Probate Lawyer

The Artful Investor

New research calls art a smart investment, but skeptics point to high costs and high risk

By Christopher Palmeri
Bloomberg Businessweek

March 12, 2007

John Morrissey hunts young artists the way some money managers dig for undiscovered stocks. In the evenings the West Palm Beach (Fla.) attorney scours magazines such as Artforum and Web sites such as Artnet. He tours galleries in New York and Miami, chatting up dealers and sometimes the artists themselves. Buying works early can lead to spectacular returns. In 1998 he bought a piece by abstract painter Cecily Brown for $11,000 at her second show, at New York's Deitch Projects, a gallery. Last year, he says, a similarly sized piece from the same show sold at auction for $968,000. "My artists have outperformed any other investment I've made," he says.

Art is hot. The record price for a single painting was broken three times last year. The auction houses Christie's, Sotheby's (BID ), and Phillips de Pury sold a combined $1 billion worth of contemporary art last fall. Attendance continues to surge at art fairs such as December's Art Basel Miami Beach and February's Armory Show in New York. The common explanation is that a new breed of collector, the hedge fund manager rolling in money and looking to show off newfound wealth and sophistication, has hit the scene. There is another factor at work, however: the belief that art is an asset class that belongs in your investment portfolio along with stocks, bonds, and real estate.

The leaders of this new art-as-asset school are Jianping Mei and Michael Moses, two longtime professors at New York University's Stern School of Business. In 2002 they released a study that found art handily outperformed bonds and Treasury bills going as far back as 1876. Based on their most recent results through June of last year, Mei and Moses conclude that art narrowly edged out stocks over the past 10 years, returning 8.5% annually. Contemporary art--which they define as anything since 1950--did even better, returning 12.7% over the past 10 years, three percentage points better than stocks.

The pair founded a consulting firm, Beautiful Asset Advisors, to sell their research to investors. Moses says that because their studies show a low correlation between the performance of art and other assets, art can be used to diversify an investment portfolio. He suggests an allocation of roughly 10% for investors who have at least $500,000 in financial assets, after debt. "We try to be quantitative," he says, "and get the war stories and folklore out of it."

Mei and Moses were not the first academics to examine art as an investment. Over the years dozens have done so, and their results vary widely. Most concluded that art performs poorly. In one of the most cited works, then Princeton University economist William Baumol reported in 1986 that art delivered a return of just 0.55% per year between 1652 and 1961.

Moses argues that his research is more comprehensive than past attempts. Baumol looked at just 640 sales over a 300-year period. Mei and Moses track sales in a database that now approaches 10,000 transactions. The professors only count works that have sold at least twice at one of the major auction houses. By focusing on repeat sales of the same piece, they hope to account for the fact that works, even by the same artist, aren't identical.

Other compilers of art data use different approaches. London-based Art Market Research also uses results from the big auction houses. The firm lops off the top and bottom 10% of prices under the theory that outliers unduly influence the averages. Its contemporary art index shows the category returning 8.7% over the 25 years ending in 2005, which is about four percentage points per year below the contemporary art returns from Mei and Moses. Whichever method is used to calculate returns, it's dicey for investors to count on a similar return, especially if they're buying works of unknown or even up-and-coming artists.

Nearly all of the research into art as an investment concludes that it is riskier than stocks. In a study published last year, Merrill Lynch & Co.'s (MER ) chief investment strategist Richard Bernstein found that while the probability that an investor will lose money in stocks, bonds, or real estate declines sharply the longer it is held, the chance of losing money in art remains high. Over a five-year period, an investor has a roughly 1 in 6 chance of seeing an art investment decline; for the Standard & Poor's 500-stock index, it's 1 in 10.

There are other drawbacks. It's far more difficult to get the same level of diversification in art that you would from mutual funds, which can contain hundreds of stocks. Commissions to buy or sell art at auction or through a dealer can easily top 10%, far higher than what you pay a stockbroker. Liquidity is poor. Even in hot markets, many items fail to sell at auction. There are transportation and insurance costs. If you're lucky to have long-term capital gains, art work is taxed at the full 28% rate, vs. 15% for securities. Dividends? They are limited to the enjoyment you get from looking at the work.

Over the years several entrepreneurs have tried to put together mutual-fund-like pools to make art investing easier for the small fry. Many have quietly gone out of business because they couldn't raise enough money from investors. Moses has an explanation for that. "One of art's great beauties is that it's fun to collect," he says. "If you put money into art, you want the fun of chasing after something."

Even Moses likens the current runup in contemporary art to the dot-com bubble. After a similar period of art inflation ended in 1990, he notes, contemporary-art prices fell by 50% over the next five years. It took a decade for paintings by the likes of Keith Haring and Julian Schnabel to bounce back, according to Artnet. Baumol, who now has offices in the same building at New York University as his art research rivals Mei and Moses, remains unconvinced of art's long-term investment potential. "There are periods when art becomes fashionable and pays off," he says, "but it's not a consistently good investment."

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