Citi GPS - THE GLOBAL ART MARKET: Perspectives on Current Drivers and Future Trends by Widewalls

THE GLOBAL ART MARKET Perspectives on Current Drivers and Future Trends

Citi GPS: Global Perspectives & Solutions November 2015

Citi is one of the world’s largest financial institutions, operating in all major established and emerging markets. Across these world markets, our employees conduct an ongoing multi-disciplinary global conversation – accessing information, analyzing data, developing insights, and formulating advice for our clients. As our premier thought-leadership product, Citi GPS is designed to help our clients navigate the global economy’s most demanding challenges, identify future themes and trends, and help our clients profit in a fast-changing and interconnected world. Citi GPS accesses the best elements of our global conversation and harvests the thought leadership of a wide range of senior professionals across our firm. This is not a research report and does not constitute advice on investments or a solicitation to buy or sell any financial instrument. For more information on Citi GPS, please visit our website at www.citi.com/citigps.

Citi GPS: Global Perspectives & Solutions

November 2015

Suzanne R Gyorgy Global Head of Citi Art Advisory & Finance Citi Private Bank

Steven C Wieting Global Chief Investment Strategist Citi Private Bank

+1-212-559-5466 | suzanne.r.gyorgy@citi.com

+1-212-559-0499 | steven.wieting@citi.com

Thierry Dumoulin Vice President of Marketing & Business Intelligence artnet

Parul Gupta, CFA Head of Strategic Asset Allocation Citi Private Bank +44-20-7508-0216 | parul.gupta@citi.com

Noah Horowitz Director Americas Member of the Executive Committee Art Basel

Benjamin R Mandel Executive Director J.P. Morgan Asset Management

Christophe Spaenjers Associate Professor of Finance HEC Paris

Fotini Xydas Art Advisor, Citi Art Advisory & Finance Citi Private Bank +1-212-559-9649 | fotini.xydas@citi.com

November 2015

Citi GPS: Global Perspectives & Solutions

THE GLOBAL ART MARKET Perspectives on Current Drivers & Future Trends Andrew Pitt Global Head of Research, Citi

This report in our Citi GPS series has been conceived in partnership with Citi Private Bank to address a selection of key issues in the global art market as well as to address the question of whether art can credibly be deemed an “asset class”. The report is arranged into six chapters written by experts and specialists in the art market to whom we are grateful for their collaboration on this project. The detailed biographies of the authors are included at the back of the report. The report begins by building out an empirical framework to pinpoint the drivers of the global art market over the past 15 years including an analysis of the huge impact of Chinese demand on global art prices. We analyze where Chinese demand within the global art market may be heading between chapters one and two as the Chinese economy faces a period of significant transition. The empirical framework outlined in chapter one includes multiple factors such as simple price growth, the numbers of artists sold at auction, lots offered per artist, the globalization of the market and the burgeoning number of auction houses. For whatever reason – including, but not limited to, growing wealth inequality or evolving preferences for art consumption – the distribution of art prices has exhibited an increasingly fat tail. Our authors speculate whether a cooling of top auction prices would provide a heathy rebalance from the upper deciles to the middle of the market, which would be a significant positive for the broader industry. Later chapters in the report examine the extent to which art can credibly be viewed as an “asset class”. Expert authentication, appraisal and public auction still set works of art apart from commodities or traditional securities. Even among other collectibles, evaluating art is more complex than evaluating classic cars or many antiques. Variability in the collective appetite for individual pieces and classes of art drives an idiosyncratic element into art valuations but a number of common factors do drive returns for art works generally. Looking at over 100 years of data, art has under-performed equities but outperformed bonds. Over time there is a clear link between art prices and the global economy. For example, some of the strongest falls in art prices were observed during World War I, in the early 1930s, following the 1973 oil crisis, in the early 1990s and after the 2008 financial crisis. Overall, we conclude that art deserves a place within illiquid asset holdings for those who would otherwise hold art for many reasons. However, successful investment in art appears to be much more a question of identifying relative value than it is of gaining exposure to the market as a whole. Other chapters of this report look at the highly topical issue of whether the art market has become saturated with art fairs and at the role of art as collateral for other financial transactions given how record prices, increased globalization and new market entrants have led to the “financialization” of the art marketplace. In today’s environment, the appeal of art for a growing number of collectors comes not only from the prestige of owning significant works but also from its status as a neutral currency. While there does not seem to be any obvious new candidate — like China or wealth inequality — waiting in the wings to give the global art market its next big leg up, participants in the art market ultimately maintain the option of just enjoying the aesthetics of art itself. In the words of Pablo Picasso, “Art washes away from the soul the dust of everyday life”.

Structural changes dominate the global art market CHINA MADE A FORCEFUL ENTRY INTO THE GLOBAL ART MARKET

2014

$10,083,000 2011

$13,660,000

2010

$7,914,999 2013

$9,943,000 2009

2012

$3,000,000

$9,518,888

Source:artnet

CHINA’S MARKET SHARE OFTHE GLOBAL AUCTION MARKET HAS INCREASED

2014

2000

0.21% Source: artnet

27.3%

THE TRAJECTORY OF TOP AUCTION PRICES IS A REFLECTION OF WIDENING INEQUALITY

350,000

Price (USD)

300,000 250,000

2014 (mean=$49,234)

200,000 150,000 100,000

2000 (mean=$26,578)

50,000 0 Source: artnet

Median

60th

70th

80th

SALES MADE AT ART FAIRS ARE ON THE RISE AND MADE UP 40% OF ALL DEALER SALES IN 2014

2010 ¤6.4bn Source: TEFAF Art Market Report 2015, artnet

2011 ¤6.7bn

2012 ¤8.0bn

2013 ¤7.6bn

2014 ¤9.8bn

Citi GPS: Global Perspectives & Solutions

November 2015

Contents The Global Art Market in 2030 Structural Change Shaping Future Markets Long-term Trends of the Global Art Market Sources of Growth in the Art Market The Rise (and Plateau) of China The Role of Top Prices Projections Through 2030 Concluding Thoughts

The Chinese Art Market Why China Is Different Structural Characteristics Make the Chinese Art Market Unique Household Wealth Gains Drove Growth Can China’s Growth Story be Replicated? China in the Future

Artistic Differences? The Financial Performance of Art, Stamps and Wine

All’s Fair The Art Fair Saturation Debate Analyzing Art Fairs Art Fairs Drive More than Just Sales Will the Internet Change the Art Landscape Again? Saturation Debate Inconclusive

Art and Banking Life Imitating Art, Art Imitating Collateral A Boom and Bust Art Banking Today The Loan Valuation Process

Art in an Investment Portfolio Earning a Place in Illiquid Asset Holdings Art Earns a Place in Illiquid Asset Holdings What the Data Tells Us Risk Drivers of Performance Art in a Portfolio Conclusion Citations

Appendix – Author Biographies

8 8 8 11 15 20 23 23

25 25 26 26 27 28

30 30

34 34 34 36 37 38

40 40 40 41 43

45 45 45 46 48 50 52 52

Chapter 1

The Global Art Market in 2030: Structural Change Shaping Future Markets

ÂŠ 2015 Citigroup

Citi GPS: Global Perspectives & Solutions

November 2015

The Global Art Market in 2030 Structural Change Shaping Future Markets Benjamin Mandel Executive Director, Multi-Asset Solutions J.P. Morgan Asset Management

The global art market has grown at an average annual rate of 13 percent since 2000. What drove this tremendous performance and is it likely to be repeated over the next 15 years? We characterize the impact of two structural factors that have propelled the market: (i) the rise of China, and (ii) the outperformance of top prices. China’s extraordinary period of catch-up growth has largely played out, while the inequality in auction prices may reach some natural limit. As a result, the slowing of these factors could subtract up to a third from the annual growth of the global market; that is, global growth would be on the order of 9 percent rather than 13 percent. What is at stake for fine art as an investment? For one, the Chinese market will not be a one-way bet through 2030, suggesting a cautious approach to Chinese art. The US and UK markets, in turn, have been boosted by a steady stream of record auction results, possibly driven by widening global wealth inequality. While it is difficult to predict when this trend will end, the US and UK markets will be far more exposed to the fallout when it does. At the margin, there may also be negative implications for the development of art as an alternative asset class; slower transaction growth will do little to improve liquidity and reduce liquidity premia demanded by investors. Finally, slower growth reinforces the idea that successful investment in art is more a question of identifying relative value than gaining exposure to the overall market; ships will rise less with the tide but some waves inevitably ascend higher than others.

Long-term Trends of the Global Art Market The global art auction market has grown at a compound rate of 13% over the past 14 years despite the economy going through the Great Recession

This stellar growth is unlikely to continue as the source of past growth may not prove durable

The global auction market for fine art has grown dramatically since the turn of the millennium, when sales were about $3 billion in total. Since then, global auction turnover has grown at an average annual compound rate of 13 percent, reaching $16.1 billion in 2014. 1 Not bad considering that the period was punctuated by the deepest global recession in almost a century. By way of context, in the same timeframe global GDP and exports grew at 3.5 and 8.1 percent per year, respectively. The art market clearly outperformed, even during a time of solid average growth in economic activity and substantial advances in globalization. Why did this occur? In this chapter, I present a forensic analysis of the market’s longer-term trends and use the findings to project what the market might look like 15 years from now. Will the robust growth of the 2000s continue? We argue that it likely won’t, or at least that a different adjective is in order: ‘solid’ instead of ‘stellar’ growth, ‘balanced’ not ‘burgeoning,’ and so on. The reason for the downgrade is that the sources of growth in the market since 2000 may not prove as durable as many observers believe. Rather, the narrative that emerges from the performance of the market since 2000 is one of structural one-offs that have given rise to considerable – though ultimately temporary – support for the market’s trajectory.

Unless otherwise noted, the data in this chapter draw on custom reports from the artnet global database of fine art auction records.

November 2015

Citi GPS: Global Perspectives & Solutions

China’s forceful entry into the global market

The first structural change is the forceful entry of China into the global market. 2 As is plain to see in Figure 1, the geography of the global auction market is highly concentrated in a few locations. In 2000, over half of auction sales by dollar value took place in the US, with an additional quarter in the UK. France, the third largest market, accounted for just over 5 percent, and so forth. Back in 2000, auction sales in China were essentially a rounding error in the global auction market statistics.

was the first structural change

Figure 1. The Geography of the Art Market in 2000 and 2014 40%

2000

2014

35%

50%

Global Market Share

40% 30% 20% 10%

30% 25% 20% 15% 10% 5%

USA United Kingdom France Germany Switzerland The Netherlands Sweden Italy Australia Spain Austria Denmark Canada Israel China Taiwan Finland Poland Belgium Singapore Greece Ireland Hungary South Africa Uruguay

USA China United Kingdom France Germany Switzerland Italy Japan Austria Sweden Taiwan Australia South Korea The Netherlands Belgium Denmark Canada Czech Republic Turkey UAE Hungary Singapore Spain South Africa Poland

Global Market Share

60%

Source: artnet and author calculations.

China now accounts for a third of global growth and a quarter of global sales

Growth in China is characterized by explosive growth in the quantity of art sold

Increasing importance of top auction prices is the second structural change that occurred since 2000

Fast forward to 2014. Seven of the incumbent sales locations from 2000 still appear among the top 10 markets by size, with one stark difference. China now accounts for a third of global growth and, at $4.4 billion, now claims over a quarter of global sales and the number two spot behind the United States. Compared to the US/UK duopoly in 2000 which presided over 80 percent of auction sales, the US/UK/China triad now accounts for 85 percent. Moreover, the ascent of China has radiated widely throughout the global market. Seventeen of twenty nine countries where auction sales took place in 2000 experienced a decline in market share in the wake of China’s rapid ascent. The upshot to China’s dominant contribution to global sales growth is that the performance is unlikely to be repeated in the coming years. For one, the expansion of the Chinese market has been characterized by explosive growth in the quantity of art sold, which is a common feature of the early stages of art market development. As the market matures – and there is evidence to suggest that China has reached close to its ‘equilibrium’ size in the world market – the growth in quantities will moderate, removing what has been a large tailwind to global growth. More concretely, if the only change in the art market through 2030 was that auction lots sold in China grew at the rest of the world’s historical growth rate, then annual sales growth of the global market would decline by 2.3 percentage points, or 18 percent, to 10.7 percent. The second structural change that drove markets since 2000 was the increasing relative importance of top auction prices. While the distribution of prices at auction has always been highly skewed – i.e., high-priced outliers cause the distribution to have a long right tail – over the course of the 2000s an increasing share of sales has been accounted for by relatively high prices. In other words, the tail of the price distribution has become fatter. As a result, the higher deciles of the price distribution

Reference to the auction market in China includes sales taking place on the mainland or in Hong Kong.

Citi GPS: Global Perspectives & Solutions

November 2015

accounted for a disproportionate amount of global sales growth since 2000; as shown in Figure 2, the 80th and 90th percentiles of the global art price distribution grew by 6-7 percent per year, compared to 3 percent for the median price. Notably, the bottom of the distribution actually suffered, with the tenth percentile price shedding 1 percent and the 20th percentile price not growing at all.

Growth Rate (CAGR 2000-2014)

Figure 2. Evolution of the Global Art Price Distribution

8% 7% 6% 5% 4% 3% 2% 1% 0% -1% -2% 10th

20th

30th

40th Median 60th

70th

80th

90th

Percentile of Price Distribution Source: artnet and author calculations.

The exact reason for the skew of price distribution is hard to discern

What has driven the increasing skew of the price distribution over time? Given the shortage of information on the buyers of art at auction – which is simply unknown for the bulk of transactions – it is difficult to pinpoint exactly. But it is tempting to draw a link between secular trends in global income and wealth inequality with the relative success of top auction prices. That connection has manifested itself in correlations between equity and art performance, and in an increasing fixation on trophy assets. 3 From the perspective of the art market’s trend growth, increasing inequality of prices presents a downside risk. Insofar as the factors underlying the changing price distribution cannot persist forever – for instance, because the skewedness of wealth or the evolution of social norms for conspicuous consumption seem to have their natural limits – the resulting impulse from top prices to global growth may well fade. Indeed, I estimate that the contribution of top prices, particularly in the US and UK markets, has been quite large, accounting for 1.6 percentage points (about 12 percent) of global growth since 2000.

Accounting for the China effect and the top price effect, global art market growth could be a third lower than the headline rate that has prevailed since 2000

Looking ahead, if prices grow at the historical rate of the median of the price distribution, it would correspond to a downgrade of 1.9 percentage points annually through 2030. All told, combining the China effect and top price effect (while holding everything else constant at historical trajectories), global growth through 2030 would be roughly 8.7 percent per annum, a third lower than the rate that prevailed since 2000.

For more formal treatments of these phenomena, see for example: (i) Goetzmann, W., L. Renneboog and C. Spaenjers (2011): “Art and Money,” American Economic Review, 101(3): 222-226, or (ii) Mandel, B.R., (2009): “Art as an Investment and Conspicuous Consumption Good,” American Economic Review, 99(4): 1653-63.

November 2015

Citi GPS: Global Perspectives & Solutions

Geographic considerations are important

What is at stake for fine art as an investment? The main messages that emerge are geographic in nature. The Chinese market, having essentially caught up with the US and UK, will not be a one-way bet through 2030. Moreover, the risk of either a disorderly slowing – or unwinding – of the blistering market expansion in the 2000s or of a broader credit bubble popping suggests a cautious approach to Chinese art. The US and UK markets, in turn, have been boosted by a steady stream of record auction results, driven in part by widening global inequality. While it is difficult to predict when this trend will end, it is worth noting that the US and UK will be far more exposed to the fallout than other mature markets such as France and Germany.

when looking towards the direction of the art market in 2030

Slowing growth could negatively impact the development of art as an alternative asset class . . .

. . . and reinforce that successful investing in art is a question of identifying relative value

To a certain degree there may also be negative implications of slowing growth for the development of art as an alternative asset class. For instance, art hedge funds are part of a small but budding industry providing investors the ability to buy into speculative inventories of fine art. The value added of such businesses, in addition to art selection, is reaching a scale that would be difficult to obtain as an individual collector. However, the hurdle rate on such investments is quite high given the large implicit liquidity premium in a relatively small asset class; that is, investors need to be compensated for the relative illiquidity of the market. Slowing growth in the number of global transactions will do little to fix this problem and will maintain liquidity premia at a relatively high level. Finally, slower growth reinforces the idea that successful investment in art is much more a question of identifying relative value than it is gaining exposure to the market as a whole; ships will rise less with the tide but some waves will still ascend much higher than others. As such, while the structural factors underpinning the market in China and top prices may begin to wane, it is not necessarily the case that opportunities in the art market have generally abated.

Sources of Growth in the Art Market China accounted for exactly one third of the total gross increase in the art market between 2000 and 2014

We develop a simple empirical framework to pinpoint the drivers of the global market over the past 15 years. As mentioned above, the entry of China into the fray has altered the landscape. That notion is crystal clear in Figure 3, where the growth rate of global auction sales is broken down by country. China accounted for exactly one third of the 450 percent gross increase between 2000 and 2014. The US was a close second, contributing another third, with a large part of the remainder divided among the UK and France. All told, the global growth story is one of strong growth by incumbent markets and China’s entry as a mammoth interloper.

Citi GPS: Global Perspectives & Solutions

November 2015

Figure 3. Contributions to Sales Growth, 2000-2014

Other, 45% China, 150%

France, 18%

UK, 91%

USA, 146% Source: artnet and author calculations.

We start to look into the nature of Chinese growth by looking at sales per auction house

Given China’s outsized role, the key questions are: what is the nature of Chinese growth and will it last? To answer these questions, we need to delve deeper into the details. As an empirical starting point we examine the growth in the dollar volume of sales per auction house in China compared to other markets. Consistent with our observation that China went from a very small contributor to global growth pre-2000 to a very large one, sales per auction house in China grew blisteringly fast: 19 percent compound annual growth between 2000 and 2014. That growth rate is a multiple of comparable rates in mature markets, where sales per auction house printed in the single digits. A slightly more formal way of modeling these growth rates is to decompose the ratio of sales per auction house into a series of ratios using the algebraic identity in Figure 4. Each ratio is driven by a particular feature of the auction market. For instance, the first term on the right-hand side is the sales value per lot sold or, in other words, the average price. 4 By way of context, the average price for fine art at auction globally was $49,234 in 2014, up from $26,578 in 2000. All of the ratios to the right of that one have to do with quantities, rather than price: quantities of auction lots, artists, artist nationalities and art categories.

Defining average price in this manner has its drawbacks. For one, comparing the simple average over time does not take into account changes in the composition of the art sold from one period to the next. For example, if a higher quality set of artworks are put up for auction in the second period relative to the first, then part of the measured price change will reflect an increase in quality in addition to the underlying change in ‘quality-adjusted’ price. Index construction issues are discussed at length in the academic literature on art markets, for instance in: “The Computation of Art Price Indices,” Victor A. Ginsburgh, Jianping Mei and Michael Moses, Handbook of the Economics of Art and Culture, Victor A. Ginsburgh and David Throsby eds., NorthHolland, 2006. For our purposes here, and given the nature of the data at hand, we do not distinguish between quality-adjusted price changes and other price changes.

November 2015

Citi GPS: Global Perspectives & Solutions

The second ratio is lots sold as a fraction of those offered for sale. Artworks that do not meet the seller’s reserve price at auction are said to be ‘bought in.’ This phenomenon is fairly common, accounting for roughly 40 percent of all global auction lots on offer in 2014. The second ratio in the equation is simply one minus the buy-in rate. The third and fourth terms are measures of artists’ prevalence in the public auction records. The number of artists per nationality gauges the quantity of artists sold at auction – over 66 thousand artists in total in 2014 – while the number of lots offered per individual artist measures how prolific each one is. Each artist whose work was put up for auction in 2014 had an average of 8 lots offered. Figure 4. Growth Accounting Framework

Offered Artists Sales # Lots Sales Nationality Category = * * * * * Offered Artists Auction House # Lots Nationality Category Auction House Average Price

One Minus Buy-In Rate

Artist Prevalence

Market Globalization

Market Breadth

Source: GIM Solutions, JP Morgan Asset Management

The fifth term is a measure of market globalization. The number of nationalities per category measures the degree of participation of artists from various countries in the various segments of the art market. Categories are defined herein as specific combinations of market sector and medium; for example, impressionist paintings, old master works on paper, contemporary prints, and so on. 5 A high number of nationalities per category indicates a high degree of global variety in that category. Finally, the number of categories sold per auction house is a measure of the breadth of offerings which, in turn, can serve as a proxy for the breadth of the overall market. For example, if auction houses are cropping up that only serve local demand for contemporary paintings, the market might be construed as narrower than one in which many more market segments and types of medium are sold per auction venue. According to this ‘growth accounting’ equation, increases in any of the ratios contribute – at least in an accounting if not a causal sense – to the growth in overall sales per auction house. Differentiating the equation with respect to time gives an expression that is linear in the growth rates of each of the ratios; these can be interpreted as the contribution of each term to growth in sales per auction house. 6 We find that for developed markets, the bulk of auction sales growth is accounted for by price growth

The results for the largest art markets are displayed in Figure 5. Our first general observation is that for developed markets, the bulk of auction sales growth is accounted for by price growth. Sales in the US, UK, France and Germany grew between 3-8 percent annually, driven largely by price growth of 4-9 percent. Globalization was another, albeit smaller, contributor to growth, adding 1-3 percent. In the US and France, growth in the number of artists added 3 percent to each. The one consequential drag on sales growth in developed markets was the number of categories per auction house. That is because in developed markets the number of 5

All in all, there are 35 categories defined in the artnet data: 7 types of medium (works on paper, sculptures, prints, photographs, paintings, installations, design) by 5 market segments (post war/contemporary, impressionist, modern, old master, other). 6 In other words, the sum of the growth rates of each expression on the right-hand side approximately equals the growth rate of sales per auction house.

Citi GPS: Global Perspectives & Solutions

November 2015

categories sold in the average auction house was already quite high (e.g., 30 of 35 in the US) back in 2000. As a result, the negative growth in the ratio of categories per auction house reflects the fact that the number of auction houses grew. For instance, in the US the number of auction houses increased from 53 to 97 between 2000 and 2014. The growth accounting results for China tell a different story (last line in Figure 5). Annual growth of 19 percent is only weakly driven by annual average price growth of 3 percent. Rather, the massive proliferation in sales was due to explosive growth in quantities in several dimensions. The number of artists per nationality rose at a staggering rate of 17 percent per year, while the number of lots per artist and the number of artist nationalities per category grew at 8 percent each. Quantities sold were also propelled by the explosion in the number of auction houses – from 1 dominant house to 66 – which caused categories per auction house to fall at a rate of 18 percent per year.

However, China’s growth accounting shows that the massive proliferation in sales was due to explosive growth in quantities

Figure 5. Growth Accounting Results Sales = Auction House

Sales + Lots Sold

Lots Sold Offered

+ Offered Artists

Artists Nationality

Nationality Category

Category Auction House

USA UK France Germany

5% 6% 8% 3%

4% 9% 4% 5%

0% 0% -1% -1%

1% 1% 1% 0%

3% 0% 3% 0%

2% 1% 3% 2%

-4% -4% -2% -3%

China

19%

17%

-18%

Source: artnet and author calculations

In summary, developed market sales growth per auction house has been mainly characterized by price growth and, to a lesser extent, globalization. Together these forces more than offset the gradual rise in the number of auction houses. In China, in contrast, price growth plays a proportionately smaller role, with the bulk of sales growth accounted for by rising numbers of artists sold at auction, lots offered per artist, the globalization of the market and the burgeoning number of auction houses. China’s market is in an early development stage and as it matures will likely be more sensitive to price growth

More generally, one can think of the dominance of growth in the quantity of art sold in China as characteristic of the early development of the market. As the market matures, it is likely to evolve to look more like large incumbent markets where price growth – driven predominantly by demand – is the main driver of sales growth per auction house rather than the expansion of quantity supplied to the market. This phenomenon is illustrated in Figure 6, which shows the price and quantity growth in each country between 2000 and 2014 and their respective initial market shares. Larger, more mature, markets – i.e., those with a higher share of the global market in 2000 – tended to have faster price growth and slower quantity growth in subsequent years. The fact that the linear relationship fits reasonably well on a logarithmic scale for market share implies that the relationship is exponential in nature. That is, as market share increases, subsequent price growth increases at a diminishing rate and, similarly, quantity growth decreases at a diminishing rate. These observations suggest that the structural growth of quantities will fall and then decelerate as the Chinese market approaches its steady state.

November 2015

Citi GPS: Global Perspectives & Solutions

Figure 6. Growth Characteristics by Market Share Growth in # Lots up for Auction (CAGR)

10%

Price Growth (CAGR)

-5%

-10%

-15% 0.000001 0.00001

0.0001

0.001

0.01

0.1

60% 50% 40% 30% 20% 10% 0% -10% 0.000001 0.00001

Market Share in 2000 (log scale)

0.0001

0.001

0.01

0.1

Market Share in 2000 (log scale)

Source: artnet and author calculations.

The Rise (and Plateau) of China Evidence suggests that China has reached close to its equilibrium size in the global art market

The fact that China – both as a local market for auction sales and as a source of Chinese art – has played such a pivotal role in global growth begs the question: has China’s catch-up process relative to other mature markets already played out? And, if not, how much fuel is left in the tank? The evidence, on balance, suggests that China has reached somewhere close to its equilibrium (i.e., long-term) size in the global art market. This assertion is based on the various dimensions of the Chinese market having largely converged to similar measures for the US and UK, its direct comparables in terms of market share. In some instances, specifically regarding the quantities of lots and artists, China has run out far ahead of the US and UK. This actually suggests a market that is overheating relative to its equilibrium size, not one that is in the process of catching up. On the other hand, in some dimensions the growth of Chinese art still lags, suggesting further scope for broadening out and some incremental structural growth. To put a finer point on the idea of convergence, we define the concept as having market performance that is in line with the country’s relative size in the global market. The incontrovertible fact is that China has grown to over a quarter of the global market. But where it ends up in the longer-term is a function of the distance between the characteristics of China’s market and those same measures in mature markets. Even more concretely, the thought experiment translates into whether the size and ranking of market performance metrics are in line with China’s market share.

Citi GPS: Global Perspectives & Solutions

November 2015

Figure 7. China Market Development Scorecard Market Share

Share of Lots Offered

Lots/ Artist

Artist/ Nationality

Buy-In Rate

USA (36.4%)

China (18.4%)

China (10.3)

China (178)

Japan (29%)

France (0.3)

China (27.3%)

USA (17.5%)

France (6.8)

USA (99)

USA (31%)

UK (21.4%)

France (13.6%)

Italy (6.7)

UK (71)

France (4.3%)

UK (8.5%)

Japan (6.3)

Germany (1.7%) Germany (8.4%)

Category/ Share of Auction Auction House Houses

Nationality/ Category

Share of Nationalities

France (20%)

USA (5.7)

USA (100%)

USA (0.3)

USA (16%)

France (4.8)

France (85%)

China (36%)

China (0.5)

China (11%)

UK (4.3)

UK (75%)

France (69)

UK (36%)

Germany (0.7)

Germany (7%)

Germany (4.0)

Germany (68%)

Germany (6.0)

Germany (60)

Australia (40%)

UK (0.8)

UK (7%)

Austria (3.0)

Switzerland (52%)

Italy (43%)

Italy (0.9)

Italy (6%)

Switzerland (3.0)

Austria (50%)

Italy (2.5)

Italy (44%)

Switzerland (1.1%)

Italy (5.1%)

Australia (5.4)

Italy (52)

Italy (1.0%)

Switzerland (2.6%)

USA (5.2)

Japan (38)

Japan (0.7%)

Japan (2.5%)

UK (4.7)

Switzerland (33)

Austria (49%)

Australia (2.1)

Australia (2%)

Japan (2.0)

Japan (31%)

Austria (0.7%)

Austria (2.5%)

Switzerland (4.5)

Austria (32)

France (49%)

Japan (3.5)

Austria (1%)

China (1.7)

China (30%)

Australia (0.5%)

Australia (1.5%)

Austria (4.5)

Australia (30)

Germany (50%)

Austria (3.8)

Japan (1%)

Australia (1.7)

Australia (27%)

Switzerland (43%) Switzerland (1.9) Switzerland (3%)

Source: artnet and author calculations.

Figure 7 operationalizes this definition by examining China’s relative performance compared to the top 10 countries by market share – accounting for 95 percent of sales in 2014. As mentioned above, China’s 27 percent market share in 2014 makes it the world’s second-largest purveyor of fine art at auction, wedged between the US and UK (column 1). The subsequent columns show a number of other market characteristics and their relative ranking. Generally speaking, the market share ranking of the mature markets corresponds closely with the relative ranking of the other characteristics. For instance, the US ranks in the top two spots in 8 of 9 columns. France, ranked fourth in terms of market share, ranks at least fourth in 8 of 9 columns. At the other end of the spectrum, the lowest ranked market by size, Australia, is ranked in the bottom three spots in 7 of 9 columns, and so on. According to this definition of convergence, China is roughly where it should be according to its size, ranking in the top three spots in 7 of 9 columns. That being said, the level of market development is still somewhat uneven across market characteristics, some of which have run ahead of its relative size ranking and some of which lag behind. Interestingly, in terms of the relative quantity of art sold at auction, the scorecard suggests that China is actually overheating. The market was home to 18 percent of the lots put up for auction globally in 2014, higher than the US (column 2), and a glut of lots per artist and artists of like nationality (columns 3 and 4). The fact that the prevalence of certain artists and artist nationalities at auction is about twice as high as in the US implies that the Chinese market is running ‘above capacity’ relative to global norms in the segments which it does serve.

November 2015

Citi GPS: Global Perspectives & Solutions

The breadth of the Chinese art market

In contrast, the breadth of the Chinese market remains far below its rank in market share. The largest mature markets tend to offer artists from a broad array of nationalities (columns 8 and 9). The number of artist nationalities is highest in the US at 181, corresponding to an average of almost 6 per sub-category of the market; the other large incumbents have measures of 4 or above. China, in contrast, had only 54 nationalities represented at auction in 2014, or an average of less than 2 per category. At 70 percent fewer artist nationalities than the US, China remains well behind.

remains far below its rank in market share

Finally, in certain respects China’s level of development is more or less in line with its size. China’s buy-in rate in 2014, at 36 percent, is still 5 percentage points higher than that in the US but in line with that in the UK. An important caveat is that the rate shown in Figure 7, which includes Hong Kong sales, is below the buy-in rate in Mainland China (column 5). Recent reports peg the mainland rate at closer to 50 percent, which would rank at the bottom of the list. 7 Secondly, the rapid growth in the number of auction houses since 2000 (from 1 to 66) has brought the Chinese market roughly in line with the US and Germany in terms of the number of categories per auction house and the share of auction houses (columns 6 and 7). The fact that many of the Chinese market’s characteristics are at (or exceeding) the levels of incumbents suggests that the scope for future headline market share growth is more limited

Going forward, the scorecard offers some clues as to the mechanics of future growth in the Chinese market. Given China’s current market share, settling at an equilibrium size implies that the overheating of quantities will moderate, the number of artists and lots per artist will consolidate, and the breadth of the market will continue its slow but steady path catching up. Of course, this is not to say that Chinese growth in market share will necessarily be curtailed in the near-term. Rapid growth in quantities sold in a narrow set of market segment may well continue to be a tailwind for some time. However, the fact that many of the market’s characteristics are at (or exceeding) the levels of incumbents suggests that the scope for future headline market share growth is limited. Another perspective on the convergence process is the relative price of Chinese art sold domestically in China versus abroad. Specifically, the observation that the price premium for international sales was very large in the early 2000s but has narrowed considerably over time suggests that the rate of integration of Chinese art into the global market has slowed. Bai, Guo and Mandel (2013) document the fact that Chinese art – therein defined as art by Chinese artists rather than art sold in China – sells at significantly higher prices outside of mainland China. 8 The left panel of Figure 8 illustrates that the price premium of 156 percent for artworks sold internationally between 2000 and 2010 was driven largely by quality differences; that is, Chinese art sold outside of China had more desirable and valuable characteristics. Similarly, the art sold domestically of artists who had previously sold at auction internationally garnered a significant, albeit smaller, premium.

There is also the issue of non-payment for successful auction bids, which is reportedly extraordinarily high in mainland China, which would imply that the development of the Chinese market still lags behind in spite of the relatively low buy-in rate. For a deeper dive on the mainland art market, including estimates of buy-in rates, see: “Global Chinese Art Auction Market Report 2013,” artnet and the China Association of Auctioneers (CAA), http://www.artnetmarketing.com/chinaartnet/2013-report.asp. 8 See: Bai, Jennie, Jia Guo and Benjamin R. Mandel (2013), “Going Global: Markups and Product Quality in the Chinese Art Market.” Federal Reserve Bank of New York Staff Report #614.

Citi GPS: Global Perspectives & Solutions

November 2015

160%

450%

140%

400%

Quality Differences

120% 100%

127%

80%

Quality Differences

60%

85%

40% Other 29%

20% 0%

International works

Other 15% Domestic works of international artists

International Price Premium

Figure 8. Price Premium for Chinese Art Sold Internationally: Average (left) and Over Time (right) Quality Differences

Other

350% 300% 250% 200% 150% 100% 50% 0% 2000

2002

2004

2006

2008

2010

Source: Bai, Guo and Mandel (2013).

These observations suggest that there is a learning process – both by international buyers and by buyers in China – that has been evolving as the market grows. The learning process for international buyers involves devoting a certain amount of time and effort to learning about Chinese art. Given those fixed costs of participating in the market in the first place, buyers might find it more worthwhile to spread out those costs by buying more expensive, higher quality artworks (i.e., the fixed cost per unit of quality would be lower). For domestic buyers of Chinese art, the international market offered an important source of validation for the value of Chinese art as the market developed. For our purposes of ascertaining the future growth prospects of the Chinese market, it is telling that the price gap between Chinese art sold abroad versus mainland China declined dramatically since 2000 (right panel of Figure 8). Price differences driven by the relative quality of Chinese art sold abroad peaked at 400 percent in the early 2000s before falling to just over 100 percent by the end of the decade. Applying a learning process interpretation to the quality differences, it means that the fixed costs associated with learning about Chinese art diminished as the Chinese market grew and became a more familiar part of the broader market. The much smaller price gap might also suggest that China is that much closer to its long-run position in the world market. We also look at the particular art market categories behind China’s rapid growth

We conclude this section by documenting the particular art market categories that were behind China’s rapid growth in the 2000s. Consistent with the idea that sales quantities growth has been explosive in a relatively narrow subset of the market, growth in the Chinese market was heavily skewed towards modern and contemporary art and, within those market segments, paintings and works on paper. To get an idea of how important those categories were, the contributions of particular categories to the 4.5 times (i.e., 450 percent) increase of the world market are shown in Figure 9. Of the top ten largest contributors, five were in China. Modern works on paper in China alone accounted for about 10 percent of global growth since 2000. Post-war and contemporary (denoted PWC) paintings and works on paper in China accounted for an additional 13 percent.

November 2015

Citi GPS: Global Perspectives & Solutions

Figure 9. Top 10 Categories in Terms of Contributions to Global Growth 0.8

Contribution to Global Market Growth (Total=4.5)

0.7

0.6

0.5

0.4

0.3

0.2

0.1

China, Paper, USA, UK, China, Paper, China, Paintings, Modern Paintings, PWC Paintings, PWC PWC PWC

USA, UK, China, Paper, Paintings, Impressionist Sculptures, Modern PWC

USA, China, Paper, Paintings, Old Master Modern

Source: artnet and author calculations.

The reliance of China on only a few categories is stark when looking at the contributions of market segment and medium to overall Chinese growth (Figure 10). In China, the market grew by 717 times, or 71,700 percent since 2000. Of that 717 multiple, post-war and contemporary paintings accounted for 514 times, virtually all of which were either works on paper or paintings. Figure 10. Contributions to Chinese Market Growth by Category 600

283

250

232

200

150

100

0 Post War and Contemporary (PWC)

Modern

Source: artnet and author calculations.

ÂŠ 2015 Citigroup

Impressionist and Post Impressionist

Old Master

Other

Contribution to Chinese Market Growth (Total=717)

300

538 500

400

300

200

170

100

Sculptures

Design

0 Works on Paper

Paintings

Prints and Photographs Multiples

Citi GPS: Global Perspectives & Solutions

November 2015

All told, the top five categories from China made up 30 percent of global growth and a whopping 87 percent of Chinese growth over that period. In contrast, the sum of the remaining five categories (i.e., the top five non-China contributors to global growth) resided in the US and UK and accounted for only about half of non-China growth. It is precisely this disproportional concentration of sales in just a few categories that is expected to moderate as the Chinese market matures.

The Role of Top Prices The second structural change that has been taking place in the art market has to do with the distribution of prices becoming increasingly unequal

The second structural change that has been taking place in the art market has to do with the distribution of prices becoming increasingly unequal. For whatever reason â&#x20AC;&#x201C; including, but not limited to, growing wealth inequality or evolving preferences for art consumption â&#x20AC;&#x201C; the distribution of prices has an increasingly fat tail. In this section, we present measures of the global art price distribution and discuss how it has evolved since the year 2000. The increasing contribution of top prices to global sales is directly implied by the levels of the art price distribution in Figure 11. While the median global price increased by almost 50 percent between 2000 and 2014 (from $2,047 to $3,034) that difference is barely visible in Figure 11 in relation to the doubling of prices at the 80th percentile (from $153 thousand to $330 thousand). Purely mechanically, the faster growth rates for the top deciles of the distribution induce a higher contribution of top prices to growth. Figure 11. Evolution of Art Price Distribution

350,000 300,000

2014 (mean=$49,234)

Price (USD)

250,000 200,000 150,000 100,000

2000 (mean=$26,578)

50,000 0

Median 60th 70th 80th Percentile of Price Distribution Source: artnet and author calculations.

ÂŠ 2015 Citigroup

November 2015

Citi GPS: Global Perspectives & Solutions

To formalize this idea, we approximate the distribution of prices from the mean and median using a log-normal distribution. 9 Among the benefits of this particular type of distribution is the ability to decompose changes in the average price into the percent change of the median price, plus a second term indicating the contribution of top prices. 10 Thus, average annual sales growth can be expressed approximately as: %∆Sales ≈ %∆ Quantity + %∆ Median Price + Contribution of Top Prices Growth in the number of lots sold accounts for around two thirds of overall auction turnover growth

The results of this growth decomposition for the largest markets are shown in Figure 12. Growth in the number of lots sold accounted for 64 percent of overall auction turnover growth. Consistent with our earlier observations, quantities in China accounted for a staggering 94 percent of sales growth. Meanwhile, quantities were generally less important in more mature markets; the US and France are at the high end of the spectrum close to the global average compared to only about 20-30 percent of growth in the UK and Germany. Median price growth played a smaller role than quantities in driving sales – albeit a heterogeneous one across countries. For instance, the quarter of global sales growth driven by median price growth belies the fact that the median price was stagnant in both of the world’s two largest markets (US and China). Similarly, top prices contributed modestly to global sales, though highly unevenly across countries. In the US and UK markets, top prices drove 34 and 53 percent of sales growth, respectively, while in France and Germany their contribution was close to zero. Interestingly, mature markets come in all stripes. Between the US, UK, France and Germany, all four combinations of high/low quantity growth and high/low top price growth are covered. It remains to be seen which type of market China will become as it evolves.

I identify the parameters of the log-normal price distribution, P ~ log-N(μ,σ2), using the mean (Ṗ) and median (Pm) price for each segment of the market, as follows: μ = ln(Pm), σ2=2*ln(Ṗ/Pm). One can test the validity of this distributional assumption by projecting the total size of the market implied by the distribution and the total number of lots sold. It turns out that the log-normal provides a reasonably close prediction for market size when lots sold are spread over the first 8 deciles. Above the 80th percentile the prices the tail is slightly fatter than the actual price distribution. 10 Formally, the percent change in the price can be expressed: ∆ln(Ṗ) ≈ ∆ln(exp(μ)) + ∆ln(exp(σ2/2)), where the first term is the percent change in the median price and the second term is the contribution of top prices to average price growth.

Citi GPS: Global Perspectives & Solutions

November 2015

Figure 12. Evolution of the Art Price Distribution

Fraction of Sales Growth

100% 80% 60% 40% 20% 0% -20% World Quantity growth

USA

China

Median price growth

France Germany Top price growth

Source: artnet and author calculation.

Figure 13. The Global Art Market in 2030 2014 Market Share France 4%

2030 Case I: History Repeats Itself → CAGR = 47.6%

Germany 2%

Other 9%

USA 37%

UK 21%

China, 99% China 27% Source: artnet and author calculation

2030 Case 2: China Quantity Growth Moderates → CAGR = 10.7%

Other 11%

France 4%

Germany 1%

France 5%

USA 32%

China 28%

UK 13%

Germany 1% USA 37%

Other 14%

UK 24%

Source: artnet and author calculations.

2030 Case 3: China Moderates & Median Price Growth → CAGR = 8.7%

China 30%

November 2015

Citi GPS: Global Perspectives & Solutions

Projections Through 2030 Two main headwinds to global growth are (i) moderation of the Chinese market with less dependence on quantity growth and (ii) top prices eventually stabilizing relative to median prices

The structural changes in the art market discussed in the previous sections give rise to an array of possible outcomes. The two main headwinds to global growth that we have identified are: (i) that the Chinese market will likely moderate and become less dependent on quantity growth, and (ii) top prices will eventually stabilize relative to median prices. Either headwind would translate into a slowing of global growth. However, how fast the market will end up growing, and what the geography of sales will ultimately look like in 2030, remain wide open empirical questions. These questions are answered, at least in part, in a series of steps in Figure 13. Moving from left to right from the top-left quadrant, which shows the distribution of market share in 2014, case 1 illustrates what would happen if each country continued growing at its historical pace. We can dismiss this outcome simply by noting that the distribution of global sales is completely implausible. The continuation of 60 percent annual growth of the Chinese market, off today’s larger base, corresponds to China having a 99 percent market share by 2030! Case 2, in the bottom-left quadrant, examines the outcome wherein the number of lots sold in China settles down to the rest of the world’s historical growth rate while all other countries continue along the same path that they were on. Given these assumptions, global growth slows from 13.0 percent to 10.7 percent, Chinese market share stabilizes and the UK and other countries continue their gradual path of convergence with the US. With the added assumption that price growth in each country follows the trajectory of median prices (i.e., excluding the contribution of top prices) growth falls by another 2 percentage points to 8.7 percent. Given the outsized contribution of top prices to UK sales growth, its market share falls and gets redistributed among the other countries, effectively consolidating the global market further in the US and China. All in all, cases 2 and 3 correspond to a downgrade of global growth in the order of 20 to 30 percent, going from 13 percent to 9-11 percent.

Concluding Thoughts In many ways the art market has mirrored the global economy, for which the early 2000s was an exceptional period

However there does not seem to be any new obvious candidate – like China or wealth inequality – waiting in the wings to give the art market its next big leg up

In many ways the art market has mirrored the global economy, for which the early 2000s was an exceptional period. China joined the WTO in 2001 and deepened its global engagement which, in turn, dramatically altered the landscape of international commerce. Demand from China and its seemingly insatiable investment appetite drove a massive global commodity cycle. Today, the Chinese economy faces the difficult task of pivoting away from an economic model that is widely viewed as unsustainable in the long run. So, too, does the Chinese art market face the fact that years of break-neck growth have run their course. Similarly, the trajectory of top art prices as a reflection of widening inequality must also eventually settle, though economists remain far from agreed on the path of the latter. While it might seem inherently undesirable for the market to cool off, silver linings abound. The Chinese market’s impending growing pains are symptomatic of a market that has come of age. And a cooling of top auction prices would provide a heathy rebalance from the upper deciles to the middle of the market, which would be a significant positive for the broader industry. Finally, while there does not seem to be any other obvious candidate – like China or inequality – waiting in the wings to give the market its next big leg up, participants in the art market always maintain the option of just enjoying the aesthetics of the thing itself and not worrying too much about that.

Chapter 2

The Chinese Art Market: Why China is Different

ÂŠ 2015 Citigroup

November 2015

Citi GPS: Global Perspectives & Solutions

The Chinese Art Market Why China Is Different Thierry Dumoulin Vice President of Marketing & Business Intelligence artnet

The Chinese art market has been a subject of fascination for art world insiders and casual observers alike for the last decade. Since its peak in 2011, speculation has been rampant about where the Chinese art market is headed and which art market may next experience a similar boom. To try to answer these questions, it is important to first gain a deeper understanding of why the Chinese art market boomed, how it fits into the larger continuum of the art market and its relationship to global economic trends in capital markets. Since the beginning of the century, the economy of mainland China has experienced significant growth, bolstered, in particular, by economic reforms and globalization. Strong economic growth over this period fostered the development of the Chinese art market, now the second largest in the world.

Tracing the development of the Chinese art market from the mid-1990s

The Chinese art market took root in 1996, with the first significant contemporary auction sale — Reality: Present and Future — taking place at Sungari Auctions in Beijing. From then until the early- to mid-2000s, the market remained in an early developmental state, with sales values remaining relatively low. However, starting in 2009, market volatility increased, and in just two years auction sales grew from approximately $3 billion to over $13 billion in 2011, an astonishing 355% increase. This brought China’s art market, for a short time, more or less on par with the size of the US art market. It then dropped just as precipitously in 2012 — by nearly 30% — to $9.5 billion. After a slight recovery and modest growth throughout the 2013 and 2014 auction seasons, partial data points to another, potentially significant contraction in 2015, which could jeopardize China’s second place rank in the global art market. Figure 14. Auction Sales in China, 2004-2014 millions

$16,000 $13,660

$14,000 $12,000

$9,518

$10,000

$9,954 $10,083

$7,914

$8,000 $6,000 $4,000 $2,000

$2,757

$3,166 $3,000

$1,890 $1,960 $860

$0 2004

2005

2006

2007

2008

Source: 2015 TEFAF Report, Art Economics and AMMA.

2009

2010

2011

2012

2013

2014

Citi GPS: Global Perspectives & Solutions

November 2015

Structural Characteristics Make the Chinese Art Market Unique Characteristics of the Chinese art market

There are several important characteristics that are unique to the Chinese art market and bear noting. First is the greater importance of the auction market (i.e. ‘secondary market’) relative to galleries (the ‘primary market’). It is estimated that up to 70% of the art market in China can be attributed to public auctions — a stark contrast to other, more established markets, where the primary sector is responsible for the majority of sales. 11 This inverse relationship is grounded in the relative weakness of Chinese galleries. While several of them, such as Pace Beijing, ShanghART and Long March Space, are highly regarded and rank among the best in the world, the vast majority simply lack the experience and resources to steer the development of an artist’s career — a task that has, by default, fallen to a few powerful auction houses with more clout and function. Transparency in the international auction market, while occasionally called into question, is relatively high, as global auction results are made public by auction houses and price databases (such as the artnet Price Database, which holds over 10 million sales records from more than 1,600 auction houses). Data from mainland China, however, tends to be less reliable, especially historically, although active efforts are being made towards change. According to the Global Chinese Art Auction Report 2014, the non-payment rate for works sold for over CN¥100 million was as high as 63% in 2014, over 20% higher than in 2013. 12

Chinese high net worth (HNW) individuals hold an above average amount of their wealth in art and antiques

Another characteristic unique to the Chinese market is that local investors hold a relatively high proportion of their wealth in art and antiques; while the average global holdings of so-called treasure assets such as art, antiques and jewelry is less than 10%, Chinese high net worth (HNW) individuals hold an average of 17% (versus 3% in India, 9% in the US, and 7% in the UK). 13 This is partly due to the local regulatory environment, and is a reflection of the fastevolving nature of China’s economy. Investment vehicles in China are still somewhat less sophisticated than in many other parts of the world, making options for investors more limited and, to a higher degree, subject to the changing priorities of the government. This has made buying art a relative safe haven for those who want to invest.

Household Wealth Gains Drove Growth The Chinese art market’s staggering growth coincided with the rapid opening up and expansion of the Chinese economic system, which generated an extraordinary amount of wealth. According to The Economist Intelligence Unit Spotlight on New Wealth Builders report, between 2010 and 2014 China saw a 4.8% increase in average wealth per New Wealth Builders — defined as households in with financial assets of $100,000 to $2 million — the fastest growth of all countries in the survey. The number of New Wealth Builders qualifying households saw compound annual growth of 25.5% over the same period. In addition, assets for these households amounted to $19.5 trillion, second only to the US, which held $23 trillion. 14

Dr. Clare McAndrew, TEFAF Art Market Report 2015, p. 31. Dr. Clare McAndrew ‘Introduction’, Artnet Worldwide Corporation & China Association of Auctioneers, Global Chinese Art Auction Market Report 2014, p. 19. 13 Ibid. p. 11 14 The Economist Intelligence Unit, sponsored by Citi, “Spotlight on New Wealth Builders”, April 2015. 12

November 2015

Citi GPS: Global Perspectives & Solutions

With China topping the list for average annual growth, the number of wealthy individuals who could suddenly afford to buy art rose on a scale that befits the world’s most populous country. Suddenly flush with cash, the affluent turned to art as a way to diversify their assets. This movement was compounded by a similar search for alternative investment vehicles by high net worth individuals around the world who had been left reeling by the global economic collapse. With the Great Recession affecting most Western economies in 2008 and 2009, the appeal of once-reliable investments, such as real estate or equities, was greatly diminished, generating a new appetite for investing in art. During this time of global economic contraction, the Chinese economy managed to maintain an impressive growth rate — an expansion that would be the envy of Western nations even in the best of times. The Chinese market is not yet moderated by a developed and engrained art criticism ecosystem, even at the academic level

Yet even a strong and fast-evolving economy is not immune to challenges. China’s growth eventually started decelerating, and that slowdown was reflected in the art market’s contraction between 2011 and 2012. This was compounded by a government crackdown on corruption that has certainly also played a role in reducing the flow of cash towards art. The adjustment was as swift as the rise had been, especially since, unlike in the West, the Chinese market dynamic is not moderated (yet) by a very developed and engrained art criticism ecosystem, even at the academic level.

Can China’s Growth Story be Replicated? Many of the characteristics of the Chinese art market are unique, and the speed and scale of its economic rise present few current parallels. There are, however, other examples of art markets that suddenly flourished only to fade out, having scaled great, if temporary, heights. In the last 30 years, one can look at numerous similar boom cycles in the art market, with varying degrees of parallel and scale: Aboriginal, “Outsider,” Cuban, Russian, Latin American, African and other art markets have all experienced periods of greatly expanded interest. Examples from other countries

Aboriginal art, for instance, was “discovered” by global collectors toward the end of the last century. In the early 1990s, then-art critic for Time magazine Robert Hughes (himself a native Australian) declared Aboriginal art “the last great art movement of the 20th century.” At this point, according to Australian Art Sales Digest, Aboriginal art in Australia went from total sales of $1 million in 1994 to a high of $23.9 million in 2007. Three years later, it had plummeted back down to around $6.4 million. 15 The Great Recession played an important role in this drop, of course, but so did a raft of government measures. By 2007, as the financial crisis struck, the Australian government began investigating financial and ethical concerns in the Aboriginal market and launched a series of reforms aimed at curbing abuses. By 2010, these reforms included measures to weed out “carpetbagging” in an effort to curb the exploitation of artists (instituted in 2007), a resale royalties act, and changes to Australian tax code’s superannuation rules (both in 2010). With these new reforms and the Great Recession, global collectors seemed to move on and never came back.

Nicholas Rothwell, Art market gets ugly as indigenous bubble bursts, theaustralian.com.au, July 30. 2010; and Katie Hamann Indigenous Australian art market suffering substantial decline, PM, abc.net.au, August 9, 2013).

Citi GPS: Global Perspectives & Solutions

November 2015

This example illustrates the global market factors that play a role across countries. The regulatory environment plays an important part, and the vagaries of the economic cycle, global and even local, are also crucial, especially in large markets. International tastes come and go, and bigger countries like China, with vast economies that have the ability to generate a huge glut of savings to be invested, can be partially sheltered from fickle global trend swings. The rise of China as an ever-more active global superpower has also coincided with the diversification of its art market, with tastes expanding to reflect a more global perspective on contemporary art, in particular. This is demonstrated in the impressive collections of multiple world-class museums that have opened in China during the past few years, such as the Shanghai Power Station of Art, Yuz Museum, and the Long Museum in Shanghai. Over one hundred new museums have been built in China each year, totaling 4,510 museums by the end of 2014, with more being added to this day.

China in the Future Even at a lower growth rate, the Chinese economy continues to fuel the country’s rise as a global power and will greatly influence the performance of its art market. The Chinese government’s active promotion of culture and the arts, coupled with new regulations allowing foreign auction houses to enter the market, plus the effects of Internet-driven globalization, point to an ongoing maturation of the market. Investors well-versed in economic developments may be able to spot opportunities in art in other countries, especially in Africa, just as they do in other types of investments

Other parts of the world, such as many countries in Africa, for example, are currently seeing major economic gains at great speed (if less noticeable because of their size relative to that of China’s economy), and may well see similar patterns of sudden rise and fall in their respective art markets. Savvy investors well-versed in economic developments, and with an eye focused on the fast-changing politics of some countries, may be able to spot opportunities in art just as they do in other types of investments. But for all the external factors, the most powerful one may be the most elusive to predict: a vibrant culture that is dynamic, bold, ambitious and generous. This is the kind of culture that ultimately generates the most successful of all art — that which can inspire and move collectors around the world in ways that only great art can.

Chapter 3

Artistic Differences? The Financial Performance of Art, Stamps and Wine

ÂŠ 2015 Citigroup

Citi GPS: Global Perspectives & Solutions

November 2015

Artistic Differences? The Financial Performance of Art, Stamps and Wine Christophe Spaenjers Assistant Professor of Finance HEC Paris

Motivations for the purchase of art

The growth of the art market in recent years has been well documented. The most recent TEFAF Art Market Report estimated the global sales at €51 billion in 2014, a seven percent increase compared to 2013. Other statistics from the same report showcase an increasing interest in art — often from new types of buyers. Sales in China accounted for 22% of the global art market in 2014 and there are now 180 major art fairs — many of which did not exist at the start of the millennium. The way art is being sold is also changing, as online sales are starting to gain traction and now account for at least €3 billion of sales. Both long-standing buyers and newcomers to the market have a variety of reasons for purchasing art. Most of these motivations are of a non-financial nature. There is the personal appreciation of artistic creativity and the satisfaction that comes from the ownership of an important piece of art history. Art may, moreover, also serve to signal one’s wealth, status, background, or taste — or give access to a particular lifestyle (fairs, exhibition openings, auctions) or social circle (artists, dealers, collectors). Yet, financial motivations are relevant as well. Most — if not all — collectors care about fluctuations in the value of their portfolio, even if investment is not their primary motive for buying. They may, for example, consider their art collection as a form of retirement savings or insurance against bad times. There is, furthermore, a fraction of art buyers for whom making profits is a goal in itself. A growing art investment field — art funds, art price services, art market analysts, art advisors, etc. — aims to meet the demand of collector-investors for both information and investment products. 16

Market data since 1900 shows that art has under-performed equities but outperformed bonds over the long haul

Academic research can be of interest to buyers of art, by evaluating the historical investment performance of art and studying how art returns compare to — and correlate with — more traditional assets. Figure 15 shows an art price index, in real (i.e., deflated) British pound terms, for art sold at auction in the UK over the period 1900–2012. 17 The annualized (geometric mean) real return over this period was 2.3%. The same figure also shows a comparison of this price index with UK stocks, bonds, and bills, based on data from Elroy Dimson, Paul Marsh, and Mike Staunton. 18 During this time period, art has clearly under-performed equities, but outperformed bonds and bills. But the figure also shows that there is a clear link between art prices and the global economy. For example, some of the strongest falls in art prices were observed during World War I, in the early 1930s, following the 1973 oil crisis, in the early 1990s and after the 2008 financial crisis.

Erica Coslor and Christophe Spaenjers, 2014, “Organizational and Epistemic Change: The Growth of the Art Investment Field”, working paper, http://ssrn.com/abstract=2321627.

William N. Goetzmann, Luc Renneboog, and Christophe Spaenjers, 2011, “Art and Money”, American Economic Review 101, 222–226. (Returns for the years 2008–2012 are from Artprice Global Indices.)

Elroy Dimson, Paul Marsh, and Mike Staunton, 2002, Triumph of the Optimists, Princeton, NJ: Princeton University Press. Ibid, 2014, Global Investment Returns Yearbook 2014, Zurich: Credit Suisse Research Institute.

November 2015

Citi GPS: Global Perspectives & Solutions

Figure 15. Value of Various Collectibles and Financial Assets since 1900

1,000 Equities

100 Wine Stamps

Art Bonds Bills

0 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 Note: This figure shows index values in real British pounds for various collectibles and financial assets since 1990. Each index is set equal to 1 at the beginning of 1900. Source: See Footnotes 17 through 20.

Art versus other collectibles

Although a lot of attention has traditionally gone to the art market, other collectibles — such as wine, stamps and coins, classic cars, antique furniture, and musical instruments — are important in high net worth individuals’ portfolios as well. Moreover, specialized funds often enable investment in these luxury assets. This makes it worthwhile to study whether the returns realized by art investors are similar to those earned by other collectors. Figure 15 therefore also shows price indexes for stamps and for wine, in deflated British pound terms, for the period 1900-2012. Both series stem from recent research based on hand-collected archival data. The stamp price index uses historical dealer prices for British investment-grade stamps. 19 The wine price index is based on London auction and dealer prices for the five (red) Bordeaux Premiers Crus. 20 Interestingly, the long-term performance of stamps (annualized real return of 2.8%) is very close to that of art. Buyers of highend Bordeaux wines have realized slightly higher returns over the period 1900– 2012 (annualized real return of 4.1%). (When only considering relatively old wines, the returns are close to those on art and stamps.)

Elroy Dimson and Christophe Spaenjers, 2011, “Ex post: The investment performance of collectible stamps”, Journal of Financial Economics 100, 443–458. (Returns for the years 2009–2012 are from Stanley Gibbons.)

Elroy Dimson, Peter L. Rousseau, and Christophe Spaenjers, forthcoming, “The price of wine”, Journal of Financial Economics.

Citi GPS: Global Perspectives & Solutions

All collectibles have a positive correlation with Equity market returns and also GDP growth has been shown to affect prices

November 2015

Art, stamps, and wine are thus not very different from each other in terms of their long-run price appreciation. This is maybe not surprising given the sensitivity of the demand for luxury consumption to wealth creation. All collectibles have a positive correlation with (lagged) Equity market returns, and also GDP growth has been shown to affect prices. Short-term returns can nevertheless differ substantially between different collectibles, which suggests variation over time in the relative importance of different drivers of demand. For example, stamps did very well in the 1970s, when inflation hedging demand was substantial; diamonds and gold also showed high returns in that time period. Art appreciated quickly in the 1980s, when Japanese art collectors were buying up (Post-) Impressionist art. Over the last decade or so, wine has done particularly well, driven largely by increased demand from China. Interestingly, relatively high returns for a collectible category are typically followed by an underperformance relative to other collectibles. In other words, it seems that a “bubble” component can temporarily inflate the price of a collectible. It is important to acknowledge that indexes like the ones shown in Figure 15 describe market-wide trends, based on the aggregation of many different transactions. The indexes are not investible, and only very wealthy investors can aim for a level of diversification across artists and movements close to that of an art price index, for example. At the same time, however, it is possible that well-informed market insiders can outperform the index by selectively purchasing undervalued objects.

Transaction costs and liquidity considerations

It is also crucial to keep in mind that the indexes do not account for transaction costs, which are very high in these markets. Relatedly, liquidity is typically low, with distressed sales being associated with steep discounts. Finally, it is clear that investors may face a number of risks and expenses that they do not encounter in other asset markets. Yet, the obvious upside is that they may also enjoy benefits that traditional financial investments cannot deliver — unless in the form of antique stock and bond certificates suitable for framing.

Chapter 4

All’s Fair: The Art Fair Saturation Debate

Citi GPS: Global Perspectives & Solutions

November 2015

All’s Fair The Art Fair Saturation Debate Noah Horowitz Director Americas Member of the Executive Committee Art Basel Note: This article was written while Noah Horowitz was acting Executive Director of The Armory Show.

Critics have been quick to pass judgment on how the market’s event-driven focus is now placing undue strain upon the system’s supply chain

In recent years, the phenomenon of art fairs and their seemingly endless international rollout has generated an equally endless spate of commentary – upbeat, derisive and everything in between. It is now estimated that there are at least 180 major fairs worldwide, up from about 55 at the turn of the millennium, and that fairs account for 40% of dealers’ annual revenue, versus 30% just five years ago. 21 But even these figures may understate the central role art fairs play in the global art market: it is not uncommon for galleries, especially young ones or those located in peripheral cities, to rely on these events for half to three-quarters of their business, and fairs have unquestionably realigned the movements of collectors and the timing of auctions and exhibitions throughout the world. The first half of this year sand Sandy Angus, who created and later sold Art HK to Art Basel), and two existing fair franchises (Art Miami and 1:54, focused on African art) alight with new editions in New York to coincide with the May auctions and the Frieze Art Fair on Randall’s Island (itself a relative newcomer at just four years old). At the same time, there is a budding sense that something has to give. “Fair fatigue” is firmly enmeshed within the current art lexicon and process (gallery-going, especially, and possibly even the notion of gallery representation altogether). One sign of the toll this is taking on the art fair business surfaced late last year with the “postponement” of FIAC Los Angeles, which was set to debut in spring 2015 as the sister fair to the French heavyweight in October; this followed the December 2013 cancellation of the much anticipated Beijing edition of The European Fine Art Fair. Meanwhile, as fairs continue to alight, seasoned galleries are becoming more strategic and selective with their fair-going experience — cutting the ones that don’t work and redoubling their efforts on the ones that do. The market appears to have its rationales and limits.

Analyzing Art Fairs Sales data only tells part of the story for galleries which leverage their participation in fairs to build their profile

Yet despite a growing suspicion that we may be nearing a saturation point with fairs, there is neither consensus on the matter nor an obvious way to analyze it. One reason for this stems from the opacity and extensive segmentation of the dealer trade, which makes it challenging to assess how much demand there actually is for any given level of supply and thus to inform opinion on when an equilibrium is being reached. Even when available, sales data only tells part of the story for galleries which leverage their participation in fairs to build their context and profile, and to sustain existing client relationships while generating new ones with prospective buyers, curators and press who are essential to their livelihood.

Clare McAndrew. The European Fine Art Foundation Art Market Report: 2015. The Netherlands: The European Fine Art Foundation, 2015, p.155-157.

November 2015

Citi GPS: Global Perspectives & Solutions

A recent attempt to address the subject was offered by Skate’s Art Market Research which evaluated gallery participation and visitor attendance at 12 fairs in the first quarter of 2015. 22 Based upon slowing rates of growth for both criteria (the first time in a decade that these areas have failed to expand at a double-digit rate), their report concludes that fairs are losing steam. However, while Skate’s efforts to quantify this debate should be applauded, their metrics are not convincing: declining gallery participation in a single quarter does not necessarily tell the full story as galleries could have shifted their attention to events later in the year, or the fairs, themselves could be getting more selective, filtering out galleries in an effort to emphasize quality over quantity. In addition, modest fluctuations in overall attendance means little given the concentration of purchases made by a relatively small number of collectors and institutions. The example of The Armory Show in New York

To use a firsthand example from my former position as Executive Direcor of The Armory Show in New York, the fair received a record number of applications for the March 2015 edition, and yet in the end had the smallest exhibitor count in years (application numbers were up over 40% from 2012, with the exhibitor count down by 14% over the same period and 28% from 2011). This was the result of a more rigorous selection process focused on cultivating higher caliber exhibitors and more ambitious projects, effectively driving an overall increase in booth space and an even larger increase in average booth size. In this instance, declining exhibitor numbers do not equate with flagging demand. Furthermore, an independent survey that was conducted after the 2015 fair indicated that VIPs, consisting of high net worth private collectors, art advisors, museum directors and curators, gallery owners and other art market professionals, account for 88% of sales. The disproportionate importance of this select community in contributing to the commercial success of The Armory Show (VIPs represent about 15% to 20% of overall fair attendees in any given year) points to the limitations of an analysis focused purely on overall attendance. As an alternative, why not look at how sales conducted at fairs stack up against fairrelated expenditures? Even if this metric is not perfect (again, there are a number of reasons to participate in fairs beyond bottom line concerns), it reveals certain trends within the business and provides a logical starting point to address its continued health. Data collected by Dr. Clare McAndrew as part of her annual TEFAF Art Market Report offers a relevant path to undertake this analysis. 23 Her numbers, based on exhibitor surveys from the past five years, are as follows: Figure 16. Art Fair Sales and Expenditures Fair Sales Fair-Related Expenses Sales-to-Expense Ratio

2010 €6.4 billion €1.6 billion 4.00

2011 €6.7 billion €1.8 billion 3.72

2012 €8.0 billion N/A N/A

2013 €7.6 billion €1.9 billion 4.00

2014 €9.8 billion €2.3 billion 4.26

Source: The European Fine Art Foundation Art Market Report: 2015.

Sergey Skaterschikov, Skate’s Art Fairs Report, Spring 2015. New York: Artnet News LTD., 2015. 23 Clare McAndrew. The European Fine Art Foundation Art Market Report: 2015. The Netherlands: The European Fine Art Foundation, 2015.

Citi GPS: Global Perspectives & Solutions

November 2015

While a conclusive pattern fails to emerge from these figures, it does not appear that the return on investment from participating in fairs is diminishing. To the contrary, the sales to expense ratio reached its highest level in 2014, up 6.5% from 2010, and also strengthening versus 2013. Should this ratio continue to rise, it would appear to strengthen the case for fair participation; on the other hand, should it suddenly reverse, there may be legitimate evidence of market saturation. 24 McAndrew’s data is also interesting contextually because it falls in line with a ratio of about three or four to one that most galleries say is needed in order to breakeven at a fair after factoring in commissions (typically around 50% for artists in the primary market, plus an additional 10%-15% cut for advisors or consultants) as well as shipping, insurance, travel/entertainment and production-related costs. Based on the aforementioned numbers, it seems that on a whole most galleries tend to either match or exceed costs, with average returns up to about 35% or so at the higher end – a solid explanation for the attractiveness of fair participation. 25

Art Fairs Drive More than Just Sales Art fairs as a means of accessing new customers

Fairs are not just about galleries turning over inventory but also meeting new clients. A more nuanced prognosis of the fair business should also take this on board. McAndrew’s TEFAF reports do not go here. However, an anonymous survey completed by exhibitors at The Armory Show 2015 found that galleries reported a majority of sales (57%) went to new buyers, exceeding internal expectations. As with the sales to expense ratio, growth here would underline the value that art fairs provide to exhibitors, while a tapering off would flag a key facet to be addressed. Some other fruitful areas to investigate are the age and geographic origin of buyers, as well as the balance of sales to private collectors, versus advisors, versus institutions – not to mention a basic gauge of the value for money perceived by exhibitors. A more layered measure of the fair landscape based on the size and sales volume of the dealer universe is also essential and could help generate a more sophisticated reading of how costs and returns stack up for dealers across all levels of the spectrum.

For comparison, the exhibitor survey that was conducted following The Armory Show 2015 delivered a sales-to-expense ratio of 5.53, which compares favorably to the industry-wide average ascertained by McAndrew in recent years. 25 Which is not to say that participating in fairs is always lucrative. Assuming that fairrelated expenses are essentially limited (to the price of the booth, plus customizations, shipping, insurance, entertainment, etc.) but returns are theoretically unbounded (galleries can clear millions onsite at fairs, and also place work from their inventory that they do not bring with them), one can also begin to appreciate why the overall returns appear to be positive — influenced by larger galleries who do disproportionate amounts of business at fairs, relative to costs. At the same time, a gallery may lose money at a fair in absolute terms, but still be happy with the results if they make meaningful new contacts with buyers, curators, writers and other market professionals. The key for galleries over the longer term is learning how to strike a balance between achieving actual financial gains and these critical, but also costly, softer dividends.

November 2015

Citi GPS: Global Perspectives & Solutions

Will the Internet Change the Art Landscape Again? The growth of the online art market

Lastly, the Internet is a critical area of the fair business that is germane to this debate. According to Skates, the rise of online sales channels is “not yet a disaster, but a loud wake-up call” for fair operators, as galleries may start shifting their marketing budgets towards digital platforms in the coming years due to a combination of rising e-commerce possibilities and escalating fair costs. 26 This sentiment is difficult to dispute – especially when considering the fundamental business model of fairs has remained relatively stagnant for decades. At the same time, the diagnosis is murky and likely to vary substantially from one fair to the next – with the greatest immediate threat seemingly biased against fairs in hard to reach places and others who fail to make compelling in-person offerings. During my tenure, The Armory Show staked out a proactive position within this space, being the first major fair to partner with online art resource Artsy beginning in 2013 and continuing up to present. The rationale for the partnership was to avoid the deep sunk costs and stickiness of making a substantial investment in proprietary technology and to benefit instead from Artsy’s international following and digital offering, from booth previews for galleries, to online editorial and wayfinding technology for visitors on site. The aforementioned 2015 post-fair survey shed some light on these efforts: 88% of exhibitors acknowledged listing works on Artsy, with 55% reporting “meaningful inquiries” and 13% reporting actual sales through the platform. Artsy, meanwhile, reported that The Armory Show mini-site received 34,474 unique visitors and that 80.5% of exhibitors received sales inquiries, of which 43% received more than five.

The online art market is competing with a more inherently social system that other online markets do

Even as fairs of all shapes and sizes are still in the process of understanding how to gauge such metrics, the results appear to be trending in the right direction, and there is scant evidence that bricks-and-mortar business structures are being cannibalized by engaging in such partnerships – quite the opposite, actually, with the promise of new contacts and sales, expanded digital tools and social media reach merely adding to fairs’ value proposition. It should merely be underlined, in this regard, that as the art world is such an inherently social system with so much of the value chain anchored to interpersonal relationships and decisions that exceed mere profit motives, online sales represent a very different kind of beast. Although price points will invariably rise as the trade becomes more comfortable with the digital space, the impact is likely to be mainly felt at the lower to middle end of the spectrum for the foreseeable future, with the overall effects being accretive, rather than corrosive, to existing business structures — new business may well be done online, but the fundamental allure of fairs and the experience of seeing artwork in the flesh is not imminently threatened.

Skaterschikov, 2015, p.6.

Citi GPS: Global Perspectives & Solutions

November 2015

Saturation Debate Inconclusive Based on our analysis, fairs seem to be delivering solid, if not growing, economic value to participants

So are there too many fairs nowadays? It goes without saying that galleries may be tiring of participating in, producing work for, and traveling to all of these fairs, but the saturation debate is far from conclusive. Based on the simple metrics outlined here, fairs seem to be delivering solid, if not growing, economic value to participants â&#x20AC;&#x201C; in addition to the wide range of softer benefits of exposure, education and new connections and that fairs also posit. At the same time, it seems clear that the community of galleries and private dealers has to work ever harder to get by, taking on added costs and risks in the face of thinner margins as a result of intense global competition. All of this, meanwhile, is occurring against the backdrop of an increasingly bifurcated market, in which we are seeing the top end continue to grow and consolidate its position at the expense of an increasingly fragile lower and middle tier. The net result of these transformations may take years to digest. But it is absolutely clear that more research must be called on to address these concerns. Equally, the event-driven shift in the market, which many are quick to attribute to the rise and proliferation of fairs (not to mention auctions), must also be understood as a natural result of todayâ&#x20AC;&#x2122;s global, mobile, networked business environment, rather than just the inverse: causality goes both ways. To the extent that this is the case, any serious discussion about the continued vitality of the fair business must also address what a potential shakeup to the fair landscape might look like as these transformations continue to be felt, and how other aspects of the art business are realigned in the process.

ÂŠ 2015 Citigroup

Chapter 5

Art and Banking: Life Imitating Art, Art Imitating Collateral

ÂŠ 2015 Citigroup

Citi GPS: Global Perspectives & Solutions

November 2015

Art and Banking Life Imitating Art, Art Imitating Collateral Suzanne R Gyorgy Global Head of Citi Art Advisory & Finance Citi Private Bank Fotini Xydas Art Advisor, Citi Art Advisory & Finance Citi Private Bank

During the stock market turmoil and subsequent exchange closures that marked the outbreak of the First World War, collector James Dunn sent a telegram to Henry Clay Frick, whose mansion and eponymous art collection now occupy the better part of a city block on Fifth Avenue in New York City. In desperation, Dunn asked Frick to lend him £150,000 against stock and paintings, with the rights to “take any of [the] pictures at cost.” 27 Frick responded saying that, given the disruption in the markets, he preferred to invest in under-valued securities instead. 28 Mr. Dunn’s request would no doubt be far better received today and there would be a myriad of options to help him unlock capital from his art collection. While Dunn was driven to borrow against his artwork by unfortunate necessity, today business-savvy collectors leverage their art collections as a matter of course to gain liquidity from an otherwise illiquid asset. Citi Private Bank became a pioneer in art banking in 1979 when it launched its Art Advisory & Finance group. Recognizing that art made up a substantial portion of its wealthiest clients’ net worth, the bank began offering loans secured by art, in addition to advising clients on art acquisitions, sales, and collections management. While today several major banks offer art financing, at its inception Citi’s program was virtually free of competitors.

A Boom and Bust The growth of the art finance business in the 1980s

Citi’s entrance into this industry coincided with the art boom of the 1980s when certain banks began to build their art loan businesses on the extraordinary growth the market exhibited during those years. The boom was largely fuelled by the Japanese asset price bubble and the record-shattering amounts of money that wealthy Japanese collectors were spending on European Impressionist and PostImpressionist paintings. In this environment, record prices became the artworks’ most salient feature in determining the overall valuation, as opposed to the opinions expressed by art historians and critics. The monetary figures and their apparently rosy futures transformed formerly staid art galleries and auction rooms into market arenas, where prices were liable to double in a year’s time and older collectors had to stand aside. All sorts of people suddenly became art dealers, art consultants, and experts in the hope of prying away some of the quick money Japanese businessmen were spending on art transactions. The excitement grew and prices reached stupefying levels. Skeptics were reminded of Tulip Mania in seventeenth century Holland: tulips are exquisitely beautiful, but not worth the net value of a small town. When the bubble burst in the early 1990s, most of the direct liability associated with the loan defaults had to be absorbed by Japanese lenders and ultimately the Japanese government. Works that reappeared at auction on behalf of the lending institutions didn’t perform as well as they had a few years before and the high monetary values assigned to them in the preceding decade turned out to have been a matter of over-enthusiasm. Today, the terms of loan programs offered by banks are more stable and better structured as a result of the lessons learned twenty years ago.

Saltzman, Cynthia. Old Master, New World; America’s Raid on Europe’s Great Pictures. (New York; Penguin Group, 2009), p. 237. 28 Ibid, p. 238.

November 2015

Citi GPS: Global Perspectives & Solutions

Art Banking Today Top collectors today bring unprecedented levels of wealth, passion and sophistication to their interest in art and they view their art not only as a wealth holder, but as an investment and perhaps even an asset class unto itself. Notably, a new generation has sprung up alongside traditional collectors. Many of these new arrivals come from the world of finance and over the past fifteen years they have brought with them a high level of analytics into the art world. Record prices, increased globalization and new market players have led to the “financialization” of the art marketplace. In this new environment, art’s appeal comes not only from the prestige of owning significant works but also from its status as a neutral currency. Art leveraging is a way of gaining liquidity from an illiquid asset

It allows investors to establish revolving lines of credit secured by existing art collections

Art can also be used as a source of liquidity for further investment and more complex derivatives are increasing in popularity in some market areas

Tax strategies such as 1031 Exchanges illustrate the sophistication of art collectors

People often wonder why high net worth-individuals with enormous resources are interested in leveraging their art collections. First and foremost, it is a way of gaining liquidity from an illiquid asset without being compelled to sell it. Borrowing allows collectors to free up cash for use in other investments without triggering capital gains tax, as a sale would. Most art loans are simple revolving lines of credit secured by a group of artworks, which are oftentimes allowed to remain in the collector’s home or office, depending on the specific laws of the country in which the art resides. Collectors have become increasingly sophisticated both in terms of the products they expect from banks and the tools and strategies they employ themselves. Some like to isolate their art collecting from their other business activities by establishing revolving lines of credit secured by their existing art collections, which are used exclusively to acquire additional artworks. This provides collectors with ready money to act quickly when an art acquisition opportunity arises. This type of collector views art collecting and the art market as similar to the real estate market, where leveraging existing assets to purchase more real estate is common practice. This rather dynamic approach to art collecting is appropriate for those who know their area of the market well and watch it closely, almost instinctively identifying opportunities. Alternately, individuals such as hedge fund managers and private equities partners have successfully used their existing art collections as collateral for term loans, which they draw down fully to deploy back into their funds or other investments. They are essentially creating an arbitrage whereby they borrow from banks at relatively low rates and use the proceeds of the loan to gain a higher level of return. There are also tax benefits that defray the interest charges on the loan. For this group of investors, the prevailing mindset is that every asset should be an available source of liquidity for further investment. Simple interest rate swaps on art loans have also become increasingly popular in recent years and there is growing appetite for more complex derivatives in some areas of the market as well. It remains to be seen just how much collectors and financial institutions will embrace derivatives based on art loans, given the imperfect information in the market and the illiquid nature of art collateral. Collectors have added numerous tax strategies to their arsenals, in addition to financial instruments. One of the most common of these strategies in the United States is the 1031 Exchange, which has been used extensively in the real estate industry for years. Section 1031 of the United States Internal Revenue Code allows an owner to exchange an asset, including artwork, for another asset of like-kind and defer capital gains tax in the transaction. As with all tax strategies, robust legal counsel is a practical necessity for those exploring the possibility of a 1031 Exchange. The fact that today’s art collectors are willing and capable of executing such transactions illustrates just how sophisticated they have become.

Citi GPS: Global Perspectives & Solutions

The use of free ports is another tax strategy used by collectors

November 2015

In a similar vein, collectors make use of free ports for their tax advantages. The first free port was established in Geneva in 1888 as a warehouse for agricultural goods and offered clients “temporary exemption of taxes and duties for an unlimited period of time.” 29 Today, clients store all manner of valuable goods at free ports across the globe. Those goods, including art, are exempted from all taxes and duties and may even change hands within the free port with no tax due until they leave for their final destination. 30 One cannot overestimate how critical the auction houses have been to developments in the art market. Auctions remain by far the most transparent arena in which art is bought and sold. Estimates indicate that auctions account for approximately half of all art market sales and they provide crucial public data on which to base the valuation of art. The Internet has also flung open doors to torrents of market information, such as historical auction results. Knowledge that once required exhaustive research to obtain is now accessible in seconds.

In addition to banks, auction houses provide financial strategies with services that mimic synthetic forward contracts and bridge financing

The auction houses themselves have fostered some of the most exciting financial developments in the art market. As early as the 1970s, they began offering guarantees on sale prices, whereby the auction house will agree on a price for a given work with the seller before the auction takes place. 31 If the lot sells under the agreed-upon price, the auction house pays the difference to the client and if the lot sells over the price, it shares in or retains the upside. It is essentially an options strategy, similar to a synthetic forward contract. Guarantees therefore provide sellers with protection against unpredictable auction results, while allowing the auction houses to capture greater profits from successful sales. The risk for the auction houses, as for any guarantor, is of a major market correction forcing them to outlay huge sums to make up the difference on large numbers of weak sales. Since the Great Recession, they have preferred to use third-party guarantees or “irrevocable bids” to provide their clients with the same service without taking on the financial risk. 32 The most prominent auction houses also provide liquidity to prospective consignors by lending money prior to the sale of the art, as it may be many months before the appropriate sale occurs. These loans constitute advances and are paid off with the proceeds of the eventual sale. Consequently, they may be thought of as a form of bridge financing. The benefit to the auction houses in a boom market is that if the borrower is unable to repay the loan, they have the right to sell the art and realize the gain in sales commissions. In a more stagnant market, they tend to reduce their lending activities, since any upside in an eventual sale is greatly diminished.

Segal, David. “Swiss Freeports Are Home for a Growing Treasury of Art”, New York Times, July 21, 2012. 30 Kinsella, Eileen. ”The Art of Avoidance: The Tax Strategies Used by Jet-setting Art Collectors.” BlouinART INFO, Armory Arts Week Edition, March 6, 2014, p. 10. 31 “The Art Market: Financial Machinations at Auctions.”, The Economist, November 11, 2011, Prospero sec. 32 Ibid.

November 2015

Citi GPS: Global Perspectives & Solutions

The Loan Valuation Process Evaluating art is made up of both measureable factors and subjective factors making it a complex task

Fair market valuation is the one standard used for valuation for lending purposes

In addition to valuing the quality and marketability of the art, lenders also asses the financial health of the client

Art finance is not just transaction-based but a business that enhances client relationships

Evaluating art is a complex task. No two artists are alike and no two works by even the same artist are exactly alike. When compared to equities or valuable cars and watches, art remains intractably difficult to value because every work of art is completely unique. Appraisers must understand both measurable and subjective factors that contribute to an artwork’s value. Measurable factors include provenance (ownership history), exhibition and publication history, recent sales history, condition, subject matter, rarity and medium. Subjective factors include opinions on quality, importance and beauty. The latter factors are more emotional in nature and prospective buyers often process them unconsciously. However, they carry equal weight to the “hard” data in the final analysis. This is why an art expert must understand two very different things: what makes great works of art and what makes the art market. Citi and some other lending institutions use fair market valuation for lending purposes. A fair market value is the price at which an appraiser believes a piece of art would sell in the open market at present. Most appraisers use web-based resources such as artnet or Artprice to analyze recent auction results for comparable works, along with private sales data when verifiable. Again, the importance of art expertise cannot be overemphasized because of the multitude of factors involved in determining both the price of a work of art and how that price is likely to change in the future. Lending is the critical first step in the securitization of non-income producing assets, and if the collateral is both illiquid and intrinsically difficult to value, derivatives based on art loans may be quite problematic. Some financial institutions have shied away from lending against art at all because of the very same obstacles. Therefore, it is unlikely that art finance will be brought into the fold of mainstream commercial banking anytime soon. This is not because art finance cannot be a stable and lucrative business, but rather because it is not scalable in the way that mortgages are, for example. Generally, the financial due diligence bankers perform for clients pursuing art loans is similar to that which they would perform for an unsecured loan. Bankers need to assess the financial health of the client along with the quality and marketability of the art and, unlike asset-backed lenders and auctions houses, banks have no desire to be in the business of selling art if the client is unable to repay. For that reason, the client’s cash flow and investments are relied upon for repayment rather than the sale of the art. Consequently, to underwrite an art loan, a banker must assess the borrower’s principal assets, liabilities and contingent obligations and must determine unencumbered liquidity and the quality of recurring cash flow. The latter is important because art collections require maintenance (e.g. insurance, restorations and storage), are not income producing and may be highly illiquid. For private banks, art finance is not a hard asset lending business, but rather a relationship business. In certain instances, lending at private banks may be guided chiefly by the client’s cash flow, rather than the market value of the collateral. When a suitable client affixes their personal guarantee to an art loan, it becomes stable because the bank feels confident that the client’s cash flow and investments can be relied upon for repayment. A well-managed, properly valued art loan portfolio with carefully structured loan facilities is a business that enhances the client relationship. The risks arise when banks fail to grasp the mechanics and nature of the art market, improperly value the art, or do not understand the client’s true financial situation. When properly executed, art loans allow banks to offer their clients a unique opportunity to use a traditionally non-liquid asset as collateral for loans to re-invest in their businesses, acquire additional art, and diversify their assets.

Chapter 6

Art in an Investment Portfolio: Earns a Place in Illiquid Asset Holdings

ÂŠ 2015 Citigroup

November 2015

Citi GPS: Global Perspectives & Solutions

Art in an Investment Portfolio Earning a Place in Illiquid Asset Holdings Steven C Wieting Global Chief Investment Strategist Citi Private Bank Parul Gupta, CFA

There is more to art than meets the eye. Holders of art and antiquities can consider their assets a part of long-term portfolio wealth even as such objects lack the liquidity of equities and bonds. Long established markets for valuing and liquidating “mature art” distinguish it from pure consumption in economic terms, as some liquidation value is likely in almost any economic environment.

Head of Strategic Asset Allocation Citi Private Bank

While private transactions in art can be prone to controversial sales practices and opacity, there is excellent data on repeat-sales at auction going back to 1815. This provides valuable insight into the behavior of art as an asset class. The data show a return pattern similar to other risk assets, with periods of economic stability boosting asset values and volatility reducing them.

Art as a diversifier of portfolio risk

Art also has some value as a diversifier of risk. Its annual return correlation to US equities is a low 11% in a 40-year sample period and 16% in an 88-year sample period. This is lower than the 33% correlation between returns on US shares and investment-grade credit markets. Notably, the absolute decline in a broad repeat sales index provided by researchers Mei and Moses was 63% from 1929-1932 and 22% in 2009, clearly defining art as a “risk-asset”. The real US dollar return for art was an annualized 2.4% in the past 40 years with a Sharpe ratio averaging 0.43 33. The comparative figure for US stocks was 6.7% and 0.82. For long-term Treasury notes, real returns have been 3.2% with a Sharpe ratio of 0.28. However, the Treasury returns correlation to equities is -0.02 and far more negative over some short periods during corrections in risk-asset prices. Given also their greater liquidity, bonds are clearly the true portfolio diversifiers. While less liquid, art may best be compared to gold, which generated a real return of 1.8% and a Sharpe ratio of 0.48 over 40 years and (just 1.6% and.0.05 over an 88-year sample) 34. Gold is theoretically similar as a “prestige investment” and a store of value. Like gold, art provides no income, and responds to changes in real interest rates as an opportunity cost for holdings. Yet, art has outperformed commodities in absolute and risk-adjusted terms perhaps because of its defining uniqueness. In an asset allocation optimization equation, the repeat-sales index for art shows more value than emerging markets debt and commodities, assuming a minimum holding period of 10 years. Art deserves a place within illiquid asset holdings for those who would otherwise hold art for many reasons.

Art Earns a Place in Illiquid Asset Holdings Buying and selling of art is not as simple as other assets such as gold and real estate

In recent times, technology and markets have advanced to allow physical holdings of gold to be bought and sold at the touch of a button, anywhere and almost any time. With similar ease, an investor can deal in securitized real estate. For unique objects of cultural and historical significance, buying and selling still are not as simple. Expert authentication, appraisal and public auction still set objects of art apart from commodities or securities. 33

The Sharpe Ratio is a risk-adjusted return measure. The ratio is the average return earned in excess of the risk-free rate per unit of volatility or total risk. 34 While art is most frequently thought of as a zero yield investment, markets for art leasing have emerged that generate income for owners. Conversely, where required, insurance and security costs are a drain on returns.

Citi GPS: Global Perspectives & Solutions

November 2015

Beyond this issue, matters of "collective taste" determine whether an object even belongs in the asset class of art to begin with. Variability in the collective appetite for individual pieces and classes of objects drives the idiosyncratic part of their value, while common factors drive returns for art objects generally. In this brief essay, we examine the common factors of the asset class. Historical repeat sales auction data are available back to 1815

While controversy exists over issues of money-laundering and tax avoidance in the 35 art market, art auction data for a repeat sale of the same object are available from 36 1815 from researchers Mei and Moses. This data easily rivals the lengthy historical record for publicly traded equities. Art is less bound by national borders and, like gold, it is valued and traded across cultures. With this repeat-sales auction price data, we measure some of the risk and return characteristics of broad art markets (see Figure 17 and Figure 18). We discuss some of the systematic return drivers in the next section, and finally, discuss some summary parameters for how investors may view holdings of art in their portfolio wealth.

What the Data Tells Us Inflation adjusted art market returns were 2.4% annually over the past forty years, and stronger over longer time periods…

…with positive Sharpe ratios over long-term sample periods

As Figure 17 shows, inflation-adjusted art-market returns have compounded at a 3.7% annualized rate since 1926 — the longest period which we can compare return and risk characteristic across a wide range of asset classes. Real returns have been a more moderate 2.4% in the past 40 years, a sample period we examined because of the availability of semi-annual return and volatility data for the Mei Moses index. The semi-annual data slightly improves our understanding of changing macro influences on the art market and its correlations to other assets. Perhaps more importantly, the Sharpe ratio, or a risk-adjusted return measure of the art market, is a consistent 0.43 across both a 40-year and 78-year sample. (For these calculations, we used 10 year rolling standard deviations of annual art market returns, and similar calculations for other asset classes.) Over a 40-year sample, the Sharpe ratio for the art market is higher than that for high yield debt, 10-year US Treasuries, cash and broad commodities. Over a 78year sample, the Sharpe ratio is also higher than a similar measure for gold.

See Financial Times April 7, 2015 Jianping Mei and Michael Moses. Their art market indices examined in this report were provided by Beautiful Asset Advisors LLC.

35 36

November 2015

Citi GPS: Global Perspectives & Solutions

Figure 17. Real Returns and Risk-Adjusted Nominal Returns by Asset Class Asset Class S&P 500 Developed Market (DM) Equities Emerging Market (EM) Equities 10-Year US Treasury Note DM Investment Grade Debt High Yield Debt EM Debt Hedge Funds* Private Equity* Real Estate* Cash Commodities (broad index) Gold Art

Real Return Last 40 Years 6.7 7.5 8 3.2 3.8 5 3.7 8.6 11.5 6.5 1.1 -0.3 1.8 2.4

Last 88 Years* 6.8 8 6 1.9 2.7 NA* 2.8 NA* NA* 7.7 0.7 -0.2 1.6 3.7

Sharpe Ratio Last 40 Years 0.82 0.97 1.22 0.28 0.86 0.39 1.38 2.90 2.77 0.75 0.00 -0.06 0.48 0.43

Last 78 Years* 0.92 1.19 0.93 0.38 0.73 NA* 1.13 NA* NA* 0.77 0.00 -0.10 0.05 0.43

Note: The Sharpe Ratio presented is an annualized 10-year return less the return on cash divided by the 1-year standard deviation of annual returns. * Data for earlier period for these asset classes can be reasonably estimated from their historic correlation to other assets, but have been omitted from records here. Source: Global Financial Database, Beautiful Asset Advisors LLC, Citi Private Bank as of April 2014.

There is a positive correlation between art and risk assets such as US equities…

While the risk-adjusted return measures are solid and correlations to incomeproducing assets low, the correlation between art and risk assets like US equities is positive and this correlation rises when using semi-annual data. For example, in the past 40 years of annual returns, the correlation between the S&P 500 and art is just 0.11 (Figure 18). But for semi-annual periods, it rises to 0.40. In the second half of 2008 as the shocks that triggered the Great Recession hit, the broad art index fell 21.5% and US shares fell 28.5%, while US Long-Term Treasury returns were +9.2%. Annual data show the broad art index fell 63% in the three years following the crash of 1929, almost identical to the 62% drop in US share prices measured the same way. However, correlations with risk assets are often routinely negligible too. The art index virtually missed the record short-term collapse in US share prices in the second half 1987 (Figure 19).

…and a relatively low correlation between art and US Treasuries. As such, art should not be confused with a risk hedge

In comparison, US Treasuries have high levels of immediate liquidity and have a -0.17 correlation to US equity returns over the past 20 years using monthly data, with this negative correlation sharply increasing in periods of sharp equity corrections. While art provides a relatively low correlation compared to the highly correlated returns of equities, high yield debt, hedge funds and private equity, it should not be confused with a risk hedge.

Citi GPS: Global Perspectives & Solutions

November 2015

Figure 18. 40-Year Annual Return Correlation Matrix by Asset Class 10-Year DM Inv DM EM US Tsy Grade Asset Class S&P 500 Equities Equities Note Debt S&P 500 1 0.92 0.64 -0.02 0.33 Developed Market (DM) Equities 0.92 1 0.64 -0.12 0.28 Emerging Market (EM) Equities 0.42 0.64 1 -0.37 -0.06 10-Year US Treasury Note -0.02 -0.12 -0.37 1 0.76 DM Investment Grade Debt 0.33 0.28 -0.06 0.76 1 High Yield Debt 0.64 0.67 0.57 0.01 0.46 EM Debt 0.28 0.28 0.09 0.59 0.78 Hedge Funds* 0.72 0.76 0.55 0.00 0.47 Private Equity* 0.64 0.81 0.66 -0.25 0.15 Real Estate* 0.50 0.64 0.53 -0.07 0.30 Cash 0.08 0.07 -0.07 0.16 0.28 Commodities (broad index) 0.11 0.16 0.16 0.02 -0.09 Gold -0.21 -0.09 0.12 -0.14 -0.30 Art 0.11 0.16 0.16 0.02 -0.09

High Yield Debt 0.64 0.67 0.57 0.01 0.46 1 0.29 0.68 0.64 0.64 -0.08 -0.28 -0.15 -0.28

EM Hedge Private Debt Funds* Equity* 0.28 0.72 0.64 0.28 0.76 0.81 0.09 0.55 0.66 0.59 0.00 -0.25 0.78 0.47 0.15 0.29 0.68 0.64 1 0.59 0.20 0.59 1 0.74 0.20 0.74 1 0.25 0.58 0.77 0.53 0.48 0.07 0.09 0.02 0.01 -0.18 -0.09 0.06 0.09 0.02 0.01

Real Estate 0.5 0.6 0.5 -0.1 0.3 0.6 0.3 0.6 0.8 1 -0.03 0.02 0.00 0.02

Commodities Cash (Broad Index) 0.08 0.05 0.07 0.12 -0.07 0.43 0.16 -0.39 0.28 -0.35 -0.08 0.06 0.53 -0.28 0.48 0.11 0.07 0.12 -0.03 0.07 1 -0.08 0.18 1 0.03 0.36 0.18 0.3

Gold -0.21 -0.09 0.12 -0.14 -0.30 -0.15 0.00 0.03 0.06 0.03 0.36 0.36 1 0.1

Art 0.11 0.16 0.16 0.02 -0.09 -0.28 0.09 0.02 0.01 0.02 0.18 0.27 0.1 1

Source: Global Financial Database, Citi Private Bank as of April 2013.

Figure 19. US Equities, Art Market and Gold Prices (log scale) 100000 S&P 500 Total Return Index Art Market Index Gold Price 10000

1000

100

10 '60

'65

'70

'75

'80

'85

'90

'95

'00

'05

'10

'15

Source: S&P’s, Beautiful Asset Advisors LLC, Global Financial Database, Citi Private Bank, as of April 2015.

Risk Drivers of Performance Art and gold respond negatively to periods of rising interest rates, but macroeconomic volatility also harms art valuations

As Figure 20 through Figure 22 show, the income free assets of art and gold both respond negatively to periods of rising real interest rates, which represent an opportunity cost for holders. Unlike gold, macroeconomic volatility – which harms risk assets and real incomes generally – also harms art valuations (see Figure 23 and Figure 24). Clearly, though, art has outperformed commodities – including gold – when measured over very long periods. The scarcity value of unique objects is a defining characteristic of art as an investment, and we would assume that other scarce collectables would show somewhat similar return characteristics.

November 2015

Citi GPS: Global Perspectives & Solutions

Figure 20. Real US Interest Rate vs. Gold Price (YoY %) -9

Figure 21. Real US Interest Rate vs. Art Price Index (YoY %) 75

Real Interest Rate (Left, Inverted) Gold (Y/Y%, Right)

-6

Art Market (Y/Y%, Right)

-4

-6

Real Interest Rate (Left, Inverted)

50 -2

-3

30 20

0 10 2

0 -10

4 -20

-30

-25 9

-40 8 -50

-50 '90

'95

'00

'05

'10

'15

-60 '90

'95

'00

'05

'10

'15

Source: Global Financial Database, Beautiful Asset Advisors LLC, Citi Private Bank, as of April 10, 2015.

Source: Global Financial Database, Citi Private Bank as of April 20, 2015.

Figure 22. Measured Impact of Real Short-Term Interest Rates on Art and Gold Market Annual Returns Asset Class Art Gold Gold (Post 1973 Price Float)

Coefficient -2.58 -1.20 -5.36

Constant 6.59 7.14 16.06

R-squared 0.21 0.05 0.26

Standard Error 0.54 0.57 1.42

T-Stat -4.82 -2.09 -3.79

Durbin-Watson 2.10 1.34 1.51

Source: Citi Private Bank, Beautiful Asset Advisors LLC

Figure 23. 10-year Running Standard Deviation of US Real GDP and Gold Prices 6

Figure 24. 10-year Running Standard Deviation of US Real GDP and Art Market Prices 60

Real GDP (Left) Gold (Right)

35 Real GDP (Left) Art Market (Right)

30 25 20 15

2 10

0 55

Source: Bureau of Economic Analysis, Global Financial Database, as of 2014.

ÂŠ 2015 Citigroup

5 0 55

Source: Bureau of Economic Analysis, Global Financial Database, as of 2014.

Citi GPS: Global Perspectives & Solutions

November 2015

Art in a Portfolio For those with sufficient risk tolerance, art ranks above cash, emerging markets debt, high yield debt and commodities using our estimates

As Figure 26 shows, when put into an equation that optimizes portfolio return and risk – controlling for a factor we call “extreme downside risk” – art as measured by the Mei Moses World Art Index ranks above emerging market debt and commodities in an asset class weighting scheme for investors willing to hold 10% of their wealth in illiquid assets. For those with greater risk tolerance and willing to hold 15% of wealth in illiquid assets, art ranks above cash, emerging markets debt, high yield debt and commodities using our estimates. (Extreme downside risk, or EDR, limits the share of any asset that would allow total annual portfolio losses below a certain trigger level in a hypothetical 100-year sample period. Actual losses can be different from those implied in historical data.) Figure 25. Long-Term Estimated Return vs. Estimated Risk of a Large Price Decline Private Equity

Strategic Return Estimate

Emerging Equities Real Estate Developed Equities Art

Hedge Funds High Yield Investment Grade Cash

Emerging Debt

Commodities

Extreme Downside Risk Source: Citi Private Bank.

Figure 26. Recommended Weightings for a Portfolio Including Illiquid Assets (Avg Risk Profile)

Developed Markets Emerging Markets Investment Grade High Yield Emerging Markets Debt Cash Hedge Funds Private Equity Real Estate Art Commodities

10% Illiquid Weights 36.6% 5.4% 28.2% 0.9% 0.9% 2.0% 16.0% 4.3% 4.3% 1.4% 0.0%

10% Illiquid Rank 1 4 2 8 8 6 3 5 5 7 9

15% Illiquid Weights 32.3% 4.7% 28.2% 0.9% 0.9% 2.0% 16.0% 5.5% 5.5% 4.0% 0.0%

15% Illiquid Rank

Source: Global Financial Database, Beautiful Asset Advisors LLC, Citi Private Bank, as of April 2015.

1 5 2 8 8 7 3 4 4 6 9

November 2015

Citi GPS: Global Perspectives & Solutions

It is not our purpose here to discuss forward looking returns for all the various asset classes. As noted, art and assets like equities share common risk and return drivers. But it seems conceivable that long-term real US dollar returns for the art market could be in a range near 3% going forward. This seems a worthy return in the opportunity set now available in the global marketplace. The picture painted by the historical data shows that common, measurable risk factors can determine the performance of broadly measured "mature art" as an asset class. The process of testing objects through sale at public auction is an important consideration for whether the market return characteristics from the data we study are of representative value for particular objects. Given the diversity of the art market, holding a single art work or even dozens of art works is not fully representative of the broad art market

Importantly, unlike broad asset classes that can be bought and sold at one time with a diversified portfolio of active or index funds, a single art work or even dozens of art works cannot be considered fully representative of the broad art market. The same is true of small portfolios of equities. For this, and many other practical reasons, we would not, as a wealth manager, seek to purchase and warehouse a stock of art objects on behalf of clients, as Citi Private Bank does with equities, bonds, cash, hedge fund holdings, and occasionally with commodities in portfolios managed for clients. The art market is not about a single commodity like gold or petroleum, but a unique collection of diverse objects. Some categories, such as old masters, represent a limited set of historical works while new art supplies likely have a less predictable performance. The Mei-Moses data provide significant sub-categories with return characteristics and measurable risks against which certain pieces of art could be measured more accurately (Figure 27). Figure 27. Mei Moses World Art Market Index, Sub-Categories

Old Masters Impressionist/Modern Post War and Contemporary Traditional Chinese Works of Art American Painting Latin American Painting British Painting

Period 1913-2013 1930-2014 1965-2014 1985-2014 1941-2014 1976-2014 1959-2014

Real Return (%) 1.1 3.6 6.5 6.9 4.9 7.0 5.4

* Common sample period. Source: Beautiful Asset Advisors LLC (Annual 1815-to-date; Semi-annual 1960-to-date)

ÂŠ 2015 Citigroup

Real Return (%) 1985-2014* 1.3 2.8 6.3 6.9 1.4 4.0 2.4

Citi GPS: Global Perspectives & Solutions

November 2015

Conclusion We would not make short-term tactical recommendations for art relative to other assets but art deserves to be considered as part of a long term portfolio for those investors with appropriate risk tolerance

Because of the infrequency of trading and lower level of liquidity for the asset class, we would not make short-term tactical recommendations for art relative to other assets. However, for some clients who do hold or desire to collect art, we would analyze holdings and allocate portfolios of other liquid and illiquid assets in customized asset allocations accounting for these particular holdings. Estimated real returns that could possibly endure near 3% over long periods are far from a ubiquitous opportunity in financial markets currently. 37

In summary, art has, sometimes been labelled “conspicuous consumption” and certainly will not ever replace income-producing assets in wealth management. It is an illiquid asset that has been subject to counterfeiting and well-documented opacity and abuse away from the public auction markets. But we would not ignore its enduring portfolio investment value when comparing it to other asset markets.

Citations Mandel, Benjamin R. "Art as an Investment and Conspicuous Consumption Good." American Economic Review 99.4 (2009): 1653-663. Web. McAndrew, Clare, and Rex Thompson. "The Collateral Value of Fine Art." Journal of Banking & Finance 31.3 (2007): 589-607. Web. Mei, Jianping, and Michael Moses. "Art as an Investment and the Underperformance of Masterpieces." American Economic Review 92.5 (2002): 1656-668. Web. Mei, Jianping, and Michael Moses. "Vested Interest and Biased Price Estimates: Evidence from An Auction Market." Jmei-Home. New York University, n.d. Web. Picinati Di Torcello, Adriano, and Anders Petterson. Art & Finance Report 2014. London: Deloitte, 2014. Print.

Mandel (2009).

November 2015

Citi GPS: Global Perspectives & Solutions

Appendix â&#x20AC;&#x201C; Author Biographies Suzanne Gyorgy is a Managing Director and Head of Citi Private Bank Art Advisory & Finance. This group, established in 1979, features of a team of art specialists who consult with private collectors on building art collections, art management, estate planning for art and offering loans secured by fine art. Suzanne brings over 25 years of professional experience to her position. Before joining Citi in 1999, Suzanne was the Director of Exhibitions and Collections for the Morris Museum in Morristown, New Jersey, where she organized many exhibitions ranging from 19th Century European & American paintings to a series of Contemporary art projects and exhibitions. Prior to that, Suzanne served as the Director of the PaineWebber (UBS) Art Gallery in New York, organizing exhibitions in partnership with non-profit arts and cultural institutions. Suzanne also worked as an independent art advisor managing several important private art collections and as a consultant to art museums on exhibition coordination. Suzanne began her career as a Registrar for the Department of Paintings and Sculpture at the Museum of Modern Art, New York. Suzanne has lectured widely on the topics of Art as an Asset Class and Art Finance and participated on numerous art market panel programs. She has commented on the art market for CNN, the Wall Street Journal, New York Times, Financial Times, Barrons and Art and Auction magazine among others. Suzanne is a board member of the Association of Professional Art Advisors (APAA) and serves on the membership committee. She graduated from Pratt Institute with a degree in Fine Arts. Steven Wieting is Managing Director and Citi Private Bank's Global Chief Investment Strategist, responsible for formulating investment views and strategies on a macro basis and across asset classes. A member of Citi Private Bank's Investments Leadership team, Steven has assumed the Chairmanship of the Global Investment Committee. Prior to his appointment as CPB's Chief Strategist in early 2013, Steven served as Citi Investment Research's lead economist for the US institutional Equities business from 2000 to early 2013. Based in New York, he was responsible for advising the firm's institutional and government clients globally on macroeconomic developments, forecasts and policy analysis. Steven has published extensively on demographic and policy challenges with a focus on the implications for long-term asset market performance. Prior to joining Citi (via Smith Barney) in 1996, Steven was an economics correspondent with Dow Jones, where he followed financial markets and reported on the views of Federal Reserve policymakers. He also served as a contributor to The Wall Street Journal's "Credit Markets" column. Previously, Steven worked for the US Department of Commerce. Steven received an M.S. in Quantitative Economics at Baruch College.

ÂŠ 2015 Citigroup

Citi GPS: Global Perspectives & Solutions

November 2015

Thierry Dumoulin is artnet’s Vice President of Marketing and Business Intelligence. Before that, he was the Managing Director of Saatchi & Saatchi X New York. He has spent much of his career at advertising agencies such as JWT, Ted Bates and Imagination, in Paris, London and New York, working on blue chip brands such as Citi, Smirnoff, Samsung and Christie’s. His remit at artnet includes raising awareness and adoption of its art market analytics products amongst collectors and investors around the world.

Parul Gupta, CFA is Head of Strategic Asset Allocation responsible for overseeing and implementing Citi Private Bank’s strategic asset allocation methodology. Parul started her career at Citi Private Bank and has more than ten years of industry experience in providing asset allocation advice and macro research to high net worth individuals, family offices and foundations globally. Parul earned a MS in Financial Engineering from Columbia University, New York. She also received her BA in Computer Science from the University of Cambridge and her BSc in Mathematics from Delhi University. She is a Charter Financial Analyst (CFA®) Charterholder and a member of the CFA Institute.

Noah Horowitz joined Art Basel in August 2015. In his role as Director Americas, Horowitz oversees Art Basel’s Miami Beach show and strengthens Art Basel’s relationships with galleries, collectors, artists, museums and institutions from the Americas, promoting them throughout Art Basel’s activities worldwide. Horowitz previously served as Executive Director of The Armory Show in New York from 2011 to 2015. Prior to this, he was Director of VIP Art Fair. Horowitz holds a Ph.D. from the Courtauld Institute of Art, London, and is the author of numerous publications, including Art of the Deal: Contemporary Art in a Global Financial Market (Princeton University Press, 2011). He is a frequent lecturer on contemporary art and economics, and his writings have appeared in publications including The New York Times, Texte zur Kunst and The Art Newspaper.

Benjamin R Mandel is a global strategist in the Multi-Asset Solutions group at J.P. Morgan Asset Management in New York. He is also an adjunct professor at Columbia University’s School of International and Public Affairs. Ben began his career as an economist in the International Finance division at the Federal Reserve Board and in the International Research group at the Federal Reserve Bank of New York. Prior to joining J.P. Morgan, he was a member of the Global Economics team at Citi Research. Ben’s academic research has been published in leading scholarly journals, including: American Economic Review, American Economic Journal: Macroeconomics, American Economic Journal: Economic Policy, Quantitative Finance and the Journal of Economic Perspectives. He has a Ph.D. in Economics from the University of California, Davis and a B.Sc. in Applied Economics from Cornell University.

November 2015

Citi GPS: Global Perspectives & Solutions

Christophe Spaenjers is an Assistant Professor of Finance at HEC Paris. He received his PhD from Tilburg University in 2011. His research interests include alternative investments, investor behavior, international finance, and financial history. He has published in journals such as the Journal of Financial Economics, American Economic Review (Papers and Proceedings), Management Science, and Financial Analysts Journal. He teaches in the MBA programs at HEC Paris. Fotini Xydas is a Vice President and Art Advisor for Citi Private Bank Art Advisory & Finance. Fotini specializes in 19th Century European, Impressionist and Modern art, and advises clients in these collecting areas. She also evaluates and helps manage Citi’s international art finance portfolio. Fotini has worked with some of the top collectors in the world, helping them build museum quality art collections by identifying opportunities and providing comprehensive, objective advice on acquisitions and sales. Fotini began her career at Sotheby’s, where she conducted research for appraisals. Fotini also assisted in curating several exhibitions, including Inheriting Cubism, at the Hollis Taggart Galleries in New York. Fotini holds a BA from the University of Pennsylvania and a Master’s from Columbia University in Modern Art: Critical and Curatorial Studies. She is currently pursuing a PhD in art history at the CUNY Graduate Center, where she is specializing in 19th and early 20th Century European art.

Citi Global Perspectives & Solutions (Citi GPS) is designed to help our clients navigate the global economy’s most demanding challenges, identify future themes and trends, and help our clients profit in a fast-changing and interconnected world. Citi GPS accesses the best elements of our global conversation and harvests the thought leadership of a wide range of senior professionals across the firm. All Citi GPS reports are available on our website www.citi.com/citigps `

The Curtain Falls How Silicon Valley is Challenging Hollywood October 2015

Energy Darwinism II Why a Low Carbon Future Doesn’t Have to Cost the Earth August 2015

Disruptive Innovations III Ten More Things to Stop and Think About July 2015

Public Wealth of Nations Unlocking the Value of Global Public Assets June 2015

Women in the Economy Global Growth Generators May 2015

Car of the Future v2.0 Mobility Transformation: Full Steam Ahead May 2015

Beyond China The Future of the Global Natural Resources Economy March 2015

Technology at Work The Future of Innovation and Employment February 2015

Investment Highlights in 2015 Dealing with Divergence January 2015

Corporate Finance Priorities 2015 Driving Corporate Growth in Divergent Markets January 2015 Energy 2020: Out of America The Rapid Rise of the US as a Global Energy Superpower November 2014

The Re-Birth of Telecom Monopoly Is the Industry Broken & Heading Back to its Monopolistic Roots November 2014 Asset Allocation for a New Era Diversification, Not Rotation, is the New Watchword October 2014 Taking It To The Streets The New Vox Populi Risk May 2014 Disruptive Innovations II Ten More Things to Stop and Think About May 2014

Future Opportunities, Future Shocks Key Trends Shaping the Global Economy and Society October 2014 The Car of the Future Transforming Mobility As We Know It May 2014 Upwardly Mobile III Mobility Unchained: From Mobile Commerce to IoT January 2014

2014 Year Ahead Investment Themes January 2014

Abenomics Four Arrows to Target Four Challenges October 2013

Energy Darwinism The Evolution of the Energy Industry October 2013

Call of the Frontier II On the Right Track to be Tomorrow’s EMs September 2013

Energy 2020 Trucks Trains & Automobiles: Start your Natural Gas Engines June 2013

The Global Search for Yield How Today’s Markets Shape Tomorrow’s Companies May 2013

Disruptive Innovation Ten Things to Stop and Think About April 2013

Energy 2020 Independence Day: Global Ripple Effects of the N American Energy Revolution February 2013

2013 Year Ahead Investment Themes January 2013

2013 Year Ahead Corporate Finance Priorities January 2013

Upwardly Mobile II A Long and Winding Road for Mobile Payments November 2012

China in Transition What We Know, What We Don’t Know November 2012

Global Debt Mr. Macawber’s Vindication November 2012

Sub-Saharan Africa The Route to Transformative Growth September 2012

China & Emerging Markets China is About to Rebalance. How Will EM be Affected? July 2012

Energy 2020 North America, the New Middle East? March 2012

Upwardly Mobile An Analysis of the Global Mobile Payments Opportunity March 2012

2012 Year Ahead Corporate Finance Priorities January 2012

2012 Year Ahead Investment Themes January 2012

Call of the Frontier The Search for a New Generation of Emerging Markets November 2011

Trade Transformed The Emerging New Corridors of Trade Power October 2011

Citi GPS: Global Perspectives & Solutions

November 2015

IMPORTANT DISCLOSURES This communication has been prepared by Citigroup Global Markets Inc. and is distributed by or through its locally authorised affiliates (collectively, the "Firm") [E6GYB6412478]. This communication is not intended to constitute "research" as that term is defined by applicable regulations. Unless otherwise indicated, any reference to a research report or research recommendation is not intended to represent the whole report and is not in itself considered a recommendation or research report. The views expressed by each author herein are his/ her personal views and do not necessarily reflect the views of his/ her employer or any affiliated entity or the other authors, may differ from the views of other personnel at such entities, and may change without notice.. You should assume the following: The Firm may be the issuer of, or may trade as principal in, the financial instruments referred to in this communication or other related financial instruments. The author of this communication may have discussed the information contained herein with others within the Firm and the author and such other Firm personnel may have already acted on the basis of this information (including by trading for the Firm's proprietary accounts or communicating the information contained herein to other customers of the Firm). The Firm performs or seeks to perform investment banking and other services for the issuer of any such financial instruments. The Firm, the Firm's personnel (including those with whom the author may have consulted in the preparation of this communication), and other customers of the Firm may be long or short the financial instruments referred to herein, may have acquired such positions at prices and market conditions that are no longer available, and may have interests different or adverse to your interests. This communication is provided for information and discussion purposes only. It does not constitute an offer or solicitation to purchase or sell any financial instruments. The information contained in this communication is based on generally available information and, although obtained from sources believed by the Firm to be reliable, its accuracy and completeness is not guaranteed. Certain personnel or business areas of the Firm may have access to or have acquired material non-public information that may have an impact (positive or negative) on the information contained herein, but that is not available to or known by the author of this communication. The Firm shall have no liability to the user or to third parties, for the quality, accuracy, timeliness, continued availability or completeness of the data nor for any special, direct, indirect, incidental or consequential loss or damage which may be sustained because of the use of the information in this communication or otherwise arising in connection with this communication, provided that this exclusion of liability shall not exclude or limit any liability under any law or regulation applicable to the Firm that may not be excluded or restricted. The provision of information is not based on your individual circumstances and should not be relied upon as an assessment of suitability for you of a particular product or transaction. Even if we possess information as to your objectives in relation to any transaction, series of transactions or trading strategy, this will not be deemed sufficient for any assessment of suitability for you of any transaction, series of transactions or trading strategy. The Firm is not acting as your advisor, fiduciary or agent and is not managing your account. The information herein does not constitute investment advice and the Firm makes no recommendation as to the suitability of any of the products or transactions mentioned. Any trading or investment decisions you take are in reliance on your own analysis and judgment and/or that of your advisors and not in reliance on us. Therefore, prior to entering into any transaction, you should determine, without reliance on the Firm, the economic risks or merits, as well as the legal, tax and accounting characteristics and consequences of the transaction and that you are able to assume these risks. Financial instruments denominated in a foreign currency are subject to exchange rate fluctuations, which may have an adverse effect on the price or value of an investment in such products. Investments in financial instruments carry significant risk, including the possible loss of the principal amount invested. Investors should obtain advice from their own tax, financial, legal and other advisors, and only make investment decisions on the basis of the investor's own objectives, experience and resources. This communication is not intended to forecast or predict future events. Past performance is not a guarantee or indication of future results. Any prices provided herein (other than those that are identified as being historical) are indicative only and do not represent firm quotes as to either price or size. You should contact your local representative directly if you are interested in buying or selling any financial instrument, or pursuing any trading strategy, mentioned herein. No liability is accepted by the Firm for any loss (whether direct, indirect or consequential) that may arise from any use of the information contained herein or derived herefrom. Although the Firm is affiliated with Citibank, N.A. (together with its subsidiaries and branches worldwide, "Citibank"), you should be aware that none of the other financial instruments mentioned in this communication (unless expressly stated otherwise) are (i) insured by the Federal Deposit Insurance Corporation or any other governmental authority, or (ii) deposits or other obligations of, or guaranteed by, Citibank or any other insured depository institution. This communication contains data compilations, writings and information that are proprietary to the Firm and protected under copyright and other intellectual property laws, and may not be redistributed or otherwise transmitted by you to any other person for any purpose. IRS Circular 230 Disclosure: Citi and its employees are not in the business of providing, and do not provide, tax or legal advice to any taxpayer outside of Citi. Any statements in this Communication to tax matters were not intended or written to be used, and cannot be used or relied upon, by any taxpayer for the purpose of avoiding tax penalties. Any such taxpayer should seek advice based on the taxpayerâ&#x20AC;&#x2122;s particular circumstances from an independent tax advisor. ÂŠ 2015 Citigroup Global Markets Inc. Member SIPC. All rights reserved. Citi and Citi and Arc Design are trademarks and service marks of Citigroup Inc. or its affiliates and are used and registered throughout the world.

ÂŠ 2015 Citigroup

November 2015

Citi GPS: Global Perspectives & Solutions

NOW / NEXT Key Insights regarding the future of the Global Art Market

GLOBAL REACH

In 2000, over half of auction sales by dollar value took place in the US, with an additional quarter in the UK and France, the third largest market, accounting for just over 5 percent. / Assuming China settles down to the rest of the world’s historical growth rate while all other countries continue along the same paths, Chinese market share should stabilize and the UK and other countries will continue their gradual path of convergence with the US.

SHIFTING WEALTH

For whatever reason — including, but not limited to growing wealth inequality or evolving preferences for art consumption — the distribution of art prices has an increasingly fat tail. / The trajectory of art prices as a reflection of widening inequality must also eventually settle, although economists remain far from agreed on the path to the latter.

INNOVATION

Instead of just hanging on walls or sitting in storage, collectors have historically leveraged their art collections to gain liquidity through simple art loans. / Collectors have become increasingly sophisticated and now use art collections to implement tax strategies as well as financial strategies such as synthetic forward contracts and bridge financing.

Citi GPS: Global Perspectives & Solutions www.citi.com/citigps

ÂŠ 2015 Citigroup