Investing in Art: How to Profit From Your Passion

If you can overcome its steep entry point, art can help spread risk and generate solid returns.

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For those who like to combine their passions with their investing, "real" assets might just involve surrealist paintings.

Stock market volatility and predictions for higher inflation risk have led investors to focus on better insulating their portfolios. And one way to take out some inflation insurance is with investments that are generally considered to be "real" assets. This can include commodities like precious metals, but also art and collectibles.

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Art investing is subjected to price-swing risk and does involve transaction and insurance costs, so appreciation may take longer than with traditional stock investing. But it's also a purchase that has a place outside of portfolios, since it can be enjoyed in the home and loaned out to exhibits for the broader good.

Equally important, art changes the "look" of a portfolio in other ways. "Art has a low or negative correlation with many other asset classes and can play a positive role in portfolio diversification," say art investment analysts at Deloitte. "Some academic studies claim that art or collectibles should represent around 5 percent of a well-diversified portfolio." This consultancy is making a significant push in art financing and art investing analysis, in Europe especially, because it sees a growing asset class in art.

Rebound for returns. Art prices are rebounding from a weak period that coincided with the financial crisis and recession. For 2010, the Mei Moses All Art Index was up 16.6 percent on an annual basis, a rebound from the 23.5 percent plunge of 2009. By comparison, the S&P 500 returned 15 percent last year. The Mei Moses index, created in 2000 by New York University professors Jianping Mei and Michael Moses, tracks a proprietary database of some 27,000 repeat sales at worldwide auctions of investment-grade art. The average purchase price across the entire index is $120,410, with a high of $31.4 million. The index is issued by Beautiful Asset Advisors, LLC, which also tracks artist performance, sale estimates, and other analysis, and can be found at artasanasset.com.

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The 2009 drop was the largest decline in the All Art Index since 1991, when it fell 38.7 percent. Drops in 2008 and 2009 occurred after five years of positive annual growth averaging almost 20 percent.

According to the site, the most recent 10- and five-year compound annual returns (CAR) for art, at 4.86 percent and 3.59 percent, exceed the S&P returns of 1.35 percent and 2.28 percent, respectively.

The longer-term picture is mixed. Stocks outperformed art over the last 25 years, with a CAR of 9.91 percent compared with 6.43 percent. However, for the last 50 years, the returns were very close, with art achieving a CAR of 9.23 percent compared with 9.73 percent for equities.

The index also tracks types of sales. In the third quarter of 2011, the Impressionist and Modern sub-index was up 17 percent compared with where it stood at the end of 2010. That compares with an 8.5 percent drop for the S&P 500 and a 10.5 percent decline for the U.K. FTSE All Shares in a comparable period.

In determining investment costs, art buyers must also consider insurance and collection management needs. Management is an ongoing process, extending from proper installation and the right insurance coverage to planning for subsequent stewardship. A conservator, appraiser, and attorney may all play a role, art and collectibles insurer AXA Art advises on its website. The firm offers a guide to collection management in addition to other art collecting and investing literature.

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On the block. Auction house majors Sotheby's and Christie's saw mixed results during major New York events held in early November, but sales were much improved compared with sales during in the throes of the financial crisis.

Christie's sale for Impressionist and Modern Art failed to attract bidders on important pieces by Degas and Picasso, among others. The overall sale, which was expected to bring in between $212 million and $304 million, brought in just $140.8 million—the lowest result in two years, according to a report from Bloomberg News. The article blamed lofty pre-sale predictions more than a direct financial-market impact.