Art Investment Funds: Overview

overview

This note considers fine art investment funds, a form of investment that has arguably attracted more media and academic interest than practitioners.

It covers -

this page - concepts, key issues and studies
operation - what does management of an art investment fund involve
models - an examination of specific fine art investment funds and questions about practice in Japan
music - a perspective on art investment funds by considering investment in musical instruments, classical coins and other exotica.

It supplements discussion in the e-Capital & Investment guide, collectibles note and hedge fund note elsewhere on this site.

introduction

There is a long history of individuals and retailers actively trading old master paintings, classical sculptures, ceramics, coins, drawings, antique furniture and other upmarket collectibles. Traditionally, however, there has been little interest in operation of a commercial fund that invested in art works rather than in shares, bonds or real estate and that provided superior financial rewards for investors by trading those works.

That disinterest reflected questions of status and value, for example notions that social elites were identifiable by their capacity to disregard commerce and pursue connoisseurship. Retention of what Thorstein Veblen labelled 'useless' commodities, such as Roman marbles - in contrast to useful assets such as agricultural and urban land or coal mines that generated ongoing revenue - was a distinguishing mark of the gentleman, a creature far superior to the mere trader. (Traders were characterised as creatures of coarser fibre, sullied by involvement in grubby commerce and concerned to make as much money as quickly as possible, although of course redeemable through marriage to one's genteel but poor daughter).

Disinterest also reflected the immaturity of the art market compared to other opportunities for investment. Most simply, investment in the stock market would provide wealthy individuals and insurance companies or other custodians of wealth with the desired liquidity, capital appreciation and revenue stream (in the form of dividends and share splits).

From at least the 1850s academics suggested that it would be possible to develop a fund for investment in fine art and some enthusiasts formed clubs for purchase and sale of 'recognised' paintings or new works by emerging artists. One example was the pioneering La Peau de l'Ours syndicate, discussed in the note on droit de suite, which sought to both foster struggling artists and reward syndicate members when Impressionism was recognised as one of the glories of French culture rather than a product of escapees from the Salpetriere.

Contemporary art investment vehicles (AIVs) emerged after the 2000. Emergence followed "legendary" investment in art by the British Rail Pension Fund (BRPF) from 1974 to 1989. Emergence reflected several factors.

One was simply the increasing sophistication of part of the investment community, accustomed to dealing with a range of derivatives and able to conceptualise fine art and antiquities as just another commodity that could be accurately valued and readily traded in a specialist market.

Another was the availability of capital, with major institutional investors and some wealthy individuals (who subsequently fuelled the growth of private equity funds and hedge funds) having money at their disposal and being prepared to take risks in diversifying from traditional investment portfolios that centred on treasury bonds and blue chip stocks.

A third factor was the perceived failure of those portfolios to keep pace with inflation, whether through capital appreciation or through revenue flow. That perception interacted with a recognition that supplies of some collectibles were clearly finite (for example almost all works by some Old Masters had moved off the market into museums) and that prices were showing ongoing dramatic increases.

It was underpinned by increased access to information about prices, with establishment of a range of fine art price indexes and analysis purporting to show that substantial increases were occurring irrespective of the quality or prominence of the work/artist.

The final factor, often not discussed in accounts of early art funds, was the same generational change evident among art museums, commercial galleries and auction houses, with investment in art being seen as hip, 'sexy' - far more exciting than speculation in pork bellies or copra futures - and even visionary.

In practice performance by the BRPF was not spectacular (as discussed below the trustees might have got better returns by investing in the share market) and resulted in more media coverage than emulation. There were no major public funds specialising in fine art and trading on a large scale, in contrast to funds specialising in real estate or other assets. Marketing by Merrill Lynch and Kidder Peabody of funds for speculation in classical coinage ended in pain for the investors and substantial losses for the promoters.

Easy money at the end of the millennium, coinciding with another round of price increases in the sale of Old and New Masters, saw renewed interest in art funds and upbeat announcements for the prospects of over 23 funds based in Europe and North America.

High profile launches of specialist funds were not however matched by large-scale follow through and as of late 2006 it is difficult to talk of an art fund industry that features a range of players, clear benchmarks for performance and transparency in competition.

Art funds remain a curiosity. That is unlikely to change in the immediate future, despite announcements in 2006 - as in the 1970s, 1980s and 1990s - that "art is the newest asset class".

what are art investment funds?

Art funds are investment vehicles that, like hedge funds and private equity funds, exist to provide substantial commercial rewards to two categories of people or institutions -

those who provide the capital that allows acquisition of the art
those who manage the fund.

In practice most managers draw on a range of advisers and specialist service providers. The interests of those three entities are not necessarily identical.

Although art funds deal with objects that may be described in spiritual terms (eg "embodiment of the human spirit"), may represent unique aspect of a nation or region's cultural patrimony and may be considered 'priceless' those funds are about money. They aim to maximise the rate of return on works in their collection, subject to the rule of law.

They do not aim to hold those works in perpetuity. The period of retention reflects the balance between -

pressure by investors (some are more patient than others)
particular remuneration arrangements (some fund proponents have adopted the private equity fund model, with managers gaining a percentage of aquisition and sale prices in addition to standard fees)
perceptions of when is the best time to sell, ie to secure the maximum profit on an item by item basis or fund basis

Broadly, managers and investors expect to see substantial deacquisitions. Sale of works acquired by a fund may occur progressively throughout the life of a fund - with returns being useful in purchase of works that will provide greater returns in future and in securing participation by additional investors - or through termination of the fund.

Regulatory frameworks are analogous to those of hedge funds. Lower compliance costs for provision of capital by institutional, corporate and wealthy individual investors has meant that funds are not oriented to 'mum & dad' investors.

That orientation also reflects administrative costs. It is easier to get capital from a small number of rich investors than from a large number of poor investors; rich investors are more likely to be patient and thus not burden the fund operator with costs through short term departure from the fund. As a result proposals for art investment funds have centred on provision of capital by a single entity (the BRPF model) or by a handful of investors.

relativities

It is common to see claims such as

Unlike property and shares, quality art is largely insulated from the volatility of investment markets providing vital diversification when markets are falling. The art market is considerably less volatile and is less sensitive to economic crises and geopolitical events than other assets. Compared to many alternative investments, art also involves low transaction and holding costs.

Eileen Chanin more perceptively quipped in Collecting Art (Roseville: Craftsman House 1990) that

The statement that 'Art is a good investment' usually means: 'Some works of art have been a very profitable speculation'

As discussed elsewhere on this site, owners of particular art works and other collectibles (including stamps, rare coins, vintage cars, literary manuscripts and even exotica such as the four pair of ruby red slippers worn by Judy Garland in The Wizard of Oz) have seen substantial - even staggering - increases in prices that other consumers are prepared to pay for those assets. Appreciation of ten times the initial price, or one hundred or even a thousand times, is not uncommon for canonical works.

It is clear, however, that

not all works have appreciated at the same rate
prices paid for canonical works rise and fall in the short term, with for example slumps in the price of Impressionist and modern masters during the 1980s after the collapse of the Japanese property bubble and the 1987 stockmarket crash in Australia and elsewhere
prices rise and fall in the long term as works move in and out of the canon. Prices paid for Pre-Raphaelite works, for example, dived after the 1890s and only recovered substantially from the 1960s onwards. Despite the efforts of collectors such as Evelyn Waugh and Andrew Lloyd-Webber in real terms those paintings have never reached their pre-1900 peak.
demand for some works has a geographical basis, reflecting market sophistication (Robert Hughes' tart dismissal of Japan's "weakness for yucky little Renoirs and third-string Ecole de Paris painters") or national cultures (Hans Heysen isn't part of the national myth in Thailand, Germany or the US)
acquisition, maintenance and trading costs are tangible (expertise is expensive and is required because information about the market is thin, auction houses or dealers take 10% or more of the price, there is no dividend or rental stream to offset storage and insurance costs)
prices are influenced by factors such as interest rates, inflation rates, endorsement by scholars and institutions, and 'behavioural finance' (ie perceptions that prices will rise steeply and with low risk, encouraging speculation)
some major financial institutions have been markedly more cautious about art or antiquities based investing, influenced by the experience of their peers and lack of interest among many of their clients

It is also clear that although the market value of particular art works increases, the market value of other assets often increases at a greater rate in the long term. Buying a Picasso or Leger oil in the 1950s would produce a respectable profit when that painting was sold thirty or fifty years later. The same sum, however, would have generated a better return if invested in Xerox or IBM, particularly if the investor was not passive and migrated to another growth stock when the price of Xerox and IBM declined.

The studies by Moses & Mei noted elsewhere on this site suggest that over the past half century US shares (represented by the S&P 500) returned 10.9% annually: art returned 10.5% per annum. Exceptional profits are dependent on fortune and selection of what proves to be a winner in the medium term. Moses & Mei discount transaction costs, which can be up to 20% of the sale price.

From the perspective of purchasing power - what a dollar, guilder, krona, franc or pound could buy in 1850, 1890, 1920, 1970 and 2006 - the prices paid by Gilded Age moguls for works by Romney, Makart, Friant or Bouguereau will never be fully recouped. Will works by Juan Davila, Emin, the Chapman Brothers, Hirst, Schnabel and Koons retain their value?

studies

There has been little major writing on art investment funds and in particular there is no independent monograph.

Salient works include Peter Cannon-Brookes' 'Art Investment and the British Rail Pension Fund' in Museum Management and Curatorship (15, 4) 1996 and the HBS study Fernwood Art Investments: Leading in an Imperfect Marketplace by Boris Groysberg, Joel Podolny & Tim Keller.

For questions of valuation and returns see the discussion of pricing and valuation in the Collectibles note elsewhere on this site. It points to major works such as

William Goetzman's 1993 'Accounting for Taste: An Analysis of Art Returns Over Three Centuries' in American Economic Review 83 (5)
William Baumol's 1986 'Unnatural Value: or Art Investment as a Floating Crap Game' in American Economic Review (5)
Jianping Mei & Michael Moses' 2002 paper (PDF) 'Art as Investment and the Underperformance of Masterpieces: Evidence from 1875-2002'
William Grammp's Pricing the Priceless (New York: Basic Books 1989)
Jean Picard Stein's 1977 'The Monetary Appreciation of Paintings' in Journal of Political Economy 85
Orley Ashenfelter & Kathryn Graddy's 2003 'Auctions and the Price of Art' in the Journal of Economic Literature
Helen Higgs & Andrew Worthington's 2005 'Financial Returns and Price Determinants in the Australian Art Market, 1973-2003' in Economic Record 81
Rachel Campbell & Joshua Pullan's 'Diversification into Art Mutual Funds' in Diversification & Portfolio Management of Mutual Funds (New York: Palgrave 2006) edited by Greg Gregoriou
Rachel Campbell's 2005 paper 'Art as an Alternative Asset Class'.

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