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Portfolio Optimization With Collectible Art: Portfolio Fix

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Fine art collections can pose a challenge for portfolio management. The issues are well-known and include a lack of liquidity and market transparency, plus transaction fees and storage/protection costs. Collectors know how to deal with those problems, but an often-overlooked issue is the quantitative treatment of art as part of clients’ total portfolio.

One solution is to ignore collectible art’s investment features and treat it as a personal asset, but that approach overlooks art’s potential risk and return, however.

Michael Moses, Ph.D., and Jianping Mei, Ph.D., co-founded Beautiful Asset Advisors LLC and the Mei Moses Fine Art Index to help address this situation. The firm’s index tracks repeat-sales pairs at art auctions — think of it as the S&P Case-Shiller index-construction method for home prices applied to art transactions. (A repeat-sales pair means that the firm has a record of the last two times an art object was sold at auction.)

Their database includes 27,000 repeat-sales pairs and is growing by 3,000 pairs each year. The firm uses that data to track price movements in several major art categories; they sell access to their database and analyses online.

A 2010 “Journal of Investment Consulting” article by Mei and Moses, recently analyzed by “Artes Magazine” noted that the most recent five- and 10-year periods for art, as measured by the Mei Moses All Art Index, were 3.6% percent and 4.9%, respectively.

These returns were higher than those earned by S&P 500 Total Return Index of 2.3% and 1.4% for the same respective periods. Stocks out­performed art over the past 25 years with 10.4% CAR vs. 6.5% for art, the 50-year returns were similar: 8.9% for art vs. 9.4% for stocks.

The returns for art were less volatile than for stocks, however. Mei and Moses report that the standard deviation of the changes in annual returns for the art index was 14.1% versus the S&P’s 20.5% over the past 10 years and 17.6% versus 18.2%, respectively, over the past 25 years.

Their conclusion: Art can reduce portfolio risk without substantially reducing returns. That’s good news for collectors, though it raises a question: How should an advisor include art in portfolio analytics and optimization?

One approach would be to overlook clients’ art holdings and treat them as personal assets. But that would be a mistake, Moses pointed out in a phone interview. “For clients who already have art, the art should not be ignored, because if you ignore the art, you’re exposing the client to more risk by your other allocations than you need to,” he said.

The solution Moses recommends: Use the indexes as a proxy for the asset class.

“We have lots of art indexes now for different collecting categories so you can even build a model that uses multiple indexes,” he explained. “You would then optimize everything else based on a certain percent of the total assets that the individual has allocated to the existing collecting categories. That allows you to optimize all the other allocations based on the existing art allocations.”

It’s unlikely that a client’s collection will correlate perfectly with one of the computed indexes, although the use of multiple indexes can help address that. Nonetheless, the use of art-category indexes as proxies for clients’ collections makes sense as a starting point for portfolio design that recognizes art’s investment potential.