Let's pretend for a moment that you are the portfolio manager at a large university endowment, pension fund or insurance company. You have a very basic problem. You have a giant pile of money that you need to invest wisely. You want these investments to not only preserve their purchasing power over many decades, but also provide a reasonable, risk-adjusted return as well.
Unfortunately, this is easier said than done. Inflation, geo-political troubles, debt defaults and market crashes are all normal occurrences over such a long investment timeframe. Under normal circumstances, you would hold your institutional portfolio in a mix of stocks, bonds and cash. And usually, this conventional asset mix would be good enough.
However, we are not living in economically normal times at the present. Instead, we are living in a time of acutely heightened financial risk. Most traditional fixed income and equity investments are wildly overvalued. Even some alternative assets, such as private equity, venture capital and real estate, are trading at unappetizingly high valuations.
Of course, if you are a canny institutional investor, you know there is at least one place you could safely stow some of that massive portfolio: the global art market. When I'm talking about the art market in this context, I'm referring to much more than just paintings or sculpture. I'm also including antiques, high-end jewelry, prints, antiquities and objets d'art. So I'm using a very broad definition of the art market.
Regardless, let's assume that you want to invest a modest 5% of your institutional portfolio in the global art market. If you are managing a small endowment or pension fund, this won't be much of a problem. A $1 billion total portfolio size would only equal a $50 million art allocation.
But if you happen to be managing a larger pot of money, you've got a real problem. For example, as of 2016, Harvard University had a $34.5 billion endowment. Yale isn't far behind, with an endowment of $25.4 billion. Even lowly Notre Dame University sports a substantial $8.4 billion stash.
In fact, there are fully 89 colleges and universities in the United States that have endowments greater than $1 billion in size. A modest 5% allocation to the global art market with portfolios this size would absolutely overwhelm the marketplace in short order.
The story is disturbingly similar when looking at pension funds, insurance companies or sovereign wealth funds. The California Public Employees' Retirement System, otherwise known as CALPERS, is sitting on a $290 billion nest egg. The world's largest sovereign wealth fund, the Norwegian Government Pension Fund, holds around $1 trillion in assets. The total value of U.S. insurance reserves was an estimated $5.8 trillion in 2015, to say nothing of those held at insurance firms overseas.
Institutional asset managers have a problem as large as their investment portfolios. There is no way they can collectively place even 1% or 2% of those assets into the global art market without massively driving up prices. We know this because of a wonderful little publication from The European Fine Art Foundation.
According to this gem of a report, the global art market has a turnover of around $45 billion per year. That might seem like a lot, but it pales in comparison to the global annual stock market turnover of $100 trillion, which is over 2,000 times greater than the art market's. And the global bond market puts the stock market to shame, with an annual volume that is several times higher!
The sad truth is that many institutional investors stick with stocks and bonds for the very simple reason that those markets are large enough to accommodate their oversized portfolios. But this is a lot like a drunk searching for his lost car keys at night underneath a lamppost because that's his best chance of finding them. Traditional portfolio managers buy stocks and bonds and hope against hope that everything will turn out well. There is definitely an element of wishful thinking at work among institutional investors.
They are scared to make significant portfolio allocations to the global art market because they know the asset class is illiquid, making it very difficult for them to get in and out quickly. In addition, investing in the high value segment of the art market requires special training and knowledge - skills that traditional asset managers completely lack. All of this acts as a deterrent, which helps to suppress the price of fine art and antiques relative to traditional asset classes.
But I'm going to tell you a little secret: the relative undervaluation of the global art market will not last forever. The smart money is already steadily and discreetly building their positions. Fine antiques and works of art are being systematically accumulated by the wealthy and well-connected. They are buying now because they know the market is illiquid and that they need to build their tangible asset portfolio now, before the investment merits of these choice assets become common knowledge.
I do have some good news, though. You don't have to sit on the sidelines and watch while the smart investors get rich without you. The small investor is perfectly positioned to participate in the art and antiques market.
Regular people like you and me don't have to worry about moving the global art market with our bid. We can easily buy wonderful antiques for $500, $1,000 or $5,000 at a whim, and it will immediately have a positive impact on our portfolio positioning. This is a boon to the small investor, and something that an institutional money manager can only view with jealousy.
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