* By Jessica Waldmann, Questroyal Fine Art

In May 1993 a painting by Hudson River School artist Frederic Edwin Church titled Winter on the Hudson sold at auction for $34,500. In just thirteen years the same painting was again sold; however, this time the seller earned a whopping $660,000. If the same seller purchased the work in 1993 and then sold it in 2006, the investor earned $625,500 at a compound annual return of twenty-five percent. Not bad for an investment that hangs on your wall.

Given the volatile state of the current stock market, investors are turning towards alternative investments including real estate, memorabilia and antiques. Research conducted by two professors of New York University's Stern School of Business makes a case for yet another alternative: the fine arts.

Using data collected from post-1950 auction records in which original and resale prices were tracked for individual paintings, the Mei Moses Family of Fine Art Indices reveal that the art market provides attractive qualities for private investors. The following is a brief summary of the investment potential of just one category: American art.

American Art as an Investment: Index Value vs. Stocks, Bonds, and Gold

In order to evaluate the strength of American art as an investment, Mei and Moses compiled auction records for American works created prior to 1950. Using this data, an American art index was created that could be analyzed in terms of market trends, appreciation, and risk. Notably, this index followed formulas used to study traditional assets, thereby allowing a comparison between American art and stocks, bonds, and gold.

Figure 1 below demonstrates the resultant information; here, the value of American Art and the S&P 500 Total Return index is graphed so that the two assets may be compared in terms of performance (as well as two other art collecting categories indices). Surprisingly, this line graph indicates that American art created prior to 1950 actually outperformed stocks during the past fifty years. While the presented data is sensitive to the date at which it began, it does indicate that American art - an asset class that is often overlooked - can increase in value at a remarkable rate.

Compound annual rates of return further support the finding illustrated in Figure 1. As demonstrated by the percentages in Table 2, the compound annual return for the American art index steadily surpassed the S&P 500 during the past fifty years. Although this margin slightly decreased in more recent years, the past year witnessed a significant expansion leaving the compound annual return for the S&P 500 more than fifteen percent behind that of the American art index.

A comparison between the compound annual return of American art and bonds and gold is perhaps even more intriguing. When evaluated, the compound annual return of the American art index is shown to undeniably surpass that of these investments. For example, the past year saw the return of gold at 18.4%, while bonds averaged between 2.7 and 3.1%; astonishingly, American art accumulated a 34.6% compound annual rate of return during the same period.

American Art as a Means to Diversification and Mitigation of Risk

To further analyze the potential benefits of investing in art, Mei and Moses investigated the correlation between American art index and the S&P 500 Total Return index. Using data from both indices, Mei and Moses discovered that American art and the S&P 500 produced a correlation coefficient of .22. This relatively low figure indicates that the American art market did not strongly follow the trends exhibited by the S&P 500 during the past fifty years. This information is important as it suggests that American art can act as a means to diversify one's portfolio and hedge against portfolio depreciation in times of stock market crises.

Figure 2 demonstrates the advantages of including American art in a diversified portfolio. Tracking rates of return versus projected risk, Mei and Moses graphed two hypothetical portfolios - one with and one without American art. As shown, the portfolio with American art yielded a lower level of risk at nearly every rate of return. One illustration of this point is made evident at the expected return of 10%. At this level of return, the provisory portfolio without American art carries almost a 16.5% risk, whereas the portfolio with American art carries only a 9.5% risk.

A second graph (Figure 3) details the optimal allocation required to achieve the rates of return featured in Figure 2. The values recorded here assert that a significant holding of American art can increase rate of return while mitigating risk. For example, to achieve a return 8%, the hypothetical optimal allocations would be as follows: 10% for American art, 20% in stocks, and 70% devoted to ten year bonds. Notably, to increase one's return to 10%, the amount of the portfolio allocated to American art portfolio would have to double. Although this graph records a hypothetical situation, it does suggest that American art can be a viable - and important - investment to include in one's portfolio.

Art Market Volatility: Due Diligence Required

While this data points to a number of positive conclusions regarding the investment potential of American art, there are, as always, other risks to consider. American art undoubtedly has its own dynamic variables that affect value. These factors include aesthetic concerns as well as the condition of the painting and reputation of the artist at the moment of sale. Market volatility also requires caution; in the past fifty years, the volatility of the American art index was rated at 38.4% compared to 16.5% for the S&P 500 Total Return index.

This percentage is at first alarming; however, it is important to note that the past ten years have seen a dramatic decrease in volatility, taking the calculated risk for the American art index to 13.7%. Moreover, investors who are well-versed in market trends know that higher volatility is often associated with higher potential returns, i.e. no risk, no gain.

As shown, American art is a feasible asset that not only appreciates over extended periods of time, but also helps to diversify one's portfolio while mitigating its overall risk. In addition to its investment potential, American art is also unique in its tangibility. Needless to say, this is an asset that can be seen and discussed as part of one's home while simultaneously adding to a financial portfolio. So the next time you feel ready to purchase stock or make an investment do this first: walk into an art gallery. Here, you can see both the product and its investment potential before your very eyes.

* The information provided here is a summary of the research included in Questroyal Fine Art's Art vs. Stocks and Bonds: A Comprehensive Analysis of the Investment Potential of American Art. As stated, the findings detailed in this publication are based upon the research of Dr. Jianping Mei and Dr. Michael Moses of Beautiful Asset Advisors, LLC (www.artasanasset.com). Please contact Questroyal at gallery@questroyalfineart.com for a complimentary copy of this report.

Figure 1: Growth of the Art and Stock Indices over the Last 50 Years

Table 1. Compound Annual Return: American Art Index vs. Financial Indices

 

American
Before 1950

S&P 500
Total Return

U.S. Treasury
10 Year Notes

U.S. Treasury
90 Day Bills

Gold

Last 50 Years

13.1%

10.6%

6.7%

5.5%

5.5%

Last 10 Years

10.5%

8.4%

6.9%

3.6%

3.0%

Last 5 Years

10.5%

6.1%

5.5%

2.1%

13.8%

Last Year

34.6%

15.8%

2.7%

3.1%

18.4%

Figure 2 Risk/Return Tradeoff Based on the last 50 Years: American Art Index

Figure 3 Optimal Asset Allocation Based on the last 50 Years of Risk/Return History

Correlation co-efficients are used to determine the relationship between two variables. Possible coefficients range from -1 to 1, with positive integers indicating a directly proportional relationship and negative coefficients indicative of an inverse relationship.

Source: www.artasanasset.com ©2007. This information cannot be used or reproduced without the permission of Beautiful Asset Advisors® LLC.