How art is being incorporated into investment portfolios for diversification

Over the past ten years, the Middle East and North Africa’s (MENA) arts sector has grown, supporting economic diversification while also serving as a positive indicator of its success.

Deloitte’s Art & Finance Report 2021 reveals that global sales of art and antiques reached over $50.1bn in 2020, where online sales accounted for a higher percentage than the mainstream retail categories.

The number of Middle Eastern investors participating in global sales has risen by 76 per cent over the past five years with the UAE’s participation soaring by 157 per cent.

Major art galleries that have opened up in recent years include The Louvre Abu Dhabi, Jameel Arts Centre, Leila Heller Gallery in the UAE, La Fontaine Center of Contemporary Art in Bahrain, Beirut Art Center in Lebanon, Arab Museum of Modern Art in Qatar, Mono Gallery, and Darat Safeya Binzagr Gallery in Saudi Arabia to name a few.

Diversifying portfolios
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. 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 per cent.

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 – a changing role
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.

Outperforming the S&P500 index
The contemporary art market has performed extremely well over the last 40 years, outperforming the S&P500 Index by 240 per cent since 1986. 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 per cent to 20 per cent 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.

Years ago, people purchased art only due to a personal interest or liking of an artist’s work. However, nowadays an increasing trend in art is solely from an investment perspective due to its unique characteristics as an asset class.

Can the MENA region keep up the momentum to become one of the leaders in art investment?

Vedat Mizrahi is the CFO and chief economist of Mintus, an online art investment platform

Also read: How art is gaining traction as an alternative investment option