Viewpoint Timely Insights from the Private Banking & Investment Group • JANUARY 2014 How to Allocate a Warhol Record prices have many investors looking at their collections for returns. But how should a masterpiece fit in your portfolio? Here, an updated look at art as an asset. Another auction; another record. In the case of Christie’s work by Bacon—paying $86.3 million for another triptych back annual November auction of postwar and contemporary in 2008—had decided to add to his collection. artworks in Manhattan, however, it wasn’t just one record that was smashed. Over the course of an evening of frenzied bid- The New York auctions—one in November and one in May, ding, collectors paid higher prices than ever before for works featuring a series of sales of postwar and contemporary art at by 10 artists, while the sale itself ended up winning the title both Christie’s and archrival Sotheby’s—of course, are only the of the most lucrative such auction ever, bringing a total of tip of the $61 billion global art market. The rest of the activity $691.6 million. It also featured the single most expensive work takes place in private sales or at the art fairs to which collectors of art ever sold at auction, a 1969 triptych by Francis Bacon, travel each year. Collectors and their art advisors flock from New Three Studies of Lucian Freud, featuring portraits of Bacon’s York’s Armory Show to Maastricht in March. No sooner do they peer. That was snapped up by a prominent New York dealer on finish unpacking their bags from Art Basel Switzerland in June behalf of an anonymous investor for an unprecedented $142.4 than they begin booking their hotels for the Frieze in London million, and had the market buzzing with speculation that the in October. They then wrap up the year at Art Basel Miami in same Russian oligarch who had set the previous record for a December. At each of these events, new collectors join the Merrill Lynch Wealth Management makes available products and services offered by Merrill Lynch, Pierce, Fenner & Smith Incorporated (MLPF&S) and other subsidiaries of Bank of America Corporation (BAC). The Private Banking and Investment Group is a division of MLPF&S that offers a broad array of personalized wealth management products and services. Both brokerage and investment advisory services (including financial planning) are offered by the Group’s Private Wealth Advisors through MLPF&S. The nature and degree of advice and assistance provided, the fees charged, and client rights and Merrill Lynch’s obligations will differ among these services. Investments involve risk, including the possible loss of principal investment. The banking, credit and trust services sold by the Group’s Private Wealth Advisors are offered by licensed banks and trust companies, including Bank of America, N.A., member FDIC, and other affiliated banks. Investment products: Are Not FDIC Insured Are Not Bank Guaranteed MLPF&S is a registered broker-dealer, a registered investment advisor, member SIPC and a wholly owned subsidiary of BAC. May Lose Value community. Some are the new new emerging-market rich like the Russian billionaire rumored to be behind the Bacon blockbuster, but the extravagant prices being witnessed in some corners of the market are also due to the enthusiasm of “ordinary” collectors: those with an investment portfolio in the millions or tens of millions, with a passion for art and an interest in investing some of their wealth in tangible assets. The extravagant prices being witnessed in some corners of the market are also due to the enthusiasm of “ordinary” collectors. “Never in my lifetime have collectors been so totally absorbed picture. As of the end of November 2013, the All Art Index was with the idea of playing the market,” says Thea Westreich, a up just 2.2% for the year. The co-creator of the index, Michael New York–based art advisor who has been working with affluent Moses, notes that a big drag on the overall value has been an collectors for decades. “The concept of art as an asset class has ongoing slide in the prices for Old Masters (a category that never been so much a part of the dialogue as it is today.” includes Rembrandt and Vermeer as well as hundreds of other lesser artists who are hardly household names), which were down Indeed, even beyond the headline paydays, a case can be made 18.4% through the third quarter of the year. Postwar and for art’s soundness as a legitimate investment-grade asset. contemporary (+3.7%), traditional Chinese (+6.2%) and Impres- From the beginning of 2002 through November 2013, the Mei sionist and modern (+1.3%) were each up, but even in those Moses® World All Art Index, which tracks repeat auction-house categories the pace of the gains appears to have slowed from two price results for major artists across all genres, was up 106%. or three years ago when all categories substantially outperformed That performance puts it roughly on par with the total return the stock market in the aftermath of the financial crisis. “Clearly, at for the Standard & Poor’s 500 Index over the same period. the very top of the market, there are too many very wealthy people chasing too few truly iconic works, which is driving up prices. THE WINDS OF FASHION If it continues, you might even call it a bubble,” says Moses. “What Still, viewing art as an asset class can be tricky. The record- you’re seeing further down the scale is really much more of a setting sales and sticker shock at art fairs may give the impres- normal market, with moderate gains and prices generally sion that the entire art market is ablaze, but in fact the most leveling off. Part of that, too, could be a function of more money recent figures from the Mei Moses Index paint a more muted starting to flow back into other assets like real estate and stocks.” A Good Decade for Art: Over the past 10 years, the performance of the Mei Moses® World All Art Index, which tracks any original work of art that has sold at least twice at Sotheby’s or Christie’s, compares favorably with that of the S&P Total Return. Still, a variety of factors, including lack of liquidity, regulation and transparency, makes apples-to-apples comparisons difficult. Notes Christopher J. Wolfe: “An index does not an allocation make.” Change in value of each index, assuming a value of 1.0 in 2002. 3.0 Mei Moses World All Art Index S&P 500 Total Return 2.5 2.0 1.5 1.0 2002 2003 2004 2005 2006 2007 2008 Source: Beautiful Asset Advisors® LLC (www.artasanasset.com) PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS. IT IS NOT POSSIBLE TO INVEST IN AN INDEX. VIEWPOINT 2009 2010 2011 2012 2013 (through the end of Nov.) 2 At the same time, Moses would be the first to acknowledge that in an area as illiquid and lacking in transparency as the art market all figures need to be taken with a grain of salt. The Mei Moses Index tracks thousands of artists and works of art, and yet by definition some of these works may have changed hands only twice, The art market depends in large measure on the unpredictable winds of fashion. compared with the millions of shares of stock that are bought To offer some context about how you can view an art invest- and sold every day. In addition, while the index tracks sales at ment, Wolfe cites the Merrill Lynch Wealth Allocation Framework, auction, a greater number of transactions each year are complet- which divides all of your assets into three distinct “buckets” (see ed behind closed doors and never reported. In the contemporary “A Framework for Your Art Investment,” page 4): The first includes market, thought to be among today’s hottest areas, it’s estimated the more conservative, reliable investments designed to meet such that as much as 90% of sales are handled privately. basic goals as wealth preservation and steady growth, while the second includes assets with greater risk and potential to beat the These aren’t the only factors complicating the art-as-an-asset markets. Art fits squarely into a third bucket of aspirational invest- discussion. Unlike more traditional asset classes where prices ments that satisfy an aesthetic or personal goal and might (but are based at least in part on fundamentals such as materials or very well might not) result in a substantial change in your wealth, energy costs, the art market depends in large measure on the Wolfe says: “Art has a role if you already have a well-rounded and unpredictable winds of fashion. A buzzed-about artist one year balanced investment portfolio, and have cash left over.” Note, can be a has-been the next, and choosing potential winners has however, that the idea of using excess cash in no way implies a nothing to do with financial modeling or asset-class analysis. cavalier approach to the financial side of investing in art, he adds. On the contrary, having a disciplined, structured framework for your Even the laws of scarcity that seem to be doing so much to art buying can make such investments more financially viable, even drive prices at the top end of the market can be slippery when as it makes you a more discerning collector. extrapolated too broadly. While Francis Bacon and some other established masters won’t be creating new work, historical BUILDING AN ART PORTFOLIO periods and styles can go in or out of favor, and each year The best approach to building an art portfolio is to engage an brings thousands of paintings from newcomers vying for art advisor who has deep knowledge and insight into the market. discovery as the next big thing. Unlike other tangible assets This is especially important if you are a newcomer and unfamiliar like gold or a choice piece of beachfront property, which have with the territory. When it comes to buying art, the educated intrinsic value, newer works of art could prove to be extremely collector has the edge. “Knowledge trumps all,” says Westreich. valuable or worth next to nothing, with the outcome depend- That means being mindful of the history of art going back centu- ing on many variables a collector can’t control. Subjective ries and the evolution of art to the current day. It means delving factors, from critics’ reviews to auction-house promotional into great art and understanding its greatness, and participating agendas to the changing direction of a major collector, can in a conversation about the direction of art and what is moving influence prices, often unpredictably. it forward. From there you can follow your personal interests and develop a connoisseurship and a keen eye for the art you want WHERE ART FITS AMONG YOUR ASSETS to collect. “Great art takes time to know with any degree of ac- Each of these factors makes it difficult to apply standard curacy,” says Westreich. “With careful attention and curiosity, col- financial models to art investments, or to view them in the lectors can make acquisitions based both on empirical evidence same light as traditional asset classes such as equities or and their desire to own the work.” bonds. Although a work of art may well give you a sizable return, “it’s difficult to depend on art to provide that return,” Finding the intersection between what is personally meaning- says Christopher J. Wolfe, chief investment officer, Private ful and what has true value in the eyes of other buyers may be Banking and Investment Group at Merrill Lynch. one of the most important aspects—and biggest thrills—of VIEWPOINT 3 collecting. “We ask a potential collector, ‘What is it that you like, and would want to pass on to heirs?’” explains Jeff Rabin, co-founder and principal of Artvest Partners, an independent A Framework for Your Art Investment art advisory with a financial focus. While many people gravitate to one or two narrow areas, such as photography or Impressionist painting, an advisor might suggest broadening that perspective in category and medium. The advisor might recommend that you expand your collecting to include prints and drawings done by a favorite artist or pieces by a later artist who was inspired by the work. Above all, he or she can The Wealth Allocation Framework, originally developed at Merrill Lynch in 2005 and revised in 2011, is intended to help investors match their allocation strategies to their specific goals. To do so, the framework encourages investors to think about their portfolio in terms of three distinct buckets: No. 1, designed to be risk averse enough to help ensure that they will never have to worry about basic needs; No. 2, focused on guide you when it comes to distinguishing a great work from extending an expected lifestyle goal through tempered market one that isn’t the best example of an artist’s oeuvre, and help risk; and No. 3, higher risk and potentially higher rewards for you to understand what the appropriate price is for an item life’s loftier aspirations. Clearly, art falls into bucket No. 3. The that you’re pondering for your collection, based on both the return on a collection of up-and-coming contemporary artists, caliber of the work and what’s going on in the market. The for example, may be substantial enough to actually change advisor can also help set and manage expectations for financial performance. For those collectors who view their art as an your lifestyle, but in no way should it be counted on or pursued at the expense of buckets No. 1 and No. 2. investment, one general rule is the same as with any financial asset class: diversifying across artists and periods helps lower “PERSONAL” RISK the risk that often comes with a more concentrated focus. Preserve Lifestyle tions with major shows and retrospectives, can be compared Safety already entered the canon, having established their reputa- Cash Flow Rabin draws an analogy to stocks. If those artists who have with blue-chip stocks, then emerging contemporary artists just beginning to grab headlines are more akin to growth stocks: Principal Protection “Do Not Jeopardize Basic Standard of Living” ■ Minimize downside risk ■ Prioritize safety ■ Accept below-market returns for minimal risk much riskier, relatively inexpensive, but with a potential for high “MARKET” RISK reward, both financially and intellectually. A case in point might be South African–born Marlene Dumas, only a few of whose “Maintain Lifestyle” works had reached the secondary auction market by the time she was 50, in 2003. Until then, the record for sales of her work at auction stood at only $50,000. But over the next few years, demand for Dumas’ works ignited. One work painted only 19 Cash Equities All Fixed income years earlier fetched $1.24 million at auction in 2004, and an- ■ B alance risk and return to attain market-level performance from a broadly diversified portfolio other sold the following year for $3.34 million. By 2008, when a third work sold for more than $5 million at a London sale, “ASPIRATIONAL” RISK Dumas’ works were fetching auction prices higher than those for any other living female artist. Outperform works purchased for less than $50,000 have produced an Outperform is. In calculating his index, Moses has found that since 1950 Outperform The pattern is borne out by the broad data, imperfect as it “Enhance Lifestyle” ■ Maximize upside ■ Take measured risk to achieve significant return enhancement average compound annual return of 8.8%, compared with VIEWPOINT 4 4.4% for those for which collectors paid more than $1 million. value, with total loans ranging from a few million dollars and That should be music to the ears of beginning investor- up, says Arena. Subsequent annual appraisals assess any shifts collectors, but it does make it more important for you to in value as the art market fluctuates, and the loan is adjusted identify an advisor who can help build a stable, well-rounded accordingly to minimize risk. Because art is so personal, inves- collection and identify new artists who not only fit your in- tors may understandably fear losing treasured works to the terest and taste but are also compatible with your long-term bank if a loan can’t be repaid. “We work very hard to prevent goals and risk tolerance. that,” Arena says. “The last thing anyone, including the bank, wants is for the owners to lose a piece of art. We want them ART FOR LIQUIDITY’S SAKE to remain the stewards of the art.” However seriously you choose to pursue art’s investment potential, it makes sense to consider any piece already in your The idea of stewardship calls up perhaps the most enriching personal collection as a working component of your overall aspect of art investment, as distinct from most other forms wealth, says John Arena, an expert in fine art lending at U.S. of investment. The added satisfaction comes from establish- Trust. Unlike bonds or dividend stocks, art doesn’t produce ing a collection that takes on an identity of its own, one that regular income, but it can produce liquidity—be it to purchase resonates with something deep inside you. “With the right a vacation property or to expand your collection with more art. guidance, you can enjoy some of the most exciting works in the history of art,” Rabin says. “For as long as you have them, The process starts when a third-party appraiser is called in to they will inspire awe.” That’s a return on investment that can’t value the art. Loans can reach 50% or more of the appraised even be calculated. VIEWPOINT 5 Past performance is no guarantee of future results. The opinions, assumptions, estimates and views expressed are as of the date of this publication, are subject to change, and do not necessarily reflect the opinions and views of Bank of America Corporation or any of its affiliates. The information does not constitute advice for making any investment decision or its tax consequences and is not intended as a recommendation, offer or solicitation for the purchase or sale of any investment product or service. Before acting on the information provided, you should consider suitability for your circumstances and, if necessary, seek professional advice. Nonfinancial assets, such as fine art, can be complex in nature and involve risks, including total loss of value. Special risk considerations include natural events (for example, earthquakes or fires), complex tax considerations and lack of liquidity. Nonfinancial assets are not suitable for all investors. Always consult with your independent attorney, tax advisor, investment manager and insurance agent for final recommendations and before changing or implementing any financial, tax or estate planning strategy. 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