8.2 Art indices and performance measurement

Art indices are crucial tools for measuring the art market's performance over time. They track price movements, segment the market, and provide insights into different sectors, much like stock market indices do for equities.

These indices use various methodologies, including repeat sales regression and hedonic regression models. Each approach has its strengths and limitations, offering different perspectives on art market trends and investment performance.

Art Market Indices: Purpose and Methodology

Tracking Market Performance

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• Art market indices aim to track the overall performance and price movements of the art market over time, similar to stock market indices (S&P 500)
• Indices often segment the market by price tier, artist nationality, and art movement or genre to provide more granular insights
• Indices are usually denominated in major currencies (US Dollar, British Pound, Euro) and are published annually or semi-annually

Index Construction Methodologies

• Repeat sales regression tracks the sales prices of individual artworks that have sold at auction more than once
  • Compares the price difference between the first and subsequent sales to calculate returns
  • Allows for tracking the same artwork over time, controlling for quality
  • Limited to artworks that have sold multiple times, which may introduce selection bias
• Hedonic regression models control for various attributes of artworks that influence price
  • Factors considered include artist, size, medium, subject matter, and provenance
  • Enables the comparison of returns across different types of artworks
  • Requires a large dataset of auction sales with detailed artwork information

Art Market Indices: Comparison and Contrast

Long-Running and Broad Market Indices

• The Mei Moses All Art Index is one of the longest-running indices, tracking auction prices from 1720 to the present
  • Limited to paintings only and equally weights all artists
  • Provides a long-term perspective on art market performance
• The Artprice Global Index covers a wide range of artists but weights them equally regardless of their total sales volume or value
  • Offers a broad view of the global art market
  • May not accurately reflect the impact of high-value artists and artworks on market performance

Auction House and Sector-Specific Indices

• The Sotheby's Mei Moses indices track the performance of various art market sectors (Impressionist & Modern, Post-War & Contemporary, Old Masters)
  • Only includes data from Sotheby's auctions, which may not be representative of the entire market
  • Provides insights into the performance of specific art historical periods and movements
• Auction house indices (Christie's International Index) are not independent and may be subject to selection bias in the data used
  • May overstate performance to attract consignments and buyers
  • Lack transparency in index construction methodology

Value-Weighted Indices

• The Artnet indices use a value-weighted approach based on total sales value, providing a more accurate reflection of market performance
  • Gives greater weight to high-value artists and artworks that drive market trends
  • Only covers data from 1985 onwards, limiting long-term analysis
  • Requires a comprehensive database of auction sales values

Interpreting Art Investment Performance

Comparative Analysis

• Annual returns as measured by indices can be compared to returns from other asset classes (equities, bonds, real estate) over various time horizons
  • Helps assess the relative performance of art as an investment
  • Enables portfolio diversification analysis
• Risk-adjusted returns can be assessed using measures like the Sharpe Ratio or the Sortino Ratio
  • Sharpe Ratio compares returns to volatility, considering both upside and downside fluctuations
  • Sortino Ratio only penalizes downside volatility, which may be more relevant for illiquid assets like art

Market Cycle Analysis

• Indices can be used to identify periods of market expansion and contraction
  • Rising index values indicate strong demand and price appreciation
  • Declining index values suggest market corrections or reduced liquidity
• Differences in performance across various art market sectors can be analyzed
  • Identifies sectors outperforming or underperforming the broader market
  • Helps collectors and investors focus on the most promising segments

Complementary Market Indicators

• Sell-through rates measure the percentage of lots sold versus offered at auction
  • High sell-through rates indicate strong demand and market confidence
  • Low sell-through rates suggest overpricing or weak demand
• Market share by value tracks the relative importance of different auction houses, artists, or art movements
  • Helps identify market leaders and emerging trends
• Number of lots sold reflects overall market volume and liquidity
  • Increasing volume suggests growing market participation and interest
  • Decreasing volume may signal market saturation or declining confidence

Limitations of Art Indices

• Art indices should be interpreted with caution, as they may not accurately reflect the performance of individual artworks or collections
  • Each artwork is unique, with its own set of value-influencing characteristics
  • Indices provide a general market overview but cannot predict the performance of specific pieces
• Indices do not account for the subjective and emotional aspects of art collecting
  • Many collectors derive significant aesthetic and personal enjoyment from owning art
  • Non-financial motivations can impact buying and selling decisions, irrespective of market trends

Challenges in Measuring Art Investment Returns

Auction Market Limitations

• Art indices only track auction prices, which represent a small fraction of the overall art market
  • Private sales, gallery transactions, and direct artist sales are not captured
  • Auction data may be subject to selection bias, as only certain types of artworks are offered at auction
• Survivorship bias can occur when indices only track artworks that have sold multiple times
  • Excludes works that have lost value or failed to sell, potentially overstating market returns
  • Repeat sales may reflect a higher quality subset of the market

Transaction Costs and Illiquidity

• Indices do not account for transaction costs (buyer's premiums, seller's commissions, insurance, storage)
  • These costs can significantly reduce net returns for investors
  • Failure to incorporate transaction costs overstates the true profitability of art investments
• The illiquid nature of art investments means that prices are not continuously observable
  • Artworks may not trade frequently, leading to gaps in pricing data
  • Indices may smooth returns over time, understating true volatility

Tax and Regulatory Considerations

• Tax treatment of art investments varies widely across jurisdictions
  • Capital gains taxes, wealth taxes, and estate taxes can have a material impact on after-tax returns
  • Favorable tax treatment in some countries (freeports) can distort market demand and prices
• Lack of transparency around private sales makes it difficult to accurately measure returns for the entire art market
  • Private transactions are often not reported or disclosed
  • Indices based solely on public auction data may not fully reflect market dynamics

Emotional and Aesthetic Dividends

• Indices do not capture the emotional or aesthetic dividends that collectors may derive from owning art
  • The joy of living with and displaying artworks can be a significant component of total returns
  • Quantifying these non-financial benefits is subjective and difficult to incorporate into return calculations
• Collectors may have different holding periods and investment objectives compared to pure financial investors
  • Some collectors may never sell their artworks, prioritizing personal enjoyment over financial returns
  • Long holding periods and lack of liquidity can make it challenging to accurately measure investment performance