Funds To Please The Eye

But with subjective valuations and steep costs, the new art funds look rather risky

Art is hot, but collectors aren't the only ones generating the heat. Financiers, eager to profit from escalating prices, aim to turn art into more of a mass-market asset class -- much as they did for real estate through real estate investment trusts starting in the 1960s.

Former Sotheby's Holdings (BID ) and Christie's International auction-house directors, bankers, and Wall Street money managers have plans to launch at least six investment funds in the first half of 2005. They will acquire works in various segments of the art market and hold them for up to 10 years. At least another half-dozen funds are expected to go public this year. The funds are targeting individuals with at least $5 million in investable assets, private banks, family offices, universities, and pension funds. Minimums start at $250,000, but some sponsors are talking about eventually lowering the cost of entry to $50,000.

With such activity, it didn't take long for Dutch bank ABN Amro (ABN ) to announce a fund of art funds. In addition to vetting proposals from fund managers who want to be included, "we're even hearing from wealthy families in Europe who want to turn their art collections into investment funds," says Ariel Salama, global head of private banks at ABN Amro's wholesale client business in London.

Enthusiasm like that usually hints at a frothy market. "People outside the art world see the gains and want a piece of the action," says Mary Hoeveler, managing director of Citigroup Private Bank's (C ) Art Advisory Service. The rush into art funds gives some U.S. private banks such as Citibank (C ), JPMorgan (JPM ), and UBS (UBS ) reason to stay out. "We still view art as a core passion as opposed to solely an investment," says Tony Werley, head of portfolio construction at JPMorgan Private Bank. Werley and others cite the difficulty of valuing art, its lack of liquidity, high transaction costs, and volatility as obstacles to investing in art for purely financial gain.

Still, high-net-worth investors, dispirited by lackluster returns on stocks and bonds, may respond to the art-fund pitch. Also, the numbers support the case to invest. One proxy for the broad art market, the Mei/Moses Annual All Art Index, has a 50-year compound annualized return of 10.47%, vs. 10.95% for the Standard & Poor's 500-stock index. (The Mei/Moses index is only four years old but draws data from more than 8,000 repeat art sales using New York auction records dating back to 1875. Keep in mind that steep transaction costs will reduce the returns on art.) From 1999 through 2004, the index returned 7.27%, vs. -2.4% for the S&P 500. Perhaps the biggest selling point is "that art has a low correlation with stocks and bonds," says Michael Moses, a management professor at New York University's Leonard N. Stern School of Business who created the index with Stern finance professor Jianping Mei.

The new crop of art funds isn't the first to try this investment approach. In the mid-1970s, British Rail Pension Fund put $100 million, or 2.5% of its portfolio, into art. The fund amassed a broad collection of 2,400 pieces, from Chinese porcelains to African tribal art. The portfolio wound up with an annual compound return of 11.3%, but the gains came primarily from 25 Impressionist paintings. The fund sold off all of its art from 1987 to 1999. "We tried to diversify too much," says Jeremy Eckstein, a former adviser to the fund who is consulting with some of the new players.

To avoid overextension, The Fine Art Fund, the biggest of the new ventures, plans to buy no more than 500 works in four categories: Old Masters, Contemporary, Modern, and Impressionism. Founded by ex-Christie's exec Philip Hoffman, the London-based fund has raised an estimated $100 million of the $350 million target from qualified investors who have ponied up the $250,000 minimum. Sources close to the fund say the sponsors are looking for an annual return of 10% to 15%, though they expect to make as much as 100% on some paintings. Similar to a hedge fund, investors will have to deduct a 2% annual management fee (in this case to help cover insurance, storage, and maintenance for the art). Plus, there's a 20% performance fee from the profits if the annual return exceeds 6%.

Investors' money is locked up for the fund's 10-year life. Profits and capital will be distributed starting in the third year. The fund plans to generate income by allowing its investors to rent works valued at up to three times their investment. Fund organizers won't say how much rent they plan to charge.

Most of the other ventures, such as the American Art Fund and China Investment Fund, are also structured as closed private equity funds. One exception is an open-ended fund from Boston-based advisory firm Fernwood Art Investments. Founder Bruce Taub, a collector and 20-year veteran of Merrill Lynch (MER ), plans to launch two funds this year with an estimated $150 million. One will let investors buy and redeem shares twice a year. The other will be closed, with half of its capital helping to finance art transactions. For instance, the fund may join a consortium of investors organized to fund a quick buy and sale of a piece. Neither portfolio will rent its holdings but both will lend pieces to museums or important exhibitions. That way, "the value of the art will be enhanced through exposure," says Taub, who won't disclose fees or investment minimums.

All of the art funds plan to give investors a yearly statement with a professional appraisal of the art in their portfolios. "But that value means nothing," says Lord Mark Poltimore, chairman of 19th and 20th century pictures in Europe at Sotheby's. "No one really knows what something is worth until the auction hammer goes down and the piece is sold."

It is precisely that arbitrary nature of the investment that makes Wall Street nervous. Critics of art funds argue that art indexes can be misleading because they don't take the considerable transaction costs into account. Works sold at auction normally carry both a buyer's and seller's premium of 10% or more, and dealers can charge as much as 50%. "Art funds may be able to negotiate with auction houses to drive the commissions down, but that isn't clear yet," says Karl Schweizer, head of art banking for UBS Global Asset Management in Basel, Switzerland.


Another problem with most analyses of the art market is that they account only for art sold at auction. While no one knows exactly what the breakdown is between private deals and public sales, "a huge sector of the market has no transparency and can't be analyzed," says Citibank's Hoeveler. Plus, "only paintings in broad enough demand to attract competitive bidding are offered at auctions," she says. That demand is extremely subjective, typically driven by a handful of collectors and dealers who decide what's hot. For every record-setting sale, there are pieces withdrawn from the market because bidding doesn't meet the seller's minimum price.

Liquidity in the art market is limited, and prices can go down, too -- even for the works of great artists. For instance, Pierre-Auguste Renoir's A Young Woman Bathing sold at auction for $11.3 million in 1997. Seven years later, it went for $7.3 million.

Despite the drawbacks, art fund fans say it's just a matter of time before U.S. investment advisers climb aboard. Those on the fence can learn more in early April at a conference Christie's is hosting in New York. "Interest is coming mainly from Europeans now," says ABN Amro's Salama. "U.S. managers are taking a wait-and-see approach." Individuals would be wise to watch from a distance as well.

By Toddi Gutner with Kerry Capell in London

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