Fine art is known to have little intrinsic value beyond its cultural significance and aesthetically pleasing nature, yet it seems to be an increasingly attractive alternative to traditional investment assets. The CEO of Blackrock, Larry Fink, recently remarked that one of the “two greatest stores of wealth internationally today is contemporary art,…” adding that, all jokes aside, it is a “serious asset class.” Although many art world enthusiasts advise that people only purchase art if they truly admire it, recent record high sales and huge upside potential are attracting the attention of those more focused on profit making. One mechanism utilized by some of these profit seekers to gain exposure can be found in fund-structured vehicles sometimes referred to as “passion funds.” These art investment funds, or “passion funds,” provide the opportunity for investors to tap into the potential of art works to diversify portfolios and potentially obtain significant returns. While some money managers have also taken interest in other niche asset classes including fine wine, vintage vehicles, stringed instruments, rare gems, and even comic books, this article focuses primarily on fine art.
Background & Market
Individuals and private clubs have been collecting fine art with varying degrees of investment intent for hundreds of years. However, the first institutional investor to specifically allocate capital for the purpose of investing in art is widely considered to be the British Rail Pension Fund, having acquired about 2,500 objects during the 1970’s for a total cost of about $70 million USD, close to 3% of the total fund. Institutional investing in art works has evolved since the 1970’s, resulting in the emergence of more and more funds exclusively dedicated to the asset class. The collapse of the dot-com bubble in 2001 also fueled the art fund trend as investors looked outside of the market for alternative opportunities. This trend of looking towards alternative assets was seen again following the financial crisis of 2008, as investors increasingly focused on tangible assets and alternative types of investment opportunities. Shortly thereafter, 2010 saw record sales of art works at both Christie’s and Sotheby’s, which further demonstrated the potential offered by fine art. More recently, in 2014 the global art market reached the highest level ever recorded, a total of over €51 billion.
Managers of art funds are typically professionals from the financial industry, who have an interest and/or experience in the art world. They provide a number of crucial services including fundraising, investor relations, strategy development, market monitoring, and management of the disposition of fund assets. Art fund investors generally have some kind of prior knowledge of the art market, and are largely looking to this type of asset for diversification and hedging purposes. To qualify to invest, they must be considered “accredited investors” under SEC guidelines, meaning that they are financially sophisticated individuals or institutions that require less protection than their unsophisticated counterparts. Institutional investors commonly include pension funds, trusts, family offices, insurance companies, endowments, and sovereign wealth funds, among others. For an individual to qualify for “accredited investor” status they must meet one of the following three criteria: (1) have a net worth exceeding $1 million, either individually or jointly with a spouse; (2) have an individual income in excess of $200,000 per year; or (3) have a joint income of $300,000 during each of the last two years and reasonably expect the same level of income moving forward.
Art funds are transactional in nature. They typically generate returns by strategic purchase and sale of artworks. In the US, art funds generally adhere to the traditional hedge fund structure of a limited partnership (typically in the form of a limited liability company (“LLC”)), which consists of a managing general partner(s), and a limited partner(s) who invest in the fund. Offshore funds can take on a number of more complex feeder/master fund formations, which also usually take on the form of a limited partnership, albeit with a wider variety of structuring options depending on source(s) of investment capital, taxation and accounting preferences. An open-ended fund scheme allows for the admittance of new investors and withdrawal of current investors throughout the life of the fund. More commonly used are close-ended funds, which, as the term implies, are closed to new investors once the fixed term to raise capital has ended. A third option consists of a hybrid model, which is more closely related to a close-ended fund, but which allows for some liquidity as investors can redeem shares after providing notice. Despite the likely existence of a withdrawal fee provision, the hybrid model boosts marketability since it provides for a quick exit for investors who do not like their capital locked up.
Once the structure is created and fund raising commences, a private placement memorandum detailing the objectives, risks and terms, including the investment minimum, of the offering is drafted and provided to potential investors. When an investor decides to invest, a subscription agreement detailing number of shares, price, and other terms will be executed resulting in the investor becoming a shareholder in the fund. One prominent art fund, the London-based Fine Art Group, established in 2001, has six separate funds each of which is composed of an investment minimum of between $500,000 and $1,000,000 by 30 to 40 individual or institutional investors. Under some circumstances, investors may redeem shares, or sell to another accredited investor through a private placement, but this is typically limited or prohibited by the agreement terms.
Looking to the Future
As the interest in fine art investing continues to increase, new variations of the art fund are popping up, providing new ways for investors to access the art market. One such variation is Arthena, the first equity crowd funding platform that allows investors to pool their capital in “collections” which are curated by expert art advisors. The minimum investment per collection starts at $10,000 providing access to a much broader group of investors than the typical art fund, with a floor of upwards of $100,000.
The art investment industry has also seen a recent trend of investors moving towards art funds and privately managed art investment accounts. This allows investors to get diversification in a fund or no co-mingling with their capital and provides the opportunity to customize the objectives and strategies of the investment.