Investing in Fine Art

Art as an Investment Makes Sense But for Whom? And How?

The following synopsis explains fine art as an alternative financial asset. It delves into the intricacies of art valuation, which is influenced by both subjective aesthetic factors and objective financial considerations. The aim is to assess art’s viability as a financial investment by comparing its performance with traditional financial assets.

Unique Features of the Art Market: The Role and Risks of Auctions

Art valuation is complex, influenced by both tangible financial value and intangible factors like historical significance and personal taste. This dual nature of art valuation differentiates it from other, more straightforward, financial assets.

A key aspect of the art market is the role of auctions. Auctions provide a transparent setting for pricing art, making them crucial for understanding market trends and valuations. However, while auctions provide the only publicly available valuation data points, there are data distortions.

Fine art auctions, due to their relatively low regulatory oversight compared to other financial markets, can be susceptible to self-dealing practices. Fine art auctions can sometimes be a bit like the “Wild West” due to less strict rules compared to other financial markets. This can open the door to self-dealing, where those involved might look out for their own interests more than they should. Here’s what that can look like:

• Price Manipulation: Auction houses or insiders may artificially inflate prices through shill bidding, where fake bids are placed, by undisclosed agreements between sellers and bidders, to drive up the price. Such manipulation can misrepresent the true market value of the artwork.

In my 33-year history of collecting art, for both passion and investment, I know of several instances where sellers that owned multiple pieces of an artist employed someone to bid for their auction item with the proceeds returning to the same seller minus the auction house’s standard 20% commission (yikes!). As a result, a seller could artificially inflate the value of their existing inventory, and even obtain loans based on appraisals that reflected the inflated value created by the shill bidding. 

• Insiders Playing Favorites: People employed at the auction houses may have their own stakes in some artworks, which can lead them to push certain pieces or clients unfairly.
• Playing the Market: Some folks treat art more like a quick money-making game, buying and reselling fast for profit, without really caring about the art itself. This can make the market unpredictable for artists and/or serious collectors.
• Behind-the-Scenes Deals: Secret agreements about prices or guarantees between buyers, sellers, or the auction house can impair the fairness of the auction.
• Art Market Speculation: Auctions may be used for speculative trading, where art is bought and quickly resold for profit, often disregarding the artistic value. This speculation can create bubbles and an unstable market, affecting artists and genuine collectors.
• Money Laundering: It wasn’t until the 2001 passing of the Patriot Act legislation that auction houses were also required to implement robust KYC (Know Your Customer) and AML (Anti-Money Laundering) procedures. But they only started really adhering to these requirements a few years ago. Prior, buying fine art, where a painting that can fit into your briefcase could cost $2 million, was a prime method for criminals and foreign governments to ‘launder’ criminal revenue.

So, while not all art auctions have these issues, the potential for such shenanigans shows why much more transparency would keep the playing field level for investors and collectors alike while benefiting the creators of the art.