advantage of new inefficient market opportunities, and when the general public finally catches on, the professionals quietly exit and move on to their next find, while the public pushes the market to a froth until it eventually crashes and devastates all of those marginal and Johnny-come-lately players. The psychology of greed and the continued belief in get-rich-quick investment schemes is what leads these lambs to slaughter, time and time, again.

In truth, there are no get rich quick schemes, in investment, other than the occasional spot of luck.  What the professional investment business is really about is hard work and barriers to entry, in knowledge or capital. For example, in the merger arbitrage business, in addition to doing a lot of research and legwork on our own, we spent millions of dollars a year to hire lawyers to assist in analyzing and tracking the legal aspects of mergers, especially if they were contested.  We had fifty private phone lines to other arbitrage departments and to brokers on the floors of major exchanges.  Thus, capital and expertise were both barriers to entry.  All of the newcomers and retail customers who thought that they could do the business, on their own, were only fooling themselves, and their inability to have access to the important analytical tools that are necessary to properly do the business resulted in inappropriate price levels and paltry returns.

An even more common example was in stock trading, in general.  Through the early 1980’s, in the U.S., brokerage commissions were around 75¢/share.  Thus, if a the price of a stock was, say, $10/share, it would cost you $1.50 for a round trip, which means that you would have to make a 15 percent return just to cover your commission costs.  Indeed, the barrier to entry was the approximately $1 million that it cost to buy a seat on the New York Stock Exchange (NYSE).  However, people figured out a way around that high cost of entry by registering with the National Association of Securities Dealers (NASD) and gaining access to the pennies per share that broker dealers pay for their transactions.  Thereafter, people set up discount brokers and, eventually, on-line brokers, who charged pennies per share for commissions without even a phone call to a broker.  The result that I saw, in the U.S., in the late 1990’s, and, in China, in the middle of the next decade, was that many people believed that they could trade stocks as well as professionals, and huge run-up’s and crashes, in the stock markets were a result. In the U.S., the market lost 80% on the NASDAQ stock market, in 2001; in China, the loss was around 70 percent of market value, in 2008.

The art markets are inefficient, but their inefficiency is quite different from those that exist in securities and commodities markets.  In the latter markets, there are central exchanges, like the NYSE, for buying and selling.  Smaller, second tier companies, who cannot qualify to list their securities on major exchanges, might be traded in the over-the-counter (OTC) markets, which are comprised of networks of dealers, each maintaining their own bid and ask prices and inventories of certain securities.  In both cases for securities trading, the markets are daily auction markets.  In the art markets, auction markets are wholesale inter-dealer markets, while art dealers are retail markets, although dealers also maintain their own interdealer wholesale markets.  Thus, there is no direct analogy between art markets and the other traditional investment markets.  Moreover, in those other markets, the investment is fungible: one share of IBM stock is the same as any other share; gold is gold.  In the art markets, one painting by Monet is not the same as every other painting by Monet.  In this situation, there is only one copy or a limited edition, as in the case of Lithographs made and signed by an artist.  If a buyer/investor wants a painting, there is only one place to buy it: the specific dealer, auction house, collector, or artist who currently owns it.  As a result, the analogy between the art market and the traditional investment markets breaks down, even further.  A better analogy between art and investment might be with venture capital or private equity.

Information is the most important thing, in any investment business, and effective price discovery is an important piece of information.  Indeed, the continuous daily price-reports on securities contribute to a certain amount of efficiency, in those markets.  A similar price discovery mechanism is not in place for the art markets, and because of the breaks in analogy between art and traditional investment markets, it would be quite difficult to create.  The new language in investment would say that there is a lack of transparency in the art markets, and we have been hearing that word being used in discussions of the art markets, lately, too.  An appropriate venue for transparent price discovery, in the art markets, would be an on-line platform, in which all dealers, auctions, and collectors have all of their art, displayed with an offer price, and similar ability for buyers to enter bids.  Indeed, with all of the information on-line, today, pricing in the art markets has become more efficient than it was in the 1980’s.  However, there is not the frequency of auctions that there is in securities, there is no dealer reporting of sales prices for what they sell, and the non-fungiblity of artworks further limits the use of the price information that is available.

In that regard, art dealers will continue to maintain a certain advantage, in the art markets, because, like the sell side in securities, they are the professionals nearest to the business.  They have connections or even exclusive contracts with artists, and they establish and maintain their own networks of information and trading with other dealers and collectors, in addition to being aware of all of the public information that is available to others.  Moreover, they hold inventories of specific works of art, gaining total monopolies over those: infinite barriers.  They also bridge the retail and wholesale segments of the market.

Over my lifetime, I have seen many new investment vehicles designed and marketed by the investment community.  Some are developed to fill a general need, like commodities futures and stock options, but most will also become the subject of speculation and abuse.  Some are developed to fill a niche that the investment business perceives is ripe for filling, like the LYONS (liquid yield options notes) that Merrill Lynch designed in the 1980’s when someone from the Money Market Accounts department noted that many of the holders of money market funds also put some of their money into stock options.  Although LYONS sounded like a great chance to make high returns, in the end, as is often the case with such designs, the holders made very little.  Our latest financial crisis was caused by mortgage-backed securities, which were originally invented over half a century ago to allow banks to increase liquidity to be able to create more new home loans, in the U.S., by packaging and securitizing older mortgage loans.  The abuse came when Lehman Brothers packaged very high risk loans and led investors to believe in yet another high-return get-rich-quick scheme.

Especially in the local Chinese art market, I have already seen an abundance of people entering the market, as dealers, auctioneers, and collectors, who have no knowledge of or experience with art and who have entered the business only because they hear it can make money.  Those things, themselves, will cause some market distortions, yet they will also create opportunities for the true professional.  We have seen banks adding art advisors to their wealth management divisions.  Now, we see art funds and art stocks in the news as the latest art investment vehicles, designed to attract those with no knowledge of art or with monetary barriers to entry into the dealer business, both inside and outside China.  Although newly designed investments can and have hurt the traditional investment markets, as we see it, art funds and stocks will have little effect on the art market, in general, but only on those individuals who venture into investing in them.

Investment has its reason for being in that some people are willing to give up current consumption and save some current income.  People are willing to lend out or invest their cash savings, only if they expect to get back more buying power than they had when they saved it.   That sets up an interest rate structure, depending on inflation, time to maturity, and risk, among financial investments, given their expected future cash flow generation.  Art began as decoration and adornment.  Craftsmen and artists made furniture, decorative art, sculpture and paintings of people and events.  Eventually, value was placed on the works of certain masters whose creations stood up to the test of time and quality.  Beyond that quality, supply, and demand issues, there is a marketing factor, which has an even greater role in the art markets than in the other traditional investment markets, even in their expanded form of today.  However, the real purpose and value of art is in being added to a room or a museum, not in sitting in a vault with ownership shares attached.

Thus, art funds and art stocks offer only the chance of appreciation of the value of the underlying art.  There may be some income distributions, if, for example, the fund sells some art and distributes some of the proceeds of the sales.  However, there is no guarantee that prices of the underlying art will appreciate.  Tastes and attitudes change, and there are many examples of artists who were “in”, one day, and “out”, the next.  The demand side of the market is shaped by marketing from both dealers and critics.  The supply is fixed for dead artists but is ever increasing for living artists, albeit it limited, in some way.  In truth, we have even seen examples of living artists destroying the values of existing works by producing a number of copies after an original was sold.

As we have noted, in general, fund managers, even most of the new funds who called themselves hedge funds, are usually not the true professionals, in any investment venue.  If one invests in a fund, he will pay a fund management fee, whether the fund makes money or not.  Money might be made on appreciation of the works, and some cash flows might be generated by the occasional sale, resulting in special dividend payments.  However, the art will sit in storage, missing another advantage of the professional, the art dealers.  The fund may allow some people to overcome some capital barriers to entry by pooling a larger amount of capital to be able to buy more expensive works of art.  We have even heard of a specialty art fund that focuses on buying art from distressed seller, which is similar to the vulture funds previously created to earn money from corporate bankruptcies or from mortgage foreclosures.  Moreover, such a fund will be in competition with auction houses and dealers, who will maintain certain advantages over them.  The question is: will that kind of niche fund be able to maintain high returns over time?  In the end, all such funds will have little effect on the art market, as a whole, but will only provide miniscule additional competition.  Non-tradable funds will limit ability to liquidate your art investment, while exchange-traded funds, like one recently launched on Russia’s MICEX stock exchange, may increase liquidity but might also quickly move to bubble prices, as has happened with several recent launches of art stocks, in China.

So far, concerning art stocks, there has been the launch of an art stock exchange, in France, which securitizes works of art, sells the shares and trades them in an auction.  In China, both the Tianjin and Shenzhen Cultural departments have set up portfolios of artists and sold shares that were tradable on an on-line auction.  About a month ago, news leaked out that the Tianjin Exchange had indefinitely halted trading as the value of the stock of a particular artist bubbled to a price equivalent of twenty times his last art auction record.  Seeking further information about the exchange, a number of news agencies and investigators were met by closed lips.  Through our own research, we have found that a similar state of affairs also currently exists at the Shenzhen art exchange.  Shenzhen is making plans to develop more of an on-line presence, including offering access to art stock trading to a larger population and sales of art on-line.  A similar art exchange has been in the works, in Guangzhou, but still has not yet made its debut. 

In the final analysis, what is the point in bidding up the price of a single work of art or art portfolio stock?  In order to actually realize the value of the art underlying the stock, the work would actually have to be sold in the art market, not the art stock market, which, unlike the art stock market, will not overprice works, and on eventual liquidation of the stock or portfolio, investors will end up with realized losses.  In other investment trading, professionals consider the interconnections, like the price of oil per barrel versus the price per ton of coal; FX futures connected with spot FX prices and interest term rates and forwards.  So far, art stock market participants are not doing that but instead are wildly and blindly bidding up prices of art stocks, while ignoring the realities in the real markets for art.

Again, we believe that art stocks will have more of an effect on the wealth of those who venture in, than on the art market, in general.  They will also have a propensity to bubble because their small size versus the potential pool of investors may contribute to irrational bidding because of the limited quantity.  That was partly the reason that the Shanghai stock index came to a froth a few years back, as millions of Chinese nouveau investors, able to trade on-line, were met with insufficient relative supply of equities.  The rapid growth of issues, in that market, will help it iron out the volatility, over time.  In the art market, on the other hand, securitization of art will always be limited because most people buy art to display and to enjoy in their homes and offices, and art would lose its true value, if all of it was securitized and relegated to vaults.

In the end, I believe that art funds and stocks are just one more investment instrument designed to convince the unsophisticated investor that there is yet another get rich quick scheme, and certain investors will, once again, become ensnared in the latest trap.  In my personal investments in art over the past five decades, I have found that if I buy art that I like, and I use it for decoration, making my home or office more comfortable and inviting, then, later, when I sell it, I will make some money.  Making yet one more tailor-made investment vehicles to draw in the masses, especially one in which the art never even gets used, but is only the focus of monetary gain, has the potential to create boom and bust for only those who become involved with them. 

My advice to those who want to participate in the art market is, first, learn to appreciate art for its true worth.  If you cannot do that, then, do not even bother trying to invest in art.  Thereafter, depending on how much money you have to invest, find some good art by searching dealers and auctions, including on-line resources.  Do your own homework to decide what is a reasonable price to pay for any particular piece of art.  Then, begin your collection, your art portfolio, and use it for your own enjoyment and for the enjoyment of your family and friends.  As time goes on, add to your collection, and sell pieces whose prices have appreciated.  You will find, eventually, as have I, that, in retrospect, you will have made a respectable return on your investment. 

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Craig Mattoli,
Leona Craig Art
Guangzhou, China
86 136 3241 0877

Website: http://www.leonacraig.com 
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