Investing

Investment-grade art and antiques have done tremendously well over the last 10 to 15 years.  The worst case scenario seems to have been about a doubling in value over that time – with many areas within the asset class tripling or even quadrupling.  But a classic mistake many investors make is projecting past returns forward indefinitely.  In other words, just because art and antiques have generated excellent returns over the past decade, it doesn’t mean they are destined to outperform over the next decade.  So what, if anything, are we able to divine about their future returns?  There are a few indicators that we can assess to give us a reasonable idea of their future performance.

First, I think it highly probable that precious metals – gold, silver and platinum – will be higher in the coming years.  This trend will be primarily driven by flight to safety demand caused by inevitable future financial sector disruptions.  Granted, this will only tangentially impact the pricing of antiques, specifically those that contain precious metals.  But it will be an important contributing factor nonetheless.

High-end raw materials are another element that is sure to become dearer in the future.  Honduran mahogany, Ceylon sapphire and British Columbian nephrite jade are just a few examples of the varied luxury raw materials often found in investment-grade objets d’art or antiques.  These materials – and many others as well – are simply not as readily available in good quality and sufficient quantity anymore.  The low hanging fruit – sources easily and cheaply exploited – has already been plucked clean long ago.  While I don’t think there will be widely publicized shortages of luxury good constituents per se, I do believe there will be a slowly growing realization among the knowledgeable that they are no longer abundant.  Consequently, one can expect the smart money to gradually begin accumulating art or antiques that use these materials, driving up prices in the process.

It is also obvious that the global economy is severely unbalanced in the current age.  At times like this I like to paraphrase U.S. economist Herbert Stein who said, “Trends that cannot continue, will not continue.” However, while a financial crisis usually ensues from a prolonged period of market distortion, it also true that there will always be a day after – a time when the global economy is on solid footing again.  When one invests in art and antiques, this is implicitly the scenario one is planning for – not the crisis, but the inevitable recovery.  When people have money to spend again, they will undoubtedly want beautiful, rare and artistic items.

The final aspect that bodes well for the outlook in the art and antiques market is the growing trend of automation.  In the future, factories will churn out massive amounts of consumer goods cheaply and quickly.  In addition, 3D printers will be found in almost every home.  Today’s ultra powerful computer processors are very good at mathematically intensive computations, but fail miserably at mimicking the human mind.  This shortcoming of computer AI is even more apparent in the artistic space.  As they are now, computers are simply incapable of conceiving of new ideas or amending existing concepts.  Therefore, it stands to reason that those things that computers can create will become common and affordable while those things that only skilled humans can make will become scarce and highly prized.  The creative endeavors of mankind will be revalued relative to everything else, which will just be “stuff.”

So even though the prices of art and antiques have already risen considerably, I believe it probable that this is just the start of a much broader trend.  Rare and highly sought after, art and antiques will be widely and avidly collected in the years to come.  The march of time will only serve to emphasize their positive qualities.  In my opinion, prices will rise for most, if not all, categories of this underappreciated asset class.

Many of us are looking for the perfect investment – something that produces good, steady returns with modest risk while not being too complicated.  Unfortunately, stocks are not that investment, at least not right now.  The major equity indices currently sport obscenely high valuations while the underlying companies are cesspools of financial engineering and undisclosed risk.  And the dividends you receive from holding shares are paltry – provided you’re lucky enough to own shares in a company that pays any dividend at all.

Bonds, in contrast, are at least a little bit better.  They disburse a (usually modest) cash interest payment semi-annually.  Unlike dividends, bond payments are almost always contractual obligations, a fact that grants the average investor a certain degree of protection as well as peace of mind.  Bonds also reside higher in the capital structure of a company, guaranteeing payment of principal before preferred and common stock shareholders in the event of bankruptcy.

However, bonds aren’t perfect either.  Interest rates on most bonds these days are unimpressively low, to say the least.  And many corporations have over-levered their balance sheets by issuing excessive debt to finance stock buy-backs and dividends in an attempt to “boost shareholder return”.  This leaves them vulnerable to future financial crises where their excessive debt loads may precipitate their insolvency.  This financial fragility is a serious concern for today’s vigilant corporate bond investors.

Art and antiques are a compelling alternative to these traditional financial assets.  In fact, they combine some of the best elements of both stocks and bonds into a single, largely undiscovered assets class.  At its core, investment grade art behaves very similarly to a high quality zero coupon bond.  A zero coupon bond is a financial instrument that pays no interest before maturity, but is sold at a discount to its par (redemption) value.  Later, when the zero coupon bond matures, it is redeemed at its full par value.  The difference between the (discounted) purchase price and the full redemption value is the bond’s return.

Investment grade art and antiques mimic the more desirable attributes of a zero coupon bond.  They are purchased for a certain (discounted) price today, and then are later sold (redeemed) in the future for a (usually) higher price.  The difference between the purchase price and the sale price of a work of art is profit, just like with a zero coupon bond.  However, unlike zero coupon bonds, art has strong future return potential.  For example, right now (August 2016) a zero coupon U.S. Treasury bond with 5 years to maturity yields 1.15%, while a 10 year yields 1.56% and a 25 year zero coupon bond yields 2.31%.  These aren’t the kinds of returns that will allow you to retire one day to a warm beach surrounded by palm trees.  And although I will not (and cannot) make any specific promises in regard to the future performance of art and antiques as an asset class, I will say that it won’t be very difficult for art to beat 2.5% returns over the next couple of decades.

Another potential downside of zero coupon bonds absent from art is that they have specific redemption dates that may not mesh with your evolving financial goals.  This means you may be forced to reinvest proceeds at a lower interest rate from a bond that matured earlier than you wanted, or, conversely, forced to sell into the wildly unpredictable financial markets if you need cash before maturity.  Art, on the other hand, can be “cashed in” by selling it whenever you like, although I don’t advise doing so before you’ve achieved a minimum holding period of 7 to 10 years.  But this longer investment horizon is offset by the fact that the art market isn’t subject to the serial boom-bust cycles that are commonplace in today’s stock and bond markets.  The art market – largely devoid of speculators and hedge funds – tends to appreciate more steadily and predictably than paper assets.

Another great feature of art is that it has no counterparty risk, a major consideration when buying zero coupon bonds.  Because a zero coupon instrument pays no cash flows before maturity, it is very exposed to the prospect of the issuing authority declaring bankruptcy before maturity.  This is why investors usually only purchase zero coupon bonds issued by the most credit-worthy institutions.  Of course, the drawback of buying a bond with a good credit rating is that it will have a very low interest rate.  Art and antiques, however, cannot go bankrupt.  This allows a prudent art investor to wait out the occasional poor market while, in effect, receiving substantial principle protection.  In addition to this enhanced asset security, art and antiques have far higher return prospects than traditional assets classes.  Investing in art and antiques is like having your zero coupon bond cake and eating it too.

Traditional financial assets – stocks and bonds – are an important part of a diversified investment portfolio.  They have their place.  But art and antiques are overlooked investment gems that shouldn’t be excluded from a savvy connoisseur’s asset allocation model.  Art combines some of the best attributes of stocks (high returns) and zero coupon bonds (minimal reinvestment risk) and then surpasses them both by eliminating the possibility of default.  There may not be any such thing as a perfect investment, but art and antiques come as close as anything I’ve ever seen.