If you had asked me a few months ago about my opinions on buying art as an investment strategy, I would have made the following observations:

1. Hmmm.
2. I see.
3. So what you’re saying is, you’d like to veer clear of productive assets in favour of the persnickety tastes of the art world?
4. Sounds risky to me.
5. More risky, in fact, than the return would substantiate.
6. And what exactly do you know about art?
7. Art seems an awfully subjective thing.
8. And where do you start?
9. Also, here’s an art index from Citadel:

   

10. Buying art looks to have the same return as home-owning.
11. And you know how I feel about home-owning.
12. So just buy equities. They’re productive assets. Come now.

But then I decided to buy some art.

And if I’m entirely honest, I must confess that I didn’t view it as an investment decision – or, rather, I didn’t see it as an investment decision purely for the sake of the art. My thought process:

• I work in the professional services industry.
• Which means that I need to connect with potential clients (although, the need for connection is pretty much consistent across the board).
• Connection doesn’t take place in a boardroom – in there, we’re all business.
• Connection has to take place in the five minutes before we step into the boardroom, while the cappuccinos are being prepared, and the pleasantries are being exchanged.
• Five minutes is not a huge amount of time.
• And so often you can end up with awkward silences and the standard “So how was your weekend?” question. Which, when you think about it, is a really weird question to answer – do you talk about the personal issues you had with your spouse? The slightly too many draughts on Friday evening? The haphazard Sunday night of scrambling for leftovers and watching the 8 o’clock movie?
• That’s not really the stuff that good conversations/connections are made of.
• What you really need is a conversation kickstarter.
• Which is why I went out to try and buy a Diane Victor smoke portrait – painted with a candle. Here’s an image of her at work:

  

• Because that is a conversation starter.
• And there are few things to beat a shared moment of admiration for ingenuity.

Sadly, I didn’t manage to get a smoke portrait. The bidding war bested me, and I left my first art auction with nothing.

But I did go back to subsequent auctions. And I started visiting galleries.

Not because I was suddenly taken by the art – but because of all the money in the room. And I was beginning to ask the question: “Why is all this wealth gathered here on a Saturday afternoon?”

Here is what I’ve realised:

1. The value of art is not that subjective. Incredibly.
2. Artworks are actually not all that hit-and-miss. Some are hits. Some are misses. And there are people out there that can tell the difference. As in: real experts that would share the same opinion independently.
3. There are solid economic reasons why art investment should be high on your list of “places to put your money”.

So I’m going to start with the last.

The Economic Case for Investing in Art

How the wealthy spend their money

We live in a world of increasing wealth inequality. So if you’re going to follow the money, the question to ask is: what do the really wealthy do with their money?

I mean: there are only so many homes one can own; there is only so much vacationing that one can do; there are only so many cars that one can buy; there are only so many cool gadgets that one can use.

And, of course, there is the market for shares and bonds and commodities. But that can get tedious after a while – and every new company acquired becomes yet another headache to deal with. And besides, where is the status in that?

So while the wealthy might put much of their wealth into the traditional things – there will always be some allocated for the higher things of culture and scarcity.

And art – art is almost the ultimate positional good.

By that, I mean a good whose value is derived from the fact that other people don’t own it but would like to. There are others (rare books, coins, stamps) – but few that can be so gloriously hung from a wall for others to covet.

The further implications of wealth inequality

At the same time, looking forward, I think we can agree that the growing proportion of the wealth in the hands of the wealthy means two things:

1. The wealthy will have more money to spend on stuff like art; and
2. The lower classes will have less money to spend on consumption.

So if you’re going to invest for the long-term: should you invest in art, where there is growing demand? Or would you rather invest in companies that are going to squabble over the remnants of lower class consumption?

I also wonder whether art won’t become one of the last few private sector transfer mechanisms for wealth – where the wealthy spend money on new art being produced by up and coming artists, and these artists are always up and coming from the lower classes (it’s a statistical thing – if the 99% are the lower classes, and the production of art is classless, then they should produce 99% of the raw artistic talent).

Personally, I’m also a fan of art investment because it has that “Indian Cow Effect” (ie. Why do poor Indians invest so much money in cows when they demonstrate a -64% annual return after you take into account man hours? Answer: because the saving process feels like you’re spending money – and everyone likes to spend money).

A world of asymmetric information

My final observation about the art industry/world – there is not a lot of transparency. So to backtrack, the art world is split into two markets:

1. The primary market – where artworks are sold for the first time. This is the province of art galleries and the artists themselves.
2. The secondary market – where artworks are sold between investors. This is the auction space. But the art galleries and art dealers and so on are also often involved as well.

The crux is:

1. You can’t easily see listed prices of works for sale in the galleries (you have to request prices).
2. And you can only see listed prices of what an artist achieved at auction if you pay to subscribe to online databases.

One final component before I get to my point: from what I’ve seen, galleries hold old stock of an artist’s unsold work in their storerooms – and they’re not all that fastidious about keeping their price lists up to date. Although they do try – which is probably why prices are so rarely publicly quoted.

What that means: if you see an artist do surprisingly well at auction on a Saturday, then in all likelihood, the galleries that act as agents for the artist won’t have updated their price lists by the Monday morning. So if you’re a bit liquid, and you’re prepared to put the research time in, there is opportunity to score bargains by taking advantage of the short-term discrepancies between pricing in the primary and secondary markets.

It doesn’t happen all the time. But when it does…

So the economic summary:

• There is increasing wealth inequality
• Meaning that the wealthy will have more money
• Which makes for a promising future for art
• Because art is a positional good
• And art is also traded in an informationally-inefficient market

For some circumstantial evidence, I give you this article: “Billionaires scramble for world’s finance art pieces“.

The Case for South African Art

So putting the big picture to the side, and assuming that you agree with me so far, there are good reasons why the South African market, in particular, is an area of growth.

As a teaser, I’m going to refer you to last week’s article in the Business Day: Art takes off in SA as a diversification strategy for investors.

#ToBeContinued

Rolling Alpha posts opinions on finance, economics, and the corporate life in general. Follow me on Twitter @RollingAlpha, and on Facebook at www.facebook.com/rollingalpha.