The term alternative investments is constantly evolving and broadening to include new asset classes and definitions right now. Private equity, hedge funds or real estate spring readily to mind, but are they the only viable options for investors looking for a new asset class?
A new study by Deloitte suggests that art could become a lucrative way to diversify your portfolio, especially if you are just starting to get into new asset classes. This, in addition to conventional asset classes such as stocks, bonds and equities can play a crucial role in strengthening your portfolio. Collectible assets such as art, gemstones and wine, can be relatively low risk alternative investments if valued and positioned appropriately.
Earlier, art, in this case, exclusively paintings, used to get a bad rap as an investment class. The arts and antiques market was considered illiquid, extremely expensive and unhedgeable. It was also inconvenient to trade, as it formed a niche market, which made finding counterparts more cumbersome. Few regulations and high maintenance and storage costs further deterred potential investors.
There was also the fear that it was too sketchy (pardon the pun), as it relied heavily on short-term trends, and patron tastes, which could change without warning. Investors preferred to put their hard-earned money on more popular and “stable” asset classes, such as mutual funds or stocks. A lack of expert knowledge within the middle class, as to purchasing, valuation, storage and maintenance of fine paintings was rampant.
This fear, however, was understandable due to a sudden surge in hyped asset classes and pyramid schemes in the 2000s, which made people more skeptical of investing in something they didn’t fully understand.
While some may still consider art to be a whimsical investment for high-net-worth clients, it has never been so accessible to the regular investor.
Passive investors will find this opportunity especially attractive, as art encourages patience, and long-term holdings, sometimes taking several years to achieve their full potential.
On a general scale, investors usually hold their assets for 10 years or more. This is good news for the risk averse as well, as they don’t have to worry too much about short-term market fluctuations, apart from routine monitoring.
Another advantage is that art is not closely correlated with traditional investments, such as stocks and bonds. This is exactly what you want while diversifying your portfolio, as there is minimum cross-impact between the fluctuations of various assets. Furthermore, high quality art can yield consistently impressive value over the years, making it a profitable and stable addition to your portfolio.
However, art can be a good stepping stone to get a feel of the alternative investments market as a whole, before moving on to riskier assets, such as wine, rare stamps, gemstones and so on.
While you may be tempted to splurge on your favourite artist’s work after reading this, it’s vital to understand that not all art is created equal. Much depends on the artist themselves, of course, and whether they continue to produce excellent work, or whether this is a one-off, or part of a limited collection.
The general vibe of the market will also determine its current price, but may not always be reflective of changes to come. More developed markets, such as European and American markets will also tend to have bigger niches, and more players. This will in turn affect prices but will usually lower transaction costs.
Competent valuation is truly everything in this field, and it would be worthwhile to employ a reliable valuer and art expert for this. I say competent, as it is impossible to determine the exact value or future value of art pieces. However, your valuer should get as close as possible, by hopefully employing a cautiously optimistic approach. The overall pulse of the market should also be considered. This is crucial, as art is still quite a volatile niche, and may fluctuate without much warning.
Consider getting a second or even third opinion if you are not fully satisfied with the estimation, as this is still a new field to many valuers. A portfolio manager specializing in including alternative investments may be able to help you further in this aspect.
You should also have a fair, if not completely fixed idea of the approximate percentage of your portfolio that you want to put in art, and other alternative investments. This should be an amount that you can afford to lose, if the market depreciates.
Make sure to factor in maintenance, storage and insurance costs, which will be treated as expenses. As traditional investments usually don’t have these costs, it is advisable to take a little more time to chart them out properly, by comparing a few different service quotes.
A good rule of thumb is to start with 5% of your portfolio, to gauge the market.
Any lower, and you may not be able to invest in high-quality pieces, which will yield consistent value over the years. Any higher, however, and you could stand to lose an uncomfortably large amount, in case the market falls. This, obviously depends on relative portfolio sizes, and the stage you are at in your investment journey.
This makes reviewing and adjusting this percentage at regular, but not too frequent intervals crucial. Allow short-term fluctuations to even out, so you can better understand the overall direction of the market.
Keep in mind though that alternative investments behave differently than traditional assets. As they are mostly long-term assets, their lows and highs have to be perceived differently, since short-term fluctuations usually don’t have much of an impact on the long-term appreciation of a good painting. Don’t panic if your stocks or bonds are not doing well by thinking the same will affect your paintings too.
As with all investments in general, it is recommended to do your own research as much as possible, instead of relying completely on a financial advisor. Understand the kind of art you want to buy, the price, its potential in the market, how it can be traded and so on.
Read as much as you can, and talk to financial experts or anyone already familiar with the market. Get in touch with curators who specialize in art as an investment class. Visiting your local galleries and exhibitions could also be very helpful, in gauging the audience’s opinions about a particular artist or painting.
Only once you have an informed opinion of your own can your financial advisor truly help you chart the path forward. You can then make the most of their investment strategy and also understand your own risk appetite and comfort level.
This is invaluable, as it is imperative that you let your advisor know clearly if you’re not completely happy with their strategy, so they can work with you to improve it. Don’t be afraid to rework it several times over if necessary, until you are completely satisfied. A good portfolio manager will be more than happy to take the time to work through all your doubts.
Unfortunately, too many people still end up trusting their advisors blindly or letting themselves get subtly pressurized into overcommitting to their investments. By not doing your own share of research, it is only too easy to blame your advisor or panic when things don’t work out.
As Phillip Fisher says, “The stock market is filled with individuals who know the price of everything, but the value of nothing.’.