What 19th Century Art Dealers Teach Us About Investing
19th century dealers bought whole portfolios of paintings by great artists much like one would buy a diversified basket of stocks.
You may have heard of Vincent van Gogh, the painter who is among the most famous and influential figures in the history of Western art. Despite dazzling the world with his original use of brush strokes and colour, he died poor.
Now, his uncle, who was also named Vincent van Gogh, is not remembered. He was a very wealthy person and was a partner in an art dealership known as Goupil & Cie, which existed in 19th century Paris.
There was another great painter Henri Matisse, who is considered the second most important 20th century artist, after Picasso. In 2009, Christie’s auctioned off one of Matisse’s paintings for €32 million. However, Matisse the artist was not nearly as financially successful as the other Matisse, the art dealer, who operated the Pierre Matisse Gallery for 65 years in New York City.
The U.S.-based Horizon Research Group wrote a research paper in 2010 that suggested how the great art dealers of the 19th and 20th centuries amassed enormous fortunes even as the best painters died in poverty.
The research paper also profiled Heinz Berggruen, a German immigrant who, after arriving in the U.S. in 1939, subsequently became an Assistant Director of the San Francisco Museum of Modern Art. He eventually became an art dealer and amassed a collection by some of the world’s greatest artists and sculptors that included Georges Braque, Paul Klee, Alberto Giacometti, Matisse, and Picasso.
In the year 2000, he sold a part of his collection to the Berlin State Museum for €129 million. That’s clearly a lot of money. And if that’s not enough, this art that Berggruen sold to the German government was not his whole fortune. In the 1980s he gifted 80 paintings of Klees to the Metropolitan Museum of Art in New York City. Even so, Berggruen amassed a fortune that’s probably equal to or more than what some of the best stock market investors in the world did.
Now the big question that begets an answer is – how were people like Berggruen and the dealers at Goupil & Cie and Matisse Gallery able to choose art so wisely? And it wasn’t a question of one or two or three paintings; it was many paintings.
Choosing Wisely
Art is, after all, largely subjective. Different people interpret art differently. As the Horizon researchers wrote in their paper – “How could anyone have known what people would consider good art 50 or 100 years in the future? There aren’t any valuation metrics for art like there are for stocks. When evaluating stocks, we can talk about metrics like P/E ratios and price-to-book value ratios. They have a value, which is arguable, but at least equities can be reduced to a certain metric. There’s no such metric in art; it is much more subjective.”
So, were these art dealers so prescient? Or were they not? Were they plain lucky? Or did they have a technique? And what can we as equity investors learn from how ‘they did it’?
The Horizon researchers provide an answer they must have arrived at by connecting the dots around the one thing these art dealers did that brought them great riches over time. And that one thing, as the report reveals, is – “The great investors bought vast quantities of art.” In investing terms, they diversified.
Many of these 19th century art dealers bought whole portfolios of paintings by the great painters, much like one would buy a diversified basket of stocks.
“A subset of the collections turned out to be great investments,” the Horizon report suggests of the paintings, “and they were held for a sufficiently long period of time to allow the portfolio return to converge upon the return of the best elements in the portfolio.”
A Case For Diversification
In the fifth chapter of his book The Intelligent Investor, titled “The Defensive Investor and Common Stocks”, Benjamin Graham – known as the father of value investing – lays down the foundation for picking stocks under a section titled – Rules for the Common Stock Component.
Graham wrote, “There should be adequate though not excessive diversification. This might mean a minimum of ten different issues and a maximum of about thirty.”
He added, “Each company selected should be large, prominent and conservatively financed. Indefinite as these adjectives must be, their general sense is clear.”
In 1952, noted economist Harry Markowitz supported Graham’s view and wrote that it is inefficient to put a large holding in just a few stocks, and that investors should diversify across a large number of stocks. He wrote – “Diversification is both observed and sensible; a rule of behavior which does not imply the superiority of diversification must be rejected both as a hypothesis and as a maxim.”
Even Warren Buffett, counted among the world’s best investors ever, wrote this in his 1993 letter to shareholders – “…situation requiring wide diversification occurs when an investor who does not understand the economics of specific businesses nevertheless believes it in his interest to be a long-term owner of American industry. That investor should both own a large number of equities and space out his purchases. By periodically investing in an index fund, for example, the know-nothing investor can actually out-perform most investment professionals.
Paradoxically, when ‘dumb’ money acknowledges its limitations, it ceases to be dumb.”
Buffett, in effect, made the case of investing in index funds as a fine strategy for most investors.
Though he also added a case for not diversifying much – “On the other hand, if you are a know-something investor, able to understand business economics and to find five to ten sensibly-priced companies that possess important long-term competitive advantages, conventional diversification makes no sense for you. It is apt simply to hurt your results and increase your risk. I cannot understand why an investor of that sort elects to put money into a business that is his 20th favorite rather than simply adding that money to his top choices - the businesses he understands best and that present the least risk, along with the greatest profit potential. In the words of the prophet Mae West: “Too much of a good thing can be wonderful.”
Now, this post is not about the idea of index funds, though a broad-based low-cost index fund may be a useful diversification tool for a defensive investor. This post is about the idea of diversification – focused on equities as an asset class – and how it is such an important tool to de-risk a portfolio, even one that seems robust and built for the long term.
Surviving Shorter Cycles
A Credit Suisse report suggests that the average age of a company listed on the S&P 500 has fallen from almost 60 years old in the 1950s to less than 20 years currently. With businesses dying so soon (on an average), not just in the U.S. but also in India, concentration could be a risky idea if you are not a professional investor – the ‘know-something’ one as per Buffett’s point above. You need to sufficiently, not over, diversify.
Seth Klarman wrote in his book Margin of Safety – “Even relatively safe investments entail some probability, however small, of downside risk. The deleterious effects of such improbable events can best be mitigated through prudent diversification.”
One of the keys to creating long term wealth from stocks is to ensure that you survive long term.
And one of the keys to surviving long term is to invest in stocks of businesses that would survive the long term amidst others – from the same portfolio – that would fall by the wayside. Many would.
But that must not worry you. After all, as the 19th century art dealers from the western world proved, over a sufficiently long period of time, despite all the things you own that capitalism destroys, a well-diversified portfolio’s return would converge upon the return of the best elements in the portfolio.
Vishal Khandelwal is the founder of SafalNiveshak.com, an initiative to help people learn the art of value investing and behavioural finance to be able to make better investment decisions.
The views expressed here are those of the author and do not necessarily represent the views of Bloomberg Quint or its editorial team.