Art as an alternative investment

What do 1,000 ounces of gold, 2,000 bushels of corn and a loft in Manhattan have in common? Nothing, on the surface. But for a sophisticated investor they are all "alternative" investments, that is, products which are not exchanged on regulated markets, whose prices are not connected to the costs of more traditional financial investment, and which are able to offer expected high returns (with risk). While art also belongs to the category of alternative investments, it is hard to say that investing in art is rational.

Since the evidence varies according to the method used to appraise art's performance, with the investment item and time horizon taken into consideration, the contributions on this subject have not gained a general consensus (of the most significant, see the article by W. Baumol, Unnatural Value: Or Art as a Floating Crap Game and the article by J. Mei and M. Moses, Art as an Investment and the Underperformance of Masterpieces). Investing in art can be profitable, but it is certainly risky. What makes investing in art particularly risky are the difficulties involved in making a correct appraisal. While this problem is an issue for any financial tool, it is accentuated even more in the case of works of art due to certain elements like uniqueness, the strong personal and emotional component which influences an appraisal, and the circumstance of not generating periodic cash flows. Just as in traditional financial markets, the quantity and quality of information known are prerequisites needed to adopt effective investment strategies in the art market as well. Some of the most important sources of information are the appraisals provided by auction houses which are presented in catalogs before auction sessions.Since the appraisal process is complex, the estimate is indicated as a range between a minimum and maximum value. Furthermore, it does not represent the work's "real" value but indicates the presumed auction price, and can even vary from the estimated value formulated by that same auction house on the same work. It is crucial to understand the soundness of an estimate if an investor wants to create effective buying and sales strategies. The aim of one of our research studies (Investing in Art: The Informational Content of Italian Painting Pre-Sale Estimates) is precisely to examine the informational content of an auction house's appraisal and test its predictive ability. The analysis was conducted on a sample of paintings by Italian artists which were sold by 15 different auction houses throughout the world, between 1985 and 2006. The predictive ability of the appraisals turned out to be rather low (in less than 40% of the cases the auction price fell within the range of appraisals and the differences between auction houses, or by painting category, were absurd). However the predictive ability improved - regardless of the auction house - when the dealings were conducted in Italy or in the presence of previous auction prices (the "anchoring" effect).Therefore we should advise art investors – especially inexperienced ones – to be cautious in interpreting the value indicated by appraisals. From this viewpoint, the art market (in this case, that of Italian paintings) proves once again to be particularly shadowy, unless the appraisal is also made using past prices and regard an Italian painting negotiated in Italy. On this subject, it seems that a kind of "country effect" counts more than the particular skill of an auction house: the appraisal of an Italian painting is more dependable if it is provided by an Italian auction house or by the Italian division of a foreign auction house. This could depend on the characteristics of our national market, which is primarily domestic, distinguished by transactions whose average costs are less than those of more prestigious markets like New York or London, and less subject to fluctuations tied to imponderable components like "fashion". It is a market which is perhaps less lively, but much easier to decipher.