Survivorship Bias (& Compounding) in The Art World


Getting Rich Investing in Art Is So Easy
Just figure out what sells for peanuts today and will command a fortune in 30 years or so.
Bloomberg, May 16, 2019.

 

 

 

You, too, can make a fortune in the art market. All you need is an eye for important, beautiful works, some spare cash and a time machine. If you lack the ability to go back a decade or more to buy what we now know will bring huge prices, well, then, making great returns in art is very, very hard.1

We were reminded of this courtesy of the sale earlier this week of one of Claude Monet’s haystacks paintings, “Meules” (1890). The painting was auctioned at Sotheby’s in New York for $110.7 million, a record sum for a work by an impressionist. According to the Financial Times, the price, including auctioneer fees, was 44 times more than the $2.5 million the painting fetched when last sold at auction in 1986. This works out to an annual rate of return of 12.2% over 33 years.

Then yesterday, the estate of S.I. Newhouse Jr., the former Condé Nast chairman, auctioned at Christies in New York Jeff Koons’s stainless steel “Rabbit.” At $91 million, it set a record for a living artist. According to Architectural Digest, Newhouse bought the sculpture in 1992 for $1 million. At 91 times more than the sculpture cost 27 years ago, this works out to an annual rate of return of 18.2%.

Before you look at these gains and assume that investing in art seems like a sure thing, some cautionary words are in order. The problem with this is that investors tend to notice the big winners, while ignoring the works of art (or other assets) that fail to appreciate in value. Statistically, the vast majority of investments have returns that are nothing like this; some even lose value.

This tendency to give too much weight to the big winners while excluding the losers — otherwise known as survivorship bias — has a long and storied history in investing. Mutual funds were the first great example of this: Funds tend to regularly close down and disappear due to poor performance. The Vanguard Group and Dimensional Funds Advisors each separately found that about half of funds close within 15 years. When the losers get killed off, it makes the average performance of the survivors look that much better.

How much better?

Vanguard noted that 62% of surviving large-capitalization value funds outperformed their specific benchmark. But taking account of the funds that shut lowers the rate to just 46% after five years and the disparity gets bigger the further out you go. Larry Swedroe of the BAM alliance points to an earlier study by Lipper: In 1986, it reviewed 568 stock funds, with an average annual return of 13.4%. By 1996, those returns had improved to 14.7%. During that 10-year period, almost a quarter of the funds disappeared. These tended to be the worst performing funds, and once they exited the database, the survivors registered a cumulative 1.3 percentage point improvement — essentially accounting for all of the increase in returns.

The art equivalent of this are all of the works buried in attics and basements and, most impressively, in storage at museums. Take two big museums in New York: The Metropolitan Museum of Art‘s modern and contemporary art collection alone contains more than 12,000 works. Not far away, theMuseum of Modern Art  has almost 200,000 modern works. Most of these wouldn’t fetch nine figures at auction.

It is human nature to look at big winners after-the-fact, while failing to include the impact of the losers. It is not what we see that matters so much as what we do not see.



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