Publications

- November 1, 2021: Vol. 8, Number 10

A better deal for art: The $1.7 trillion asset class needs securitization

by Mike Parsons

Art has a long history as a transactable asset, with marketplaces and auction houses such as Sotheby’s having existed for more than 275 years. Art has proven to be valuable financially as well, with works at the high-end of the market being worth 10s of millions of dollars. Until recently, however, art’s ability to appreciate was understood principally through anecdotes of the ultra-wealthy. The lack of quantitative research around the financial profile of art as an asset has prevented the broader investment community from participating in the asset class. However, with improvements in technology and growing interest from investors in allocating to alternative investments, the financial profile of art is becoming better understood and increasingly available via securitization of the asset class.

SIZE AND INVESTABILITY

With about $60 billion in annual transaction volume and a total estimated global value of $1.7 trillion, art represents a massive asset class. Art is comparable in size to other major private markets, all of which have participation from hundreds or thousands of institutions.

Within the collectibles market specifically, which includes jewelry, watches, sports memorabilia, collectible cars and wine, art accounts for roughly 75 percent of annual transaction value. Art’s dominant share of the collectibles market is largely attributable to the international scope of the art market, greater demand levels for the asset, and a higher average price point per object. The cultural significance underlying the uniqueness of each individual work of art creates a scarcity not generally present in other collectibles, where editions and multiples are common, even at the high end of the market.

SECURITIZATION OPPORTUNITY

Despite the size and longevity of the art market, participation has been almost entirely limited to ultra-wealthy individuals buying and selling physical artwork. Securitization of the asset class is becoming increasingly prominent and will make art more accessible to the broader investor community. Securitization of the asset class occurs at the individual artwork level and can be done via the SEC. As a public offering, equity shares can be issued at the underwritten value of the painting and made investable at a substantially lower price point. Though this approach seems novel, art is following a similar trajectory to other investments like real estate and gold, which began as non-securitized asset classes and are now investable via a number of different products.

Two of the largest alternative assets today, real estate and gold, had to overcome similar obstacles of access and market inefficiencies that art currently faces.

Real estate investing has been around for 200-plus years, but it was not until the creation of REITs in 1960 that the real estate market became securitized.

Gold has historically been used as a medium of exchange. When the United States ceased using the gold standard in 1973 and was no longer linked to a currency, gold became available to legally own and trade, allowing it to begin functioning as an investable asset. However, the purchase and storage of physical gold was costly, so investor allocation remained low. With the advent of securitized gold products like ETFs in the early 2000s, global investment demand grew rapidly, averaging 14 percent per year over the next 20 years.

Similar to real estate and gold, art lacks investor participation, not because it is an unattractive asset, but because it suffers from the problem of high price points, non-transparent marketplaces, and high ownership costs — all of which can be addressed through securitization of the asset class.

Given the size of the art market, it is well positioned to follow in the path of other major alternative asset classes such as real estate and gold, which saw increased investor portfolio allocation upon securitization.

DIVERSIFICATION BENEFITS OF ART

Art exhibits low correlation and strong capital preservation qualities. As mentioned above, the low correlation between contemporary art and other asset classes is a result of the underlying driving forces of art market appreciation, which are growth in the purchasing power of the ultra-high-net-worth community, the diminishing supply of available artwork, and the international marketability of the asset.

For example, annual performance by select years highlights the lack of correlation between art and traditional asset classes. As discussed above, the driving forces of art market value are somewhat unique to the asset class, allowing art prices to perform well in years like 2008 and 2018, when most traditional asset classes lost money.

Art as a strategic diversifier presents valuable portfolio diversification qualities. Its strong potential price appreciation rates and lack of correlation make it an asset that can be deployed across a variety of different portfolios to improve risk-adjusted returns.

STATE OF THE ART MARKET

2020 further illustrated how the value of art is disconnected from general global trends and indicated that the asset class is positioned to further appreciate in the future. COVID’s impact on the art world highlights the reality that the top 1 percent, on a global basis, has been less effected than the rest of the population. While auctions were cancelled and moved online, the contemporary art market appreciated by 15.1 percent. This increase corresponded to the increase in the number and wealth of billionaires, which reached all-time highs in 2020, according to the 2021 Art Market Report published by UBS and Art Basel. The ultra-wealthy also indicated that their interest in collecting had increased during the pandemic, so while there were fewer opportunities to buy paintings as a result of COVID, the value of art continued to improve.

The longer-term outlook of the market is positive as well. The shift to online transactions from the pandemic has increased interest from young buyers in the art market. Sotheby’s estimated that buyers under 40 accounted for 25 percent of bidders in online-only auctions, compared to 15 percent in live auctions. Given the infrastructure for online sales now exists, auction houses will likely keep this feature to continue to attract younger buyers.

OUTLOOK

As art becomes an increasingly securitized asset class, growth in interest from the investor community will continue to mount. By understanding how art can be used as a strategic asset within a portfolio, investors will be able to improve both absolute and risk-adjusted returns, as well as further protect against downside losses. Understanding art as an asset can better position investors, advisers and asset managers to make intelligent investing decisions as the accessibility of investment products continues to improve.

 

Mike Parsons is a senior analyst at Masterworks.io. The full and original version of this article appears on the CAIA Association website at this link: https://bit.ly/39lZeHU

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