Thursday, November 21, 2013

21/11/2013: Art = Rubbish Investment Despite 6%+ Average Annual Returns?..

Two interesting recent studies on economics of investment in art markets worth reading.

The first study, titled "Does it Pay to Invest in Art? A Selection-Corrected Returns Perspective" by Arthur G. Korteweg, Roman Kräussl and Patrick Verwijmeren (October 15, 2013) "shows the importance of correcting for sample selection when investing in illiquid assets with endogenous trading. Using a large sample of 20,538 paintings that were sold repeatedly at auction between 1972 and 2010, we find that paintings with higher price appreciation are more likely to trade. This strongly biases estimates of returns. The selection-corrected average annual index return is 6.5 percent, down from 10 percent for traditional uncorrected repeat sales regressions, and Sharpe Ratios drop from 0.24 to 0.04. From a pure financial perspective, passive index investing in paintings is not a viable investment strategy once selection bias is accounted for. Our results have important implications for other illiquid asset classes that trade endogenously."

The study is solid on econometrics and shows very clearly how the selection bias mechanism drives abnormally high reported returns for art. This, in my view, sets a new standard of analysis for the sector. The study is available here: http://ssrn.com/abstract=2280099.

Another paper, titled "The Investment Performance of Art and Other Collectibles" by Elroy Dimson and Christophe Spaenjers (September 2, 2013) was authored by finance specialists who should have known better to test for selection biases. They did not. Which means that some of the econometrics reported should be suspect. Still, the study is interesting if only because it covers not only fine art, but also philately and musical instruments.

Per abstract: "We assess the long-term financial returns from high-quality collectible real assets, and review the unique risks that are associated with such investments. Over the period 1900-2012, art, stamps, and musical instruments (violins) have appreciated at an average annual rate of 6.4%-6.9% in nominal terms, or 2.4%-2.8% in real terms. Despite the similarity in long-term returns, short-term trends can vary substantially across these different types of emotional assets. Collectibles have enjoyed higher average returns than government bonds, bills, and gold. However, it is important to recognize the quantitative importance of transaction costs in collectibles markets. In addition, price volatility is larger than is suggested by conventional measures of risk, and these assets are also exposed to fluctuating tastes and potential frauds. Yet, despite the large costs and many pitfalls, investment in emotional assets can pay off, because of the non-financial yield they provide."

The study is available here: http://ssrn.com/abstract=2319338

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