This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on Nov 30 – Dec 6, 2015.

According to Citigroup’s data, art as an asset class has underperformed equities but outperformed bonds over the past 100 years. But the global art market is poised for a slowdown after seeing stellar growth since 2000. How will this impact investors?

Art as an illiquid asset 

The value of art, like gold, lies in its role as a diversifier of risk, say Citi Private Bank’s global chief investment strategist Steven C Wieting and head of strategic asset allocation Parul Gupta. But, unlike other forms of physical holdings, the scrutiny of objects with cultural or historical significance for the purpose of buying and selling isn’t all that simple. Expert authentication, appraisals and public auctions still set artworks apart from other types of securities.

“The real US dollar return for art has been an annualised 2.4% over the past 40 years, with the Sharpe ratio averaging 0.43. The comparative figure for US stocks was 6.7% and 0.82 respectively. For long-term US Treasury notes, real returns have been 3.2%, with the Sharpe ratio of 0.28. However, the Treasury returns’ correlation to equities is -0.02 and far more negative over some short periods during corrections in risk-asset prices. Given their greater liquidity, bonds are clearly the true portfolio diversifiers,” they say in the Citi GPS report. 

“Like gold, art provides no income and responds to changes in real interest rates as an opportunity cost for holdings. Yet, art has outperformed commodities in absolute and risk-adjusted terms, perhaps because of its defining uniqueness,” state Weiting and Gupta.

They argue that art deserves a place in investors’ illiquid asset holdings as the repeated sales of art pieces have shown more value than emerging-market debt and commodities, assuming a minimum holding period of 10 years. They stress that, unlike broad asset classes that can be bought and sold at one time with a diversified portfolio of active or index funds, a single artwork or even dozens of artworks cannot be considered fully representative of the broad art market. 

“The art market is not about a single commodity like gold or petroleum, but a unique collection of diverse objects. Some categories, such as old masters, represent a limited set of historical works while new art supplies likely have a less predictable performance.” 

Weiting and Gupta say it is plausible that in the long term, the real US dollar returns for the art market could be near 3%. “In summary, art has sometimes been labelled ‘conspicuous consumption’ and certainly will not ever replace income-producing assets in wealth management. It is an illiquid asset that has been subject to counterfeiting, well-documented opacity and abuse away from the public auction markets. But we would not ignore art’s enduring portfolio investment value when comparing it to other asset markets.” 

Malaysia’s burgeoning art scene 

The Malaysian art market has undergone an immense facelift in the last decade with the growing awareness of art as an asset class. Fine arts adviser and gallerist Shalini Ganendra says the awareness of art as an alternative investment has been pivotal in changing the art scene.

“Most of the buyers are looking at art as an investment. I would say 80% of the buyers base their decision on investment value,” she says. 

“A generation ago, this was not the case. It was really about the buyer’s personal relationship with the artist, about having a penchant for the arts and aesthetics.”

The rise in demand also saw the emergence of four auction houses — Henry Butcher Art Auctioneers, Masterpiece Auction House, The Edge Galerie and KL Lifestyle Art Space — in just five years. Prior to their arrival, art collecting was confined to a select group of individuals negotiating for works of art through dealers, galleries and private transactions. 

In 2012, the late artist and poet Ibrahim Hussein’s Red, Orange and Core painting (1984) was sold for RM797,500 at a Henry Butcher art auction. It is believed to be a record paid for a Malaysian artwork. 

While global demand is seen to be plateauing, Galeri Chandan managing director Mohammad Nazli Abdul Aziz says there are ample opportunities on the local art scene. “It is not a depreciating asset. Some people use art as part of their portfolio because it has a strong residual value, provided that the right artwork is chosen,” he adds. 

“I find that regardless of the investment value, art is still an emotional purchase. People buy based on stature, so the demand will always be there. And with the influx of new high-net-worth individuals (HNWIs), the only way is up.”

According to a white paper by WealthInsight, Kuala Lumpur had the highest number of HNWIs, at 13,800, in 2013 — more than cities like Abu Dhabi (12,500), Cape Town (8,753) and Birmingham (8,736). 

Shalini says the slowdown in the global art market presents purveyors the opportunity to pick up quality artworks and a select group of Malaysian artists to go global. “Certain Malaysian artists have the potential for a global audience because now people can sift through for quality,” she adds. 

Banking on art

A new generation of “players” has sprung up alongside traditional art collectors, according to Citigroup Inc in its latest Global Perspectives and Solutions (Citi GPS) report. “Many of these new arrivals come from the world of finance and over the past 15 years have brought with them a high level of analytics into the art world. Record prices, increased globalisation and new market players have led to the “financialisation” of the art marketplace. In this new environment, art’s appeal comes not only from the prestige of owning significant works but also its status as a neutral currency,” it says.

Leveraging art collections is a way of gaining liquidity from an illiquid asset without being compelled to sell it. “Borrowing allows collectors to free up cash for use in other investments without triggering capital gains tax, as a sale would,” says Citi.

Collectors have become increasingly sophisticated in terms of the products they expect from banks and the tools and strategies they employ themselves, the report notes. 

Some like to isolate their art collecting from their other business activities by establishing revolving lines of credit secured by their existing art collections, which are used exclusively to acquire additional artworks. This provides collectors with ready money to act quickly when an art acquisition opportunity arises. 

This type of collector views art collecting and the art market as similar to the real estate market, where a common practice is to leverage existing assets to purchase more real estate.

Citi cautions that this rather dynamic approach to art collecting is appropriate for those who know their area of the market well and watch it closely, almost instinctively identifying opportunities.

Alternatively, it says, individuals such as hedge fund managers and private equities partners have successfully used their art collections as collateral for term loans, which they draw down fully to deploy back into their funds or other investments. They are essentially creating an arbitrage, whereby they borrow from banks at relatively low rates and use the proceeds of the loan to gain a higher level of return.

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