Michael Plummer, Principal and Jeff Rabin, Principal
Artvest Partners LLC
The outstanding performance of the art market over the past 10 years, coupled with the trepidation many have about financial markets post-2008, has led to growing interest in art as an investment and increased dialogue about art fund vehicles.
Defining an art fund
The sheer mention of the term ‘art fund’ often stirs controversy. A contributing factor to the lack of understanding and agreement is that the term is broadly, and sometimes inappropriately, applied. Artvest defines an art fund as a structured investment vehicle with Offering Documents that is open to third-party investors for the purpose of financial gain. Everything from valuation methodology, to inherent conflicts of interest, to risk control and diversification must be sound, well-considered and documented. Properly created, an art fund will share similarities in structure to financial asset funds yet take into account the crucial difference that art is the underlying asset. Specialised expertise is essential to successfully manage such an entity.
Private Investment Partnerships (PIPs) are often conflated with art funds, creating additional misunderstanding. Unlike art funds, PIPs are not made available to outside investors and are simply groups of individuals who have pooled resources to invest in art or other assets.
The current art fund landscape
The scale of the art fund industry is commonly believed to be significantly larger than it is. New fund announcements usually garner extensive attention from the press yet few actually raise capital, and those that do are typically a fraction of their intended size. It is not uncommon for funds that had stated goals of US$100 million+ when announced, to have total assets under management of US$10 – US$15 million when they close on funding and begin art buying.
There are less than a handful of operational art funds investing meaningful capital — greater than US$50 million. Artvest estimates the global art fund industry to be US$1 billion, with Asian funds accounting for approximately one third of that total.
Traction has been slow for a number of reasons, most importantly apprehension about investing in a little-understood market. Another concern is the impact that unpredictable trends in fashion and taste can have on the art market over time. A scarcity of art fund structuring expertise has also been a detriment. These factors, along with the absence of established long-term track records, has made the possibility of meaningful institutional investment in art funds a challenge thus far.
Further exacerbating the broader acceptance of art funds are a few notable instances of fraud and/or incompetence in the last five years — the result of unscrupulous practices by a handful of individuals that led to the loss of investor capital, numerous lawsuits and a considerable hit to the industry.
More confusion comes from individuals successful in financial products venturing into the art fund space, believing that their experience is portable. The art market is remarkably different from all other asset classes — it is opaque, illiquid, unregulated, non-commoditised and emotional. A deep understanding of the players, artists, sectors and intricacies is essential. Getting involved without this knowledge is akin to letting a child drive the family car.
Considerable due diligence is imperative
When considering an art fund investment, many critical questions must be answered such as: how is the fund structured; are there adequate risk controls; how often is the fund valued and what is the methodology; what is the liquidation strategy; and most importantly, who are the principals and advisors, how are they compensated and what are their potential conflicts of interest? This is not by any means a comprehensive list, the questions are many and engaging a true expert before committing capital to any art fund is crucial.
The art fund industry is still in its infancy, so experts with authentic experience are few and far between. Lack of regulation has allowed for the unfortunate rise of self-appointed experts which has made it more difficult for potential fund investors to separate fact from fiction. One ill-informed art fund ‘expert’ went so far as to make the erroneous claim in an interview this past spring on the Financial Times website that art funds put a floor in the art market during the correction in the last half of 2008. This is a patently false claim given that the buying power of art funds was less than 0.25% of the US$59.5 billion market turnover that year.
Opposing sides in the art fund debate
A primary disagreement in the art fund debate centers on investment versus connoisseurship. As the tradable art market has increased dramatically, both in terms of overall transactions and values of individual works of art, interest has expanded considerably. Many new entrants see the market as another opportunity for financial gain while more traditional collectors adhere to the notion that art is simply to be lived with and enjoyed.
Art funds in Asia
China and India have seen the quickest adoption of art funds. During the past five years, the number of Asian-based art investment funds has experienced unprecedented growth. Art funds first gained traction in India, but since the financial crisis, China has become the more important player. Artvest has also identified a number of active PIPs in Asia. Though there is little information available because they are not open to outside investors, PIPs are an increasingly influential force in the market.
Primarily, Asian art funds are focused on acquiring works by native artists and are typically able to raise capital more quickly than Western art funds given the region’s predisposition for tangible assets. In addition, the willingness of Asian banks, including ICICI, Kotak Mahindra and Minsheng, to actively participate in the art fund industry has further legitimised interest.
Recently Indian-based art funds have encountered several critical setbacks. Many of India’s art funds have struggled with eroding valuations, negative press coverage and rumours of difficulty honouring fund redemptions. It has been reported that the Securities and Exchange Board of India may soon institute stringent rules and regulations for local art funds, which will have a consequential impact on the future of India’s art fund industry.
In China, however, the soaring art market has led to an increasing number of art investment funds currently raising capital or acquiring art. While inefficiencies in the art market in China present potentially lucrative opportunities for art funds, there are numerous obstacles that may hinder the industry’s future. For example, as the value of Chinese art continues to rise, Chinese art funds will face the challenge of raising increasingly large amounts of capital in order to remain relevant and competitive.
Despite these issues, interest in art funds continues to grow and the future is certain to see more legitimate vehicles coming to the market. Several funds in the US and the UK are in the process of raising capital for their second or third generation funds and finding it much easier to do so, now that they have established track records.
Continued global economic uncertainty combined with low interest rates has led many to seek investments outside of traditional financial vehicles. As new art funds proliferate and investors commit more capital, due diligence will become more imperative and a full understanding of such issues as tax consequences, legal implications, risk management, market access and collecting trends will be all the more critical.
This article first appeared in the Fall 2011 issue of Artvest Market Analysis. For more information, please visit www.artvest.com.