Author and investment adviser William J Bernstein points out that much of the appreciation in art and other collectibles is really just a lesson in the magic of compounding.
By Barry Ritholtz
You, too, can make a fortune in the art market. All you need is an eye for important, beautiful works, some spare cash and a time machine. If you lack the ability to go back a decade or more to buy what we now know will bring huge prices, well, then, making great returns in art is very, very hard.
We were reminded of this courtesy of the sale earlier this week of one of Claude Monet’s haystacks paintings, Meules (1890). The painting was auctioned at Sotheby’s in New York for $110.7 million, a record sum for a work by an impressionist. According to the Financial Times, the price, including auctioneer fees, was 44 times more than the $2.5 million the painting fetched when last sold at auction in 1986. This works out to an annual rate of return of 12.2% over 33 years.Then yesterday, the estate of SI Newhouse Jr., the former Condé Nast chairman, auctioned at Christies in New York Jeff Koons’s stainless steel Rabbit. At $91 million, it set a record for a living artist. According to Architectural Digest, Newhouse bought the sculpture in 1992 for $1 million. At 91 times more than the sculpture cost 27 years ago, this works out to an annual rate of return of 18.2%.Before you look at these gains and assume that investing in art seems like a sure thing, some cautionary words are in order. The problem with this is that investors tend to notice the big winners, while ignoring the works of art (or other assets) that fail to appreciate in value. Statistically, the vast majority of investments have returns that are nothing like this; some even lose value.
This tendency to give too much weight to the big winners while excluding the losers—otherwise known as survivorship bias—has a long and storied history in investing. Mutual funds were the first great example of this: Funds tend to regularly close down and disappear due to poor performance. The Vanguard Group and Dimensional Funds Advisors each separately found that about half of funds close within 15 years. When the losers get killed off, it makes the average performance of the survivors look that much better.
How much better? Vanguard noted that 62% of surviving large-capitalisation value funds outperformed their specific benchmark. But taking account of the funds that shut lowers the rate to just 46% after five years and the disparity gets bigger the further out you go. Larry Swedroe of the BAM alliance points to an earlier study by Lipper: In 1986, it reviewed 568 stock funds, with an average annual return of 13.4%. By 1996, those returns had improved to 14.7%. During that 10-year period, almost a quarter of the funds disappeared. These tended to be the worst performing funds, and once they exited the database, the survivors registered a cumulative 1.3 percentage point improvement—essentially accounting for all of the increase in returns.
The art equivalent of this are all of the works buried in attics and basements and, most impressively, in storage at museums. Take two big museums in New York: The Metropolitan Museum of Art’s modern and contemporary art collection alone contains more than 12,000 works. Not far away, the Museum of Modern Art has almost 200,000 modern works. Most of these wouldn’t fetch nine figures at auction.
It is human nature to look at big winners after-the-fact, while failing to include the impact of the losers. It is not what we see that matters so much as what we do not see.
Other collectible luxury items similarly attract attention from time to time. Fine wine has been popular, as have collectible cars. Recall the end of 2018, which was a disappointing year for US equities, and an even worse one for overseas stocks. The Wall Street Journal reported that luxury goods such as wine, art, classic cars and exotic colored diamonds did better than stocks and bonds in 2018. Well, not exactly. It’s only after we adjust for all of those items that weren’t counted in the investment-returns analysis that we can make a sound judgment about performance.
This is the problem with drawing any conclusions from these sorts of one-off events or sales of greatly appreciated novelty assets. Mutual funds are assets designed to appreciate and be held cheaply, but the same cannot be said for these other collectibles. Everything from art to antique Ferraris to fine wine to jewelry requires storage and insurance—costs that can add up.
Author and investment adviser William J Bernstein points out that much of the appreciation in art and other collectibles is really just a lesson in the magic of compounding. One painting by one of the Old Masters bought from the artist for the equivalent of $100 and sold 350 years later for hundreds of millions of dollars returned just 3.3 percent annually, he calculated. “If you save and you have even a modest rate of return over hundreds of years, then you’ll have a fabulous amount of money” he said on our Masters in Business podcast.
Selecting appreciated investments after the fact is easy. Instead, consider this challenge: What work of art are you willing to buy and hold for sale in 2052? That question reveals just how difficult investing in collectible assets really is.