Craig Mattoli asked:
Most people, at least, in the West, know that art can have value. After all, they have been reading about Van Gogh, Picasso, or Klimt paintings selling for millions of dollars for decades. However, most people do not know that you do not have to be a millionaire to invest in and make money from art. Art is simply another investment asset class that savvy investors include in their arsenal. Therein lays the key to understanding.
The sad truth is, also, that most people who invest in the more common investment assets, like stocks and bonds, do not understand investment in those more common investments. I always hear people talking about “playing the market”, yet, as any professional investor will tell you (it just so happens that there are so few that odds are that you never met one), although it is a game, it is not a game for novices.
The first person to formalize a mathematical framework for economics and finance was John VonNeumann, a mathematical physicist, who invented game theory as the basis for studying those fields, in the early part of the twentieth century. Indeed, until the 1980’s, most of economics and finance sprang from this basis, and the focus was to assume, just like in playing dice with perfectly symmetrical cubes or flipping a so-called fair coin, that investment was a fair game: there was equal probability of gain or loss and the distribution of outcomes was the bell-shaped curve.
Since the 1980’s the behavioral school has gained ground, in the theoretical realm, by assuming that since people are not perfectly rational, we should examine the actual behavior of people in business and investment situations. Of course, that is something that investment professionals have been doing for centuries. Dow and Jones, in the 1880’s, said, for example, that at market tops the professionals are already well out of the market. After a crash, which will always happen because emotional human beings are markets, professionals quietly begin to buy. Their buying, eventually excites technical market analysts’ technical market indicators, which are somewhat based on supply and demand analysis, in real markets, and technicians begin to buy and recommend buying. Eventually, the general public catches onto this news, which is really very old news, and they jump onto the band wagon. Everyone tells everyone how smart they are and how much money they made yester day trading on-line. Meanwhile the professionals have begun to quietly exit the market. A peak comes; a crash comes. Then, all of those self-proclaimed investment mavens console each other and support each other in their ecstasy turned agony. Some run to the authorities and claim that they were duped because they did not understand the complex nature of the mini-bonds that they bought: translation – they were so greedy when they were told that they could make unbelievable returns, and they did not want to hear about the risks. Another lesson that the theoreticians finally came to admit after the stock market crash of 1987, which, statistically, should not have happened in the whole history of the solar system, was that the distribution of returns is skewed with a longer tail on the down side.
It will be beneficial to understand the basic framework of a market, investing, and basic economics. Economics assumes that people are self-interested. Its only fault is that it assumes that people follow enlightened self-interest: no greed, lying, or cheating. Finance says that there is a difference between price and value: value is what someone thinks that something is worth, while price is the amount that someone actually paid for something. People make markets. A market is not, necessarily a place, like the New York Stock Exchange. Indeed, many people do not even realize that the NASDAQ market is not like the NYSE, it is simply a network of dealers, connected by computers, who maintain bid and ask prices for NASDAQ stocks. This is referred to as a dealer market or an over-the-counter market (OTC), as opposed to the NYSE, which is one physical exchange through which all orders to buy and sell are funneled. In fact, many people do not even know that the NYSE is a very special exchange, in that all of the stocks on the exchange are assigned to specialists who are the only one that you can buy a particular stock from. The specialist maintains an order book of bids and offers, and he has the ultimate in information about supply and demand for his stocks at any moment in time. As part of his job as a specialist, he can invest his own capital, in his stocks. All the other layers of the business that deal with the investing public, after that, are in marketing. A stock broker, for example, is just trying to make commissions when he calls you with a hot tip. Even at the level of institutional sales, salesmen, analysts and block traders are just trying to get commission dollars. None of them risk their own capital. There are also investment bankers who help companies raise capital by issuing new stocks and bonds, and there is a large market effort accompanying that. An underwriter might risk his capital by agreeing to underwrite the deal at a price for leftovers and may support the stock, in the secondary markets, by buying for a month or so.
So, let’s look at the art market. A market is where supply and demand sort out price and volume. Art buyers, collectors and investors make up the demand side. Retail investors are smaller buyers of art, while high-net-worth individuals, trusts, corporations and museums fulfill the role of institutional investor. Art dealers act as brokers, dealers, and investment bankers for art. They act as brokers by taking consignments for sale or request to buy from customers. They buy and sell art for their own account as dealers. By taking on new, undiscovered artists, by having shows for artists at galleries (much like the road show investment bankers do for IPO’s of stock), and by acting as agent or dealer for an artist, they fulfill a role, much like investment banker. Ultimately, supply is limited, depending on the artist. Once an artist is dead, supply is fixed.
Value begins, as in all of economics, with scarcity. It is the same principle that drives the precious metals market, the crude oil market, and the art markets. As with anything else, quality also plays a role in determining an appropriate price. However, also, like with many other things, including any type of investment, marketing plays a major role. Galleries, dealers, and art critics try to tell people what is good and what is bad art. Sometimes, I wonder about their opinions. Other times I have benefited, as in the sale of a table made of roots onto which birds were carved, and as one of only two found examples by this unknown folk artist from the 1800’s. Sale of the table brought over $4,000, back in the mid-1990’s. These art market analysts play the same role as securities analysts, in the stock and bond markets. They might even make buy and sell recommendations, and they might estimate values of artworks. Since art is supposed to make you feel good, your basic starting point should be to look to buy things that you, personally, like, then, check out the price.
In the securities markets, smart investors value things on a comparative basis. Instead of trying to figure out what prices or returns should be, stock analysts use comparative P/E ratio analysis, comparing one company to other companies, in the same industry, and comparing P/E’s of stocks and industries to those of the general market. In bonds, the yield-to-maturity (YTM) of a bond is compared to current market YTM’s of bonds of the same company and to general bonds with similar maturity, coupon rate, and risk. In the same manner, the value of works by an artist can be compared to one another and to those of other artists. Normalization, in the context of paintings, involves an artifice: converting prices to price per square meter or per square inch. One might make similar size normalizations for, e.g., teapot art and sculpture. However, price per unit of size might vary over an artist’s work with larger ones, perhaps, trading for lower price per unit of size, and their more famous works trading at higher price per unit of size.
Having built a comparative pricing system for art, one can compare the prices of one artist to another and the average prices of one artist over, a school, a movement or a period by construction single artist or composite price indexes and looking at their evolution over time. That also allows you to calculate returns since return is defined as the percentage change in price over time. You can compare prices from galleries, which is the retail market. The next layer of the market, much like in other investment markets, is an inter-dealer market. The final layer is the auction market, which in some respects is like the exchanges, in the securities markets, but it is a stop-out market: a market of last resort for sellers. The auction markets are more fragmented than the auction markets, in securities; they are not open every day, either, unlike their counterparts in securities. Price information of one sort can also be garnered from the auction markets for artists for whom there are auction records. There are also research and information services, in the art markets, mirroring similar services in securities and commodities markets.
I bought my first piece by a famous artist, Joan Miro, in the mid-1980’s. I was surprised to find that the price was only several thousand dollars. By the time that I bought my third Miro, I had learned about and used information from the auction record to pay the proper price. In succeeding years I bought art by many famous artists. Although the art that makes the headlines makes it seem that all art is out of reach of the man on the street, you will be surprised to find out that art by many known artists, past and present, is not that expensive. Another little known fact is the good returns that can be made in art, especially when one approaches the market with the tools and techniques as one would in any other investment asset market. During my decades of trading art, in the U.S., I cannot recall a time when I lost money, and returns have always been exceptionally good, especially when compared to returns of other investment assets. I can even recall times that I have continued to earn a profit, in art, even during downturns in securities and real estate markets.
Now, we are investing in and have set up a dealer in Chinese art. I moved to China four years ago to teach finance and economics at South China Normal University. I have been immersed in the Chinese social and economic scene, and I have concluded that the best current market in China, today, is the not the export market or the stock market or real estate, but, instead, the art market. Returns, in art, in China, have been above twenty percent per year over the last decade, in local currency, and the continued undervaluation of the Yuan versus foreign currencies, coupled with other socio-economic factors, make investment, in this market, appear to offer good opportunities over the next several years, especially for foreign investors.
Up through the 1970’s and early-1980’s, investment in stocks and bonds seemed outside the reach of the man on the street. By the 1990’s everyone and their brother was trading stocks on-line through discount brokers. Now that we are in the twenty-first century, the next time you think about art, remember that it is just like any other investment asset, like stocks, bonds, and commodities, it is not outside the realm of investment possibilities for the average investor. Think of the analogies that we have laid out between art and securities investing and markets. You can also find out more information about investment, art, China, and investment in art in China on various parts of our website.
February 24, 2009 Craig Mattoli, CEO, Red Hill Capital, owner of Leona Craig Art, Guangzhou, China
