How much does art collection make sense in terms of investment?

Introduction

Art piece collection was very population for the past several years in China; benefiting from the rapid economic growth in China, the new wealthy classes under the economic reform were trying to behave like the western “noblemen”. One of many ways to act like “noblemen” is to collect art pieces, when more people are buying art pieces, the demand increases, and the price will increase as well. This could easily explain how the art piece prices in China have increased over the past several years. As the art collection market was booming, many people rushed into the market and even TV programmes were created around the topic of art collection and were very popular in China. As the topic is so popular and the prices seem to increase continuously, some people believe there are investment opportunities in the market. Today, I want to discuss how much art collection makes sense in term of investment.

Auction and other collecting methods

There are several ways of buying in art pieces. To conclude all sorts of methods, they can be categorized into two groups: auction and price negotiation. Price negotiation is often the cheapest way to buy in art pieces; however, such method has more risk, as there is a great opportunity of buying fake pieces, especially when the buyers do not have enough professional knowledge about art pieces. Moreover, in the future, it is very likely for genuine pieces to disappear in such markets and and become more often to appear in auctions, as sellers can sell at better prices and customers are also more confident about the authenticity and quality of their consumptions. Therefore, I will concentrate on the pricing in auctions and how much could be possibly gained from buying from auctions.

Firstly, there are many types of auctions, for example, the Dutch auction, the all-pay auction, the sealed first-price auction and etc. The most common auction in the art market is the English auction (sometimes referred to open ascending-price auction), where the property is sold to the highest bidder, as long as the bidding reaches a reserve price set by the seller. The best possible strategy based on the benchmark model defined by McAfee and McMillan (1987) is to pay as much as the expected maximum price that the second bidder is willing to pay, and the bottom line is never to pay any higher than the bidder’s maximum expected price or utility. There are four assumptions (risk-neutral bidders, private valuation, symmetric information and its simple price function) in this game-theoretic model that could be different from the reality can potentially cause different results. It makes sense in the reality that any buyer (bid winner) is paying at a price somewhere between his/her maximum price/budget for the property and the second bidder’s maximum price. From this point of view, he/she is the one who offers the highest price in the market. In the short term, it is very difficult to find someone who is willing to pay a higher price in the market if he/she wants to sell out the piece bought from an auction, especially if the auction is globally famous and authoritative. Under such reason, it is definitely not an investment option for short term returns, besides we have not considered the costs for auction services and professional identifications.

In terms of long term returns, some people say that this could be investment for several generations. I completely disagree with this point that it would make some sense under certain types of inheritance tax systems as it is difficult to define the values precisely. This is part of wealth management but beyond the investment field, so I will skip this part. Firstly, art pieces as assets are extremely illiquid. The market has limited demand side as well as supply side that once one side is more urgent, the other controls more market power of pricing; therefore, when owners of art pieces are difficult to transfer art pieces to other types of assets. Secondly, the only profit can be gained from taking risk for others. The risk mainly comes from the long period of time that people from different time periods can have different art tastes and some artists could be forgotten by the general public over time. Moreover, the owners have to spend a lot on storing their art pieces and maintaining their status. This cost will increase over time. In addition, especially when the art pieces are extremely precious, owners usually buy insurance to minimise their losses from damage and theft, this is another source of additional costs of owning art pieces. Therefore, when you own an art piece, the cost of maintain its original price is becoming greater. After considering the risk of the value changes in your pieces, the inflation, the discounted rate, the costs for store and insurance, and the opportunity costs, it is really difficult to see there is an appreciation in the value of these art pieces.

The “real” value of art pieces

Even if one decides to invest in art pieces, it is extremely difficult to give an objective and commonly agreed judgement of the values of art pieces. There is a philosophy question that whether it is artists make art pieces or art pieces make artists. There is an interesting “art piece”, “Fountain”, exhibiting in Tate Modern in London. Basically it is a toilet bought by a well known artist, Marcel Duchamp, and sent to be exhibited in an art show; I do not see it as an art piece but I see it as the representation of the question of what makes art. Different people have different answers to this question, and their answers could determine their choices of art pieces. The ones who believe artists make art pieces will buy those created by big names, and those who believe art pieces make artists will choose those pieces which match their tastes. It is much easier to buy pieces created by the big names, as we do not need much professional knowledge and it has lower risk in terms of investment. I think that the value of an art piece is given by three elements: creation, condition and history. Creation is involved with who is the creator of the art piece, how well it is created. Then the condition of the art piece is also important, a well-stored piece could be valued much higher than a poorly kept piece. Finally, its history is also crucial in terms of determining its value. History is not only about when it was created, but also about the history of its ownership. If the British royal family bought a fake painting and found out and sold it and informed the market, they would still lose much smaller than the ordinary people would, as since the fake painting belonged to the royal family once, it would add extra value to the painting. Since I am not a professional in terms of the art market, I will stop here; however, my explanation would give a brief introduction about how vague the pricing and valuation could be when it comes to art pieces.

Conclusion

My advice is please keep art collection as a hobby or a social tool rather than an investment activity. It does not only involve enormous risk, but its returns are also relatively limited. When people understand more about art pieces, it becomes less and less likely for someone to pick up some precious art pieces from streets, the fine art pieces will concentrate in the auction market more and more over the time. Buying from auctions means you pay the price that no one else is willing to pay at the time, and the costs of maintaining the status and insurance are often incredibly expensive throughout the entire period of ownership. However, it is unfair to say art pieces do not any utility other than self-enjoyment, it is an effective tool to send signals to identify one’s social status and wealthy strength, and one can use its signalling effect to achieves business goals or other goals.