Investing is an art Source: Business Line (09-MAY-10)

Each artwork commands its own unique pricing.

Investing in art is an art itself. It is a highly specialised field where all the parameters used to evaluate any investment such as return, liquidity, risk and valuations are all ill-defined at the outset. If we order the various assets in terms of when a person should start investing into art, then it qualifies towards the end of the entire spectrum of available investment options.

Art is a highly unorganised market with little information except in the case of proven and well-known artists and masterpieces. Information asymmetry in such a market is high and thus makes pricing inefficient.

Valuation

Also how does one determine the price of an asset where the conventional parameters of valuation are ineffective? Each art work commands its own unique pricing without following any particular logic. Pricing in the art market is done through negotiations between buyers and sellers or through a bidding process.

The price discovery in such a scenario need not be efficient. In a negotiated pricing mechanism, the price of the artwork will depend upon the urgency of the seller to encash and the desperation of the buyer to own the piece. In a bidding process, the pricing depends upon the contest between the bidders and their desperation to own the particular artwork. In either of the above cases, the pricing will be inefficient for one party. As with any asset, if the buying price is wrong, it will take a long time to recover the investment, let alone reap returns.

Cash outflows?

Returns from other asset classes arise in the form of interim payments such as interest, dividend, rent etc or on the sale of the asset. Art has no interim payments but requires tremendous care and maintenance costs, which have to be borne out of pocket. The monetisation takes place on sale of the art work only. Art has other problems in the form of fakes, counter-party risk and physical form.

Except for real estate, other investment avenues like equities, debt, mutual funds, commodities, currency etc are institutionalised businesses with strong regulators and little risk on counter-party and delivery. There are inherent inefficiencies in this asset class, which renders it appropriate for only a small set of savvy investors.

In India, there has been an attempt to invest into art through collective investment schemes. The results of these schemes have not been very encouraging for investors.

The main issue has been liquidity due to problems with the disposal of the artworks. In some cases, since the works were difficult to dispose at maturity, investors were left high and dry on the redemption payments. Also due to the pressure on the fund managers for payouts, assets were sold at prices which were unfavourable leaving the investors with little return despite a sufficient investment period.

Pooled assets may not be the way to go for art investments. The problem here is that people who understand art may not be good fund managers and those who are good fund managers may not be art experts. There is a shortage of talent on the combination of the two skills required to successfully run an art fund.

For art sake

While there are inherent negatives, art does not cease to be an investment opportunity due to this. A fund structure tries to bridge the inefficiency of the art market by trying to correct certain inherent deficiencies. However, it is difficult for the investor to liquidate his share even under this structure as sale of one of the holdings may be difficult even to provide liquidity. Also, an exit of the existing investor may result in an artwork being sold, which will hamper the returns of the remaining investors.

Art is best bought on individual merit basis on professional advice and understanding than in the form of pooled assets or funds. Art investment is best done by art lovers who buy it because they appreciate the work more than they seeing it as an investment. It is bought for art sake but eventually may turn out to be a good investment.

Any investment has to be evaluated on investment parameters and has its inherent advantages and disadvantages. Also, each investment has a target audience and may be suitable to some and art certainly does not qualify for a large number of investors.

Information asymmetry in the art market is high, making pricing inefficient.