Lies, damned lies, and investment indices

While researching a piece for the Currensee Blog about contemporary art as an alternative investment, I came upon an excellent piece on the Reuters blog from last year with the excellent title, Artnet’s silly indices.

In this post, Felix Salmon opines that Artnet's desire to legitimize fine art as an investible asset class has gotten ahead of their ability to build a usable, meaningful index, which is unfortunately the showpiece of said legitimization strategy.  Artnet has released the C50 index of contemporary artists, which they say "combines performance data from 50 leading Contemporary artists, who best represent the Contemporary Art auction market." They proudly display a chart of this index beating the snot out of the S&P 500 since 1988. Salmon cuts it down to size quickly:

The performance of the C50, then, is largely a function of the fact that hot artists keep on getting added — after they’ve become hot. It’s a classic case of investing with hindsight: if you only bought things which performed extremely well, then you would have made lots of money. Well, thanks for that.

...

Finally, it’s no coincidence that Artnet’s first public index is its contemporary art index — the one part of the art world which has been on fire of late. It’s the third level of survivorship bias: if and when Artnet starts publishing its Old Masters index, say, you can be sure the numbers won’t look nearly as impressive.

The whole idea of an index is that it boils down a whole universe of stuff into a single figure that you can use, over time, to compare the performance of that universe to itself, and ideally, to other indices. We all know that the components of the S&P 500 change, but it's still a petty good benchmark on big business in the USA. In fact, it's pretty highly correlated with many stock indices around the world. Artnet chooses a new list of top 50 artists every year and adjusts the divisor much like the S&P does. To its credit, Artnet's selection of artists for the C50 is purely rules-based, while the S&P 500 has some subjectivity that a committee works out.

So what's the big deal? Salmon says it's selection bias, and he shows a few layers of it, from the backward-looking selection of artists to the selection of contemporary artists as a period of focus to the weighting of each artist and each kind of work for each artist. For me, the big deal is that you can't invest in art the way you can invest in markets, so the whole idea of comparing the C50 to the S&P is dangerous.

Artnet's data come from auction sales (I wonder if the buyer's premium is taken into account), and that's not the only way to buy art, especially the art of living (contemporary) artists. Artnet is aggregating (and I'm not saying that their method is good or bad as method) the prices of many works of art by a given artist, each of which could be quite different. By contrast, a share of IBM is a share of IBM, so the market cap or share price of IBM is a figure equally meaningful to all investors. Shares of stock are fungible financial assets, works of art are frequently unique.

Sure, a record-setting auction sale of a piece by a given artist can boost the value of other works by that artist, but the only way you can expect to achieve the chart of the C50 is to buy - and sell - all the works by all the artists in the index at all the auctions.  Maybe the law of averages would be on your side if you could afford just one (properly-weighted) piece by each of the 50 artists, but the easiest way to achieve results very similar to those of the S&P is to buy a share of an index fund or ETF, and you can do that for $160 or so today, plus a modest commission. There is no C50 index security to buy, and while some stocks pay dividends and none have storage costs, buying actual art has substantial transaction, storage and preservation costs, and unless you charge admission to see the work, it will not bring any dividends.

I sure don't mean to say that the stock market as embodied by the S&P 500 is the best of all possible investments, I just mean to say that somebody with a point to make and a thing to sell can probably craft an "index" that outperforms by using hindsight, selection bias, and an artful disregard for the different mechanics of the markets and assets.

So the next time somebody shows you a chart that shows that contemporary art - or Boston real estate, 2000 vintage Bordeaux, action figures from the 1970s, or any other not so liquid commodity - has outperformed the stock market, think hard about how they figured that out, and just as importantly, how you as an investor could reasonably hope to achieve those returns without either an infinite amount of money or a time machine.

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