These days, it seems like every asset manager is offering advice to their private clients about how to build a portfolio of alternatives. J.P. Morgan says the typical range among their private bank clients is 15 percent to 30 percent of their overall portfolio. “That said, some clients with significant resources and an inclination to plan multi-generationally do allocate 50 percent or more to alternatives; much like some large endowments.” Blackrock advises incorporating private credit, and Goldman Sachs Asset Management says the conversation has shifted from the “case for investing in alternatives” to “how to invest in alternatives.”
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Art investment is a favorite of the ultra-high-net-worth and their banks
As alternative investments gain popularity among private clients, one asset class is quietly emerging as a favorite: fine art. Increasingly, ultra-high-net-worth (UHNW) individuals are leveraging their art collections to access liquidity and diversify their portfolios. For an asset class that has not been traditionally viewed as a staple of an overall portfolio, this may come as a surprise. According to Deloitte, 84 percent of UHNW and high-net-worth (HNW) clients have a significant portion of their overall wealth invested in art. Sixty-three percent of wealth managers (in private banks and family offices) have integrated art into their wealth management offerings, according to a Deloitte survey in 2023.
Their private banks have a history of investing in art that dates back to the Renaissance, when Italian bank Monte dei Paschi di Siena began building its corporate art collection in 1472. Financial institutions like Deutsche Bank, JPMorgan Chase, Bank of America, have world-renowned art collections; UBS counts 30,000 artworks in its collection.
Art collectors are increasingly using art financing
Collectors buy art they fall in love with, made by artists whose artworks and messages resonate with them. But because primary prices are so high, they can’t (and don’t generally) ignore the fact that it is also an investment. Traditionally, art collectors have viewed their acquisitions as long-term investments, tying up significant capital in illiquid assets. Resales are sometimes not even a real consideration. However, a growing number of financially sophisticated collectors are realizing that the equity hanging on their walls can be unlocked and redeployed—without having to sell treasured pieces. This is where art financing comes in.
Art loans are available from several private banks, certain auction houses and specialist art lenders (including Athena Art Finance). I wrote for the 2023 Deloitte Private and ArtTactic Art & Finance Report about the myriad reasons clients take out art-secured loans, the growth and the evolution of the art lending market. Even as credit markets have tightened, art lending has proliferated. Sotheby’s Financial Service, which began lending in 1988, stated recently that its art loan portfolio grew more than 100 percent over the last two years and is at its highest-ever portfolio balance.
Art-backed debt is an attractive portfolio diversifier and a way to earn passive income
Having bundled portfolios of art-backed loans for investors for more than five years, Yieldstreet has been waiting for the broader market to take notice. Moreover, given art’s low correlation to many important asset classes, it is an ideal choice for portfolio diversification, as long as the underlying loans are carefully underwritten and serviced by experienced art finance professionals.
A year ago, in Reasons to Love Investing in Art-Backed Debt, I explained how portfolios of art-backed debt offer investors an uncorrelated asset class with attractive yields and solid principal protection—without the costs associated with owning physical art or concerns of whether the art will appreciate in value over time. Then, in The Holy Grail for Passive Income: Art-Debt Investing, I took a deeper dive into the fundamentals of art-debt investing, focusing on the types of questions that investors should ask as they consider these investments to earn passive income.
Now, with Sotheby’s Financial Services’ historic $700 million securitization of its art loan portfolio, art debt has come into its own as an investable asset with a public rating.
On April 23, Sotheby’s Financial Services launched a securitization program consisting of $700 million of asset-backed notes backed by art-secured loans. Sotheby’s securitization of its art loan book is a landmark in art’s financialization, transforming what was otherwise perceived as a less illiquid and non-income-producing asset into an institutionalized financial product. It is a powerful demonstration of the great demand for art financing and it puts to bed questions about whether art is a credible asset class. As managers for pension funds, endowments and family offices demonstrated their excitement to finally incorporate art into their investment portfolios, Sotheby’s quickly increased its offering from $500 million to $700 million to match the intense demand.
At a high level, securitization is a financial process whereby contractual debt obligations (here, art-backed loans) are pooled together to be repackaged into interest-bearing securities and then sold to institutional investors. The techniques used to mitigate the credit risk profile of asset-backed securities (e.g., over-collateralization or structuring into tranches that reflect the credit quality of the underlying assets and the attendant risks), the many parties involved in securitization and the reasons originators seek to securitize its assets are beyond the scope of this article.
How did the credit ratings agency get comfortable with this new asset class?
In the Sotheby’s pre-sale document from the ratings agency, Morningstar DBRS, they explained a number of key considerations (which closely track my prior article for Observer):
Track record of the art lender: While the ratings agency did not comment on specifics around Sotheby’s underwriting of the binary risks associated with lending against fine art (such as title, authenticity, attribution), the ratings agency explained that it got comfortable with a 10-year look back at loan performance during economic cycles, including a corporate earnings recession from 2014-15, and the financial crisis of 2007-09. “What we found is that the performance has generally been fairly consistent,” said Doo-Sik Nam, a senior vice president for U.S. asset-backed securities credit ratings at Morningstar DBRS.
Valuations of the art collateral: Morningstar DBRS gained comfort with 10-plus years of auction data, detailing the way that Sotheby’s Financial Services evaluates art and determines high and low estimates for individual works.
Characteristics of the portfolio and diversification as a risk mitigant: According to Morningstar DBRS, the portfolio, valued at $1.4 billion, is comprised of 89 loans that are secured by 2,484 works of fine art and collectibles. By genre, the breakdown is as follows: 43 percent of the collateral is in Contemporary Art, 21 percent is Old Master paintings, 15.57 percent is Impressionist and Modern Art, 5.25 percent is Latin American Impressionist and 3.72 percent is Chinese works of art. According to Bloomberg, one third of the portfolio consists of artworks by the following five artists: Rembrandt, Warhol, Picasso, Basquiat and Kahlo. It has also been reported that the collateral includes “collectibles, design furniture, coins, books, jewelry, watches, wine or other spirits”. Investors can learn more about the portfolio from the offering materials (for example, borrower concentrations, artwork concentrations, artist concentrations, etc.).
Saleability and liquidity of the art loan collateral: It is worth noting here that, as an auction house, Sotheby’s is also the sales agent in the event of a default, which greatly facilitates liquidation.
Sotheby’s securitization program is not the first time that investors have been able to invest in diversified portfolios of art-backed loans
While Sotheby’s bonds are available only to institutional investors (such as pension funds and endowments), for more than five years, Yieldstreet has been offering accredited investors (individuals who meet certain wealth and income thresholds) access to diversified portfolios of the art-backed loans underwritten by Athena Art Finance, with minimums as low as $10,000. Since 2019, Yieldstreet has launched eight art debt funds, five of which have fully matured.
Yieldstreet’s art debt offerings provide an opportunity for individual investors to participate in highly diversified portfolios of art-secured loans. Yieldstreet investors receive monthly passive income through notes that synthetically link to the underlying borrowers’ payments of interest and principal. Like Sotheby’s offering, the diversified art-debt offerings consist of pools of art-backed loans, and as such, investors are not investing directly in artworks. What’s more, these investments specifically do not depend on any appreciation of the artworks’ values.
In the coming years, as UHNW collectors increasingly use leverage to grow their collections and recapitalize their investments in art, I expect that art-debt investment offerings will proliferate in an effort to meet the insatiable demand of savvy investors seeking access to the rarified world of art finance.
