Understanding art finance: Debt vs equity investing
For decades, institutional investors have well understood the potential economic benefits of private real estate investing. What is less widely known, however, are the potential economic benefits of investing in art. Over the past 25 years, the contemporary art market has outperformed the S&P 500 by 4.5% annually (14% vs. 9.5%)1. With generally low correlation to traditional stocks and bonds, contemporary art can be viewed as a viable option for diversification of investment portfolios.
Investing in art offers a broad spectrum of opportunities and risks.
Art debt versus equity – same asset, different risk and return expectations
Art finance investment opportunities typically fall into two categories: debt and equity. When investing in art-backed loans (debt), investors can earn a return on investment tied to borrower interest payments and repayment of principal over the life of the art loan. Additionally, art-backed loans are generally made at 50% of an artwork’s value, therefore an art debt investor has a level of protection with the residual 50% value cushion. In other words, as long as the artwork does not depreciate by more than 50%, the sale of the artwork should generally fully repay the loan. While the borrower (artwork owner) bears the first order of downside risk, they also enjoy a greater share of the upside of the artwork’s increase in value. Yieldstreet’s Diversified Art Portfolio is an example of an investment in a pool of art-backed debt.
On the equity side, investors in art-equity funds are investing in a pooled investment vehicle, which owns the artworks, with an expectation that the artworks will appreciate in value over time. Unlike contractual monthly interest payments and principal payment at maturity leading to an expected target yield on art-backed loans, investors in art equity funds do not receive any defined interim payments, but instead have the potential to receive returns based on the appreciated value when the artworks are sold at some point during the life of the fund.
Art equity investments are subject to different, and often greater, risks than the art-backed debt which is why investors seeking exposure to the art equity asset class need to understand how these investments vary, and consider working alongside investment professionals who understand the art finance market and have data driven approaches.
Art equity opportunities
Investors considering allocating a portion of their investments to art equity can gain exposure either by investing in a single piece of art, or by investing in a pooled investment fund, which owns a portfolio of artworks.* In funds with numerous artworks, the price fluctuations of any one artwork is mitigated by the fund’s diversification across many others, helping to reduce concentration risk in any one artwork or artist.
What to look for in an investment manager
Given the risks inherent in the art market, investors may seek to invest with an investment manager with deep experience in assessing art-specific risks. Investors should look for managers with proven and disciplined, data driven investment processes – robust due diligence standards, extensive underwriting experience and greater access to information in an opaque market that is highly idiosyncratic.
1. CNBC, “Art Has Shown Long Term Returns That Rival Bonds“, 11/10/21
2. Not all investors may access private investments directly. In certain cases, investors may need to be “Accredited Investors” as defined by the Securities and Exchange Commission in Rule 501 of Regulation D. In other cases, investors may access private investments through other means, such as exempt offerings, mutual funds, etc.
*Certain funds may have limited assets, or only one asset, it is important to read the funds offering documents prior to investing
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2 Represents an net annualized return, using an internal rate of return (IRR) methodology, with respect to the matured investments shown in your Portfolio experience, utilizing the effective dates and amounts of subscriptions and distributions to and from the investments, net of management fees and all other expenses charged to the investments.[read more]