February 18, 2011

Art-Investment Partnerships Gaining Visibility

Recent returns and challenges have led to a growing interest in professionally managed art funds

Art is in vogue as an investment, and several factors appear to be driving the interest. The financial markets’ recovery has increased wealthy investors’ confidence, and that increase is being reflected in their spending patterns.

According to the Capgemini and Merrill Lynch World Wealth Report 2010, “[T]he demand for passion investments overall is expected to increase … as wealth levels rebound. This is evidenced by the fact that auction houses, luxury goods makers and high-end service providers all reported signs of renewed demand toward the end of 2009, and in the early part of 2010.”

Art’s recent financial performance as an asset class is another factor. The Mei Moses All Art Index grew by 16.06% in 2010 versus a 15.06% total return for the S&P 500.

From a longer term perspective, according to Mei Moses, art has had compound annual returns of 4.86% for the most recent five years and 3.59% over the past decade, exceeding the S&P’s returns of 1.35% and 2.28% respectively.

Fine-art investments pose several challenges, though. Investors need niche-market expertise to avoid mispricing purchases and sales, and misjudging market trends.

In addition, building a diversified collection of high-end art without creating excessive exposure to the illiquid asset class takes substantial wealth.

And there are problems with storage and security: As a tangible, portable asset, art pieces are at risk for damage and theft.

These challenges have led to a growing interest in professionally managed art funds aimed at wealthy investors.

Art-Focused Funds

Randall Willette, a managing director of Fine Art Wealth Management Ltd. in London, estimates that there are between 30 to 40 art and collectible investment vehicles globally, including those that are under development and/or sitting on the sidelines waiting for investors to return.

Players in this market consist primarily of specialist investment-management boutiques, private banks, family offices and a growing number of alternative-fund providers looking to integrate art into their overall offerings.

According to Rhea Papanicolaou with the Fine Art Fund Group in London, the rationale behind most art funds is fairly similar.

Works of art are bought at a competitive price and stored in warehouses or on private exhibition, only to be sold for a profit a few months or years later, she says.

In terms of structure, art funds can be set up much like private-equity funds, since they are long-term close-ended partnerships and usually charge a management fee and a performance fee.

These funds are designed for sophisticated and qualified investors (predominantly private, not institutional), according to Willette. Minimum subscription for most of these funds is currently around $250,000, experts say.

Management fees and performance fees vary but are generally comparable to other alternative funds with an annual management fee of roughly 2% per annum and a performance fee of 20% with some kind of hurdle rate.

Asset Appreciation

Willette also cites private-equity funds as an analogy for art funds, because the goal of both models is asset appreciation.

Private collectors are often motivated by a passion for an artist, a period, and so on. In contrast, art partnerships focus solely on profit potential.

According to Papanicolaou , her firm looks at art purely as an investment. Its staff members never buy a work of art because they like it aesthetically; they only buy in order to seek longer-term capital growth for their investors.

Art-fund investors are looking at fine art as a diversification of their investments, without necessarily having a passion or strong interest in art.

They can be solely interested in returns, even though they often enjoy the side benefits of this investment, namely, expert analysis, art advisory and co-ownership of a major work of art.

This is precisely why a fund manager needs to be bullish and look at art purely as a means of making money. It is all about spotting an opportunity, Papanicolaou shares, and it doesn’t matter whether it’s about paintings, commodities or shares.

That focus has paid off for the firm’s investors, according to Papanicolaou. The partnerships sometimes buy with a five- to 10-year outlook but also purchase works that they might sell within a month or two.

The average holding period for assets sold is 18 months, and the firm has realized annualized returns of about 27% on assets sold across all its funds.

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