Just as with any asset class, there are risks specific to art that need to be considered before investing.

Market Manipulation

At the high end, collectors often engage in practices that in other markets could be considered market manipulation. Wealthy collectors such as David and Alberto Mugrabi have essentially cornered the market on Andy Warhol works. While they may not own a technical majority of the Warhol market, they control enough of it that they have become price-setters. They are also very active in that market, regularly bidding up works that are comparable to those in their own collections, regardless of their intention to buy. If someone outbids them, then it increases the value of their holdings, whereas if they end up winning the lot, they further consolidate market share. It is a win-win either way. While that sort of price inflation is certainly not illegal, it does pose a risk to the uninformed collector or investor newly entering the art space.

Gallery Control

There are also significant risks around deal flow in the primary market. The best artists tend to be represented by a very small handful of galleries, predominantly based in New York, London and Paris. The term “mega gallery” refers to a small group at the top of the gallery ecosystem that have multiple locations, significant capital, and a roster of artists that are highly desirable. The best known mega-galleries are Gagosian, Hauser and Wirth, David Zwirner, and Pace. There is significant gatekeeping around which customers of those galleries are allowed to purchase the best inventory. If you are not spending significant amounts of money at that gallery on a regular basis, you will not be offered the best works.

Chandelier Bidding

Auction houses present their own unique set of risks to collectors and investors, such as having financial incentives for certain work to perform well that they are not required to disclose to bidders. There is also the practice of “chandelier bids,” making auction bids appear to come from the audience when in reality it is just the auctioneer running the price up. In almost any other market, this behavior would be strictly forbidden, but in art it is not only legal but common practice. It is also important to note that at auction, only works that sell get recorded. In other words, if a work does not meet its reserve, from a historical perspective it is like it never even happened, which contributes to the idea that art perpetually appreciates. Of course, that is not the reality.

Changing Tastes

In the 1980s and 1990s, it would have seemed like a very good idea to buy impressionist works, as the market just kept going up. But when the Japanese economy crashed and the impressionist bubble burst, tastes changed, and many impressionist works have yet to regain the valuations that they once reached. What is popular today is not guaranteed to be popular in five years or in five decades.

Conclusion

While art presents an attractive set of advantages from an investment perspective, there are also significant risks associated with this asset class. It is always key to do extensive research and to be aware of potential risk factors. Just as with any area of investing, the more experience someone has, the more likely they are to spot red flags and be able to steer clear of any issues.

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