Art as an alternative asset class is being incorporated into portfolios for diversification
Threats to the global economy have increased dramatically since the beginning of 2022, leaving many investors wondering how to best protect their portfolios.
The generally accepted rule for investors with varying risk profiles is the same: build a portfolio that can weather the volatility by being well-diversified.
Some investors think that diversification is merely allocating funds to different asset classes. However, it is not as simple as that.
Diversification is key to reducing the overall risk of a portfolio
The idea behind diversification is to combine different asset classes with different risk profiles and low to negative correlation. A risk-off event negatively affects some investments, but would have a positive impact on others, reducing the overall risk and drawdown of the whole portfolio.
During the sell-off since the beginning of the year, we have witnessed an increasing correlation between equities, fixed income, and commodities, the main asset classes in a classic portfolio with drawdowns between 5-15%. Especially in an increasing inflationary environment, other diversifiers such as real estate (or hedge funds, private equity funds, venture capital funds for qualified investors) and fine-art can be helpful in improving the risk-adjusted returns of a portfolio.
Art investment may be helpful in improving the risk-adjusted returns of a portfolio
The role of art is changing
Art is no longer just appreciated for its aesthetic value but as an investment. Developments within the art market over the last decade have been followed almost as closely as those within the stock market.
Indices tracking the performance of fine art have held up well in the recent economic slowdown with auction houses continuously reporting record prices. Art as an investment has an increasing demand coupled with an absolutely limited supply and the ability to survive the economic downturns and generate above-inflation returns.
The contemporary art market outperformed S&P500 Index by 240% in the past 40 years
The contemporary art market has performed extremely well over the last 40 years, outperforming the S&P500 Index by 240% since 1986 (data from LiveArt analytics.liveart.io/analytics). Over the years it has ridden out bumps in the stock market and shown that it doesn’t follow the movements of other types of assets.
Finding a good balance between risk and return is the aim of any investment strategy. Different studies show that there are benefits of allocating 15% to 20% of a portfolio to alternative asset classes. Once the domain of institutional and high-net-worth investors, alternative investments continue to grow in popularity and are making their way into the portfolios of retail investors.
Similar to any other investment, the rate of return for alternatives is not guaranteed and past performance is not an indicator for future performance. However, it is fair to say that an illiquidity premium is usually attached to the alternatives and hence, had generated better returns than more liquid asset classes historically. The illiquid nature of alternatives and especially the art market is one of the key risks in investing in these asset classes and as a result, their allocation in a portfolio should be determined carefully.