Do art funds make money and sense?
KUALA LUMPUR, Sept 27 — Art has become attractively complicated in Malaysia with the possibility of serving as an alternative “investment asset.” Speculation abounds. Prices are uneven with some rising beyond expectation and others not.
How much of THIS is hype and how much is real—a yet-to-be-seen truth.
Four local auction houses, developing commercial art storage facilities—the next thing we will be hearing about is the advent of local or regional art funds taking advantage of growth potential, high fees, asset diversification and an upbeat market.
What gives and how should we view these funds? Dollars and “sense” – do they come together in these funds?
Art funds are privately offered investment funds dedicated to the generation of returns through the acquisition and disposition of art works.
They are unsually managed by a professional art investment management or advisory firm who receives a management fee and percentage of any returns delivered by the fund.
Underlying characteristics of art funds are diverse and vary from fund to fund. While all art funds utilise some form and degree of a traditional “buy and hold” strategy, they differ in their aggregate size, duration, investment focus, investment strategies and portfolio restrictions.
However, the unifying factor of all art investment vehicles is fthe ocus on the art market, characterised by a lack of regulatory authority, deficient price discovery mechanisms, non-transparency, subjective valuations and illiquid nature of fine art.
Proponents of art investment funds argue that it is these very characteristics that generate the significant arbitrage opportunities within the market that seasoned art professionals can exploit for the benefit of the fund’s investors.
Critics of art investment funds in turn point to such characteristics as art being the riskiest asset class, and thereby creating the potential for substantial investment losses among a fund’s investors.
As always, buyer beware. Consider the funds carefully.Who is running them? What are the terms? What are the fees? What is the duration? Who buys what? Read on….
Compensation for art fund managers
The fees charged by art fund managers are primarily tied to performance, which serves to align the interests of such managers with those of the art fund’s investors.
Typically, art fund managers also charge an annual management fee of between 1 and 3 per cent of either the net asset value of the fund’s art portfolio or the total capital commitments made by the fund’s investors, as well as a performance fee equal to anywhere from 10-20 per cent of any profits made from the disposition of the fund’s art portfolio.
The funds resemble hedge funds with unregulated, high fee, high risk characterisation -- but to boot, add in art as an illiquid asset.
Why the growing interest in art funds?
The last few years have seen a significant increase in the number of art investment funds that have launched or are in the process of being launched internationally.
Much of that growth is due to the increasing recognition by the investment community that: (i) the art market continues to benefit from significant price appreciation; (ii) traditional investments in stocks and bonds over the last decade have generated, and many expect will continue to generate, poorer investment returns; (iii) the ownership of art can serve as an inflationary hedge, especially in light of the inflationary monetary policies employed by many countries in response to the 2008 credit crisis and resulting recession; (iv) art funds can produce returns that have little or no correlation to those of more traditional stock and bond investments thereby helping to diversify the overall risk of an investment portfolio; and (v) the lack of regulation of the art market provides unique opportunities for arbitrage that can be exploited for the benefit of art fund investors.
Moreover, as most art funds are structured so as to weight art fund managers’ compensation towards performance incentives that involve a significant sharing of the gains earned by the art fund between the fund’s managers and its investors, talented art market professionals are electing in growing numbers to form or work for art funds so as to share in compensatory arrangements that have the potential to greatly exceed those of traditional positions within the art world
So, how have art funds performed over time? An unfortunate fact is that given the lack of transparency and very private nature of these funds, there is little publicly available information.
One could surmise that since only good news would be reported, the lack of information itself does not bode well for the performance records of art funds.
Having said that, there is enough information to gleen what criteria should be considered in evaluating an art fund, through review of history and selective current successes and disasters.
The earliest establishment to formally adopt the rubric of the art fund was the British Rail Pension Fund in 1974. With Sotheby’s guidance, the BRPF trustees invested £40 million in over 2,500 works of art during a six-year period, justifying the move as a visionary but realistic diversification of their portfolio.
The BPRF gradually liquidated their holdings during the 1980s, and was able to deliver an aggregate return of 11.3 per cent per year compounded from 1974 to 1999.
In 1989, at the height of the decade’s boom years, the BRPF sold 25 Impressionist and Modern works through Sotheby’s for £34.8 million.
These works, representing less than 1 per cent of the fund’s total holdings, accounted for 20 per cent of its overall sales. The BRPF trustees had managed to ride the art market’s ebb and flow successfully, though such an achievement owes a large part of its accomplishment to lucky timing.
One of the star pieces of the collection, Monet’s Santa Maria della Salute, purchased in 1979 for £253,000, fetched £6.1 million when the fund sold it a decade later, but critics noted that comparable Monets didn’t show major increases in the following decade, suggesting that the retention of the collection into the 1990s would have produced disappointing returns.
The fund is one of the only examples of an institution investing in art funds. This eliminated the problem of raising sufficient start-up capital, an issue faced by many later funds.
A current fund, The Fine Art Fund, was founded in 2002 by ex-Christie’s director Philip Hoffman. This London-based art investment house is another more recent example of an art fund’s success.
In May 2011, The Fine Art Fund reported returns of 25.5 per cent. With Hoffman currently advising on assets of over US$200 million – a figure he expects to double by 2014 -- the organisation took the art fund model to a wider stage, becoming the first fund of its type to invest in art as a worldwide asset class.
Hoffman runs four closed funds under the Fine Art Fund Group umbrella, with 30-40 individuals and institutions who have paid between US$250,000 to US$7 million to buy into the funds investing in each: The Fine Art Fund (closed in July 2005, average annualised returns on assets sold of 34 per cent), The Fine Art Fund II (closed in 2008, average annualised returns on assets sold of 29 per cent), the Chinese Art Fund (closed 2008, no assets realised yet), and the Middle Eastern Art Fund.
Again, the funds benefitted from their timing, coinciding with the near-collapse of the banking system in 2008. Hoffman recalls a collector who had hesitated to sell at $5.2 million in 2003, but who in 2008 parted with the work for US$750,000 in his desperate search for cash.
In response to the financial crash, Hoffman opportunistically announced the planned formation of The Fine Art Fund III, a “distressed art fund” that would look to buy works of art at a fraction of their previous cost.
Like the BRPF, Hoffman’s funds have most of their profit from a handful of lucrative works, with the sale of around 70 works for a total of $50 million in the four year period between 2008-2012 accounting for the high return rate.
The vast majority of works of lesser value are stored in a Swiss warehouse, or occasionally lent to museums or investors. Hoffman’s model has gone several steps further than the BPRF prototype, however, in its creation of its new flagship product, Managed Art Portfolio Services.
The line between financial investment and luxury acquisition becomes ever more blurred in this new generation of collecting as the wealthiest investors approach the art market through a freshly carved back door.
A new model of art fund can be seen in the Art Futures Fund. Describing itself as “the world’s leading brokerage specialising in Asian contemporary arts”, Art Futures distinguishes itself from the “high cost, low control” art fund system and opting for bespoke services that promise the client more control and “complete ownership” of their investments.
Headquarted in Hong Kong, AFG benefits from the city’s tax-free port with no GST, VAT or capital gains tax, as well as its lack of wealth tax, import duty and estate tax.
While most art funds store their assets in tax havens such as Switzerland or the British Virgin Islands, AFG is clearly positioning itself to draw clients with a particular investment in Chinese and Asian art.
Focussed on investors with US$10,000 to US$20,000 to spend on mid-career mainland Chinese artists, in light of the China market optimism, it looks attractive.
While AFG’s services are tailor-made for each client, co-founder Jonathan Macey is quick to point out that the group’s approach to purchases are based on fundamentals rather than emotions.
His clients do not keep the works they invest in, but rather send them straight to storage. “We are like asset managers,” says Macey, though is careful not to say that they are asset managers.
Macey favours investing in mid-term artists with a track record of about 10 years, seeing this category as a steady investment on which his clients can generally expect returns on of 12 to 15 per cent. But none of these funds guarantee returns, do they?
Those are the positive stories thus far. There are a host of art fund horror stories out there.
The New York-based Fernwood Art Investment is an example of a fund that failed to live up to its starry appearance.
Fernwood’s founder, Bruce Taub, was a former Merrill Lynch manager. Its CEO was Sotheby’s head of marketing for Asia and America, Michael J. Plummer, and its two managing directors, Patrick Cooney and Rachel Kaminsky, were senior executives at Christies, New York.
Fernwood compounded its high-profile image by sponsoring Art Basil Miami and the Brooklyn Museum’s 2005 Basquiat exhibition.
Taub announced that Fernwood would offer two funds, the Fernwood Sector Allocation Fund (to focus on a broad range of blue-chip art acquisitions), and the Fernwood Opportunity Fund (to offer riskier investments in emerging artists).
Despite the fact that only those with US$5 million or more in investible assets were qualified to apply, Fernwood only raised US$8 million of the projected US$100-150 million required.
Fernwood cleared its Brooklyn and New York offices before the fund even opened, with some commentators noting that it could well have made significant returns had it remained open and invested in blue-chip artists.
In 2006, Taub was found guilty of embezzlement, and forced to pay more than US$2.6 million to his investors. He was accused by those around him of having used the US$8 million raised by the fund to propel himself into elite art world circles and paying his personal expenses.
Another fund that went up in flames, Osian’s Art Fund, India, that collapsed, riding on the heels of the then very successful Osian Auction House.
In April 2013, the Indian market watchdog, Sebi, demanded that Osian wind up its “collective investment scheme”, refunding investor’s capital with 10 per cent interest within three months. Osian’s seems to have fallen foul of Sebi after failing to register with the regulatory body.
This is not the only complaint that has been lodged against Osian’s Art Fund and its director, Neville Tuli.
Founded in 2006 as a three-year close-ended fund, Tuli promised his 656 investors dazzling returns of 30-35 per cent. But by 2012, many investors were still left empty handed and unsuccessfully chasing Tuli for their money.
The global recession had frozen the art market, landing Osian’s in a liquidity crisis that saw the value of Tuli’s collection plummet.
Osian tried to placate its aggrieved investors, answering demands for repayment with the claim that it was taking the ethical high ground, and waiting for the market to recover in order to protect its investors from catastrophic losses.
Unfortunately for Osian’s and Tuli, Sebi’s recent order for repayment means that this waiting game did not pay off.
In contrast, and Indian Art Fund that appears to have done well, though there is no public information on payout is Saffronart’s Advisory Service which can be seen as Mumbai’s answer to the Art Futures Group.
Offering its clients its own state-of-the-art storage facility, a dedicated team of art experts and a personal relationship manager, Saffronart is going down the smaller scale, bespoke route that clearly aims to attract the high net worth individual investors rather than a wide range of institutional investors looking for a close-ended, high-return investment option. Client privacy is highlighted, so there is no published information on the Service’s success.
So what next? There are undoubtedly numerous flaws in the standard art fund model, namely: its inability to attract large institutional investors and thus gain sufficient start-up capital; its high management and ancillary costs; and its basis on a fundamentally unregulated, timing-dependent and illiquid art market.
As a very minor investment to diversify a portfolio of stocks and commodities, art funds will perhaps hold onto their small patch of investment territory.
The real future of art investment seems to be through targeted, tailored advisory services that essentially act as hidden private galleries. Art Futures Group and Saffronart have both taken advantage of the recent growth of interest in Asian art, but have chosen to restrict their focus to high net worth individual in order to eliminate the risk of insufficient capital.
If art funds are to continue, it seems likely that it will be in this more flexible but exclusive mould, open only to the elite of an already exclusive asset type.
For the rest of the collecting world, it would be fair to say that, as with any fund, care should be taken in evaluating managers, conflict positions (who is selling what and what prices to the fund), reporting requirements and of course fees (stated and hidden).
This advisor far prefers advising clients on how to build quality collections; that give worthy returns through conservative and disciplined collecting practises; that add aesthetic lustre as well as meaning to lives—rather than investing in art that will be locked away, for huge fees, with the possibility of the art and the returns never seeing the light of day.
* Shalini Ganendra is a fine arts consultant and gallerist.