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Fine Art and Your Overall Asset Allocation

It's important to evaluate each asset you hold, including your art collection, as an integrated part of your overall wealth allocation rather than a separate and distinct piece of art.

Key Learnings:

 

  • Reviewing the percentage of your wealth committed to fine art in the context of your overall asset allocation can be an important consideration in determining the size of your fine art collection.
  • Given a historical pattern of risk and returns for various types of art paintings, asset allocation optimization tools can be useful in determining how these assets might behave in various economic environments.
  • Behavioral finance considerations must be checked closely. Specifically:
    • Endowment biases (emotional attachment to an asset or asset class)
    • Mental accounting (dividing assets into buckets based on categories)
    • In looking to optimize the allocation to fine art, there is often a tendency to overestimate the return and underestimate the risk profile of Art (known as overconfidence bias)

 

Art as an Alternative Investment

For most passionate art collectors, owning a piece of fine art is an emotional endeavor – one that produces a joy that is difficult to statistically quantify. Having said that, as you look to take any endeavor from a simple, joyful hobby to a more professional one, it becomes increasingly important to evaluate each asset you hold, including your art collection, as an integrated part of your overall wealth allocation rather than a separate and distinct piece of art.

 

If, for instance, we look more closely at historical data available among major painting markets, we can discern some of the same characteristics normally attributed to financial assets. Some of these quantifiable characteristics include historical returns, risk as measured by standard deviation of returns, and resulting correlations to traditional financial asset classes.

 

Specifically, in a study conducted in 2004 by Andrew C. Worthington and Helen Higgs 1, we find that in data collected from 1976 to 2001 an average rate of return, a standard deviation and a correlation coefficient could be calculated for different types of paintings. These financial characteristics are not too different from what we typically see from other alternative asset classes. The data shows that, depending on the specific painting market (Contemporary Masters, French Impressionists, Modern European, Century European, Modern U.S., etc.), the long-term returns ranged from 1.9 percent for Surrealist to 4.2 percent for Contemporary Masters, with 11.3 percent and 10.4 percent in standard deviation respectively.

 

Wealth Allocation Optimization

While we acknowledge that historical returns do not necessarily reflect how they might behave in the future, particularly in various economic environments, we can use it as a jumping off point to model how your current percentage allocation to art is likely impacting the overall risk and return profile of your current wealth. Moreover, you may be able to optimize the percentage allocation to your art collection that would bring your overall asset allocation in line with your return expectations and your overall tolerance for risk. In some circumstances a 5 percent wealth allocation to art might be just right; in others it might be too much. Either way, it is important to understand how changes to the art market and what type of art you own might impact your overall wealth in various environments.

 

Within our Bloomberg tool, we can utilize a proxy with similar return characteristics and stress test the portfolio to see how the entire portfolio, along with its individual pieces, might behave in a recessionary environment where the S&P loses 20 percent of its value, or bond prices rise by over 200bps in a single year. These are important insights to understand and have in your back pocket as you plan your next art acquisition or divesture.

 

Behavioral Finance Considerations

There are several behavioral finance considerations to be aware of when making decisions within this alternative asset. Therefore, the advice of a professional advisor can be priceless and additive when it comes to evaluating an asset class.

 

One of the most obvious is what is commonly known as Endowment Bias. This is the effect that results when individuals value something they already own more than something they do not yet own. The perceived greater value occurs merely because the individual possesses the object in question. Investors (and art collectors) tend to stick with certain assets simply because of familiarity and comfort, even if they are inappropriate or become unprofitable. This can be particularly problematic when we develop an emotional attachment to certain pieces of art.

 

Another common cognitive behavioral concept that we see play out with this asset class is known as Mental Accounting. This refers to the tendency people have to separate their money into different accounts based on miscellaneous subjective criteria. The cognitive error suggests the individual is likely to assign different utility to each group of assets of significant value without really understanding how they can impact other segments of wealth. This can lead to inappropriate allocations to each segment, potentially placing your entire wealth at risk.

 

Finally, the Overconfidence Bias can potentially be the most damaging, particularly in the context of estimating risk and return. The overconfidence bias refers to the tendency to overestimate one’s own skills and predictions for success. It comes from overestimating one’s knowledge and underestimating the risk of being wrong. Again, professional advice about valuations, as well as risk and return expectation, can be critical to success.

 

Conclusion

As you consider expanding or divesting your fine art collection, taking an integrated asset allocation approach to the appropriate percentage allocation to art can not only be an important component in the decision-making process, but can also ensure that your overall asset allocation remains in line with your specific risk and return profile.

 

Additionally, with the correct data in hand, utilizing Bloomberg’s portfolio optimization tools can allow us to stress test the portfolio with this alternative asset proxy included to determine how it would behave in different economic cycles. With art in particular it is important to be aware of specific behavioral biases that can creep into the decision-making process.

 

Professional advice can be critical to success in helping to avoid these common pitfalls, not only with art as an alternative asset class but with other financial assets as well.

 

 

 

Appendix

 

1 Return, risk and correlation statistics utilized were derived from work done by Andrew C. Worthington and Helen Higgs in 2004 from the School of Economics and Finance, Queensland University of Technology, Brisbane QLD 4001, Australia.

 

Fine Art and your Overall Asset Allocation

Fine Art and your Overall Asset Allocation

 

Fine Art and your Overall Asset Allocation

Fine Art and your Overall Asset Allocation

 

References

 

Worthington, Andrew and Higgs, Helen (2004) Art as an investment: Risk, return and portfolio diversification in major painting markets. Accounting and Finance 44(2):pp. 257-272.

Copyright 2004 Blackwell Publishing

 

General Disclosures

 

This information discusses general market activity, industry or sector trends, or other broad-based economic, market or political conditions and should not be construed as research or investment advice. The views and opinions expressed may differ from those of Cadence Bank or other departments or divisions of Cadence Bank and its affiliates. Investors are urged to consult with their financial advisors before buying or selling any securities. This information may not be current and Cadence Bank has no obligation to provide any updates or changes. Views and opinions expressed are for informational purposes only and do not constitute a recommendation by Cadence Bank to buy, sell, or hold any security, including any Cadence Bank product or service. Views and opinions are current as of the date of this presentation and may be subject to change, they should not be construed as investment advice. In the event any of the assumptions used in this presentation do not prove to be true, results are likely to vary substantially from the examples shown herein. This presentation makes no implied or express recommendations concerning the manner in which any client’s account should or would be handled, as appropriate investment strategies depend upon the client’s investment objectives. It does not take into account the particular investment objectives, restrictions, tax and financial situation or other needs of any specific client.


Past performance does not guarantee future results, which may vary. The value of investments and the income derived from investments will fluctuate and can go down as well as up. A loss of principal may occur.

 

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