The hype surrounding the auction has once again promoted the belief that the rate of return on collectibles is very high. But are works of art — even masterpieces — a good investment from a purely financial point of view?
Economic theory suggests that the total returns between two classes of assets, adjusted for risk, should tend to equalize over long periods of time. The total returns from holding art objects consists of a monetary return, plus the consumption (or psychic) benefit that comes from owning and viewing the art objects. By contrast, the total returns on financial assets are limited to monetary returns. Since the total returns on art objects and financial assets should, on average, be equal, it follows that the monetary returns on art should be less than those for financial assets, the difference being the implied esthetic return.
Do the data support the theory? The answer to this question is provided by two distinguished Swiss economists, Bruno Frey and Werner Pommerehne, in their classic 1989 book Muses and Markets. To calculate real rates of return on works of art, they analyzed the auction prices, net of transaction costs, of quality paintings by 305 of the world’s best‐known painters over a period of 353 years, from 1635 through 1987. To focus on works sought by collectors, the authors considered only 1,198 paintings held for 20 years or more.
Their findings: The average real rate of return on paintings over the 3.5 centuries was 1.5% per year. The price risk of an individual painting, measured by the fluctuations of the rate of return of individual paintings around the average, was very high, making an individual painting as risky as some of the most speculative stocks. And note that this price risk cannot be reduced by creating a broadly diversified portfolio of paintings, because different paintings tend to show similar price movements. Hence, the market risk is high.
Beyond the financial risks associated with the uncertainty about future prices, paintings are subject to other risks: for example, a downward revision of a painting’s attribution, outright fakes and forgeries, as well as the purely material risk of destruction. The paintings whose values were actually affected by these risks were not included in the transactions analyzed by Frey and Pommerehne. Also excluded were the costs of maintenance, restoration, and insurance. In short, the low real rates of return calculated were overstated and the risks of holding paintings understated.
Compared with the real returns for financial assets, the returns on quality paintings, those relevant for financially‐oriented investors, were low. The real return on government bonds over the 353‐year period was 3% per year, double the financial return on paintings. And the price risk associated with government bonds was much lower than for paintings.
So, as economic theory suggests, over the very long pull art has been a relatively poor investment from a purely financial point of view. The esthetic pleasure or prestige gained by owning high‐quality paintings has played a significant role.
Many art dealers and collectors argue that art has become financially more attractive since World War II. Frey and Pommerehne find that there is some truth to this argument. The real return for paintings during the 1635–1949 period was 1.4% per year; the real return on government bonds was 3.3% per year. The financial opportunity lost by investing in paintings rather than bonds was 1.9% per year.
During the 1950–87 period the real rate of return on paintings increased to 1.7% per year, and the real return on bonds fell to 2.4% per year. Thus, the opportunity lost narrowed to 0.7% per year in the postwar period studied by Frey and Pommerehne.
A more recent study published by Stanford’s Graduate School of Business in 2013 covers the art markets between 1972 and 2010. The authors — Arthur Korteweg, Roman Kräussl, and Patrick Verwijmeren — reach broadly the same conclusions as did Frey and Pommerehne in their 1989 classic.
My advice to investors and collectors is the same as that of Maurice Rheims, the great Parisian art auctioneer and connoisseur. In The Glorious Obsession, which was published in 1980, Rheims wrote, “One would like to tell the financiers to confine themselves to their proper sphere, and advise art lovers not to acquire anything unless they derive a direct esthetic satisfaction from it. Those without the true faith had better give up.”