Ludovic Subran: Is art a good hedge against inflation?

Ludovic Subran: Is art a good hedge against inflation?

RB

Inflation is something we’ve forgotten about for quite a long time because we haven’t had much of it. Then, it came back with a vengeance. Can you remind us why inflation is important and why investors should be concerned about it?

LS

Inflation is significant because it complicates everybody’s job. It complicates the investor’s job to yield returns. It complicates the household spending budget. It makes policymakers worried about how to finance social protection. It makes companies look after their margins like a hawk. Inflation is bad because it means the price of money is decreasing.

It’s true for the past ten years, and some may say since the 70s, at least in our part of the world, like in the US and Europe, that we haven’t seen much inflation. Recently, it has become a concern for investors because inflation can impact the value of their investments. When prices rise, the purchasing power of money decreases, which can lead to a loss in the real value of your investments. Even if an investment rises in price, if that price rise is less than the inflation rate, then the investor has lost money. That’s the direct effect.

The response to inflation is also through an increase in interest rates. Of course, an increase in interest rates leads to higher financing costs. If you want to use a bit of a mortgage to buy a house, or if you want to use some debt to invest, you’re also losing on that front, which is the overall cost of financing is much higher these days than it used to be just 12 months ago. It’s mostly through the value and the returns and, maybe, through the leverage angle that we see inflation bite investors. It’s creating concerns today about the future returns of investments.

RB

If you are a long-term investor, ideally, you want an investment that will give you a good real return above inflation. What investments are best to protect you in an inflation environment? And would you include our investments in those?

LS

There are many ways of investing during inflation. Beyond the more alternative investment space, like art or good wine, you have real estate, for example. Investing in a property with rental income is a good hedge against inflation because rental spaces are indexed on inflation (because the rent price is indexed on inflation). Even in the bond markets, with so-called inflation-linked bonds, you can buy a protection, a hedge.

Also, in the vanilla bond market, to protect your returns and your payment of coupons from inflation, the equity market is known to be – when inflation is not too high – a good hedge against inflation. This is because you expect that those companies in the stock market should outperform the cost of inflation. They should pass on some of the increasing costs to the customers through pricing power and still make margins. Your investments should benefit from that. Many investments can be tweaked to become inflation-proof in a way.

What I find interesting is that when you look historically, art has been a good hedge against inflation. The numbers are there to show it. It depends on the geography and how you account for it because there are different costs associated with it and various types of art. But if you go for quality and a buy-and-hold strategy and manage the overall cost of the transaction, art has proven to be quite resilient to higher inflation periods.

RB

Was that also true in higher inflation periods like the 70s?

LS

It’s hard to know. There are a few long-term studies. Christoph Spaniers, a researcher at the University of Leeds, says you can look at art as giving good returns but there will be differences between countries and areas of art.

Overall, it has worked over the past 30, 40, and 50 years. As you can imagine, the art market is less liquid than others. You don’t see as much price discovery as in the SP500, the FTSE, or some of the indices that have been there for some time.

More recently, in the last year, we’ve seen a surge in inflation. It’s spectacular - that’s why people have been talking about the 70s. But it’s a very different moment.

Central banks are much more serious about killing inflation. We don’t have the same competitive environment or wage indexation. There is no wage-price spiral we saw in the 70s. Maybe we will also be more cognisant of fiscal spending than in the 70s.

But who would have thought that we would have 10% inflation in the Western Hemisphere, right? It has made many people look back into, for example, the performance of art in the long run when diversifying the portfolio and how much people have been making from this investment.

In the long run, contemporary art has shown a strong price appreciation of close to 15% over the past 30 years. Even during periods of high inflation, it does compare quite well to the equity market, which is usually ten, or real estate, which is also ten, and also for gold, which is in the tune of seven or eight.

There is a form of resilience and a good investment in periods of high inflation of blue chip art compared to the variability of the overall transaction.

 

RB

It’s unusual where we are now, with the economies slowing in many countries worldwide, with interest rates rising and the edging away of central banks pumping money into the economy. What does all this mean for art markets and investment markets?

LS

This is where you get the second aspect of inflation that could worry people. When you have lower growth and high inflation, people worry about their income’s purchasing power.

Art is an investment you usually make after investing in more traditional things. It’s more something you do in a layered and structured approach, like with residual savings.

We’ve seen, for example, people turning to art because they had excess hoarding from COVID. They weren’t going out or travelling. They had extra savings to put into art. Of course, since then, inflation has eroded some of these excess savings and they had to tap into their more liquid investments to ensure they could protect their living standards.

The good news for the art market is this hedonistic dividend. The idea is that you put money into art not only because you expect solid, regular returns, like in the bond market. You don’t invest in art as you invest in the equity market because you believe in a company’s strategy and you’ve seen this company and its management making good decisions.

When you invest in art there is a sense of je ne sais quoi, as we say in French, which is emotional, refined and one of the reasons why it is a resilient segment. It has continued to attract Gen Z, for example. We’ve seen several new platforms that show, just like the Robin Hood generation when it came to equity investment in the US, more young people are interested in this form of investment. This is despite the income and wealth shock of ’22 and relative fears about the recession, higher financing costs and central banks not being done with increasing interest rates.

The sentiment is not as good, but there is a form of resilience among investors, especially in the segment of investors educated about art. They know why they go there and are not necessarily looking for high-frequency trading, trying to time the market, but more into a buy-and-hold strategy. They know this investment will be a positive one for their portfolio in the long run, a bit diversifying because it’s not as correlated as the other asset classes.