Art funds: the good, the bad and the ugly

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Art funds are an increasingly respectable form of investment but the memory of some disastrous early failures still lingers. Private Art Investor asked Enrique Liberman, president of the Art Fund Association and Chair of the Art Law + Art Funds practice group at Bowles Liberman & Newman LLP, what the future holds.

If you want to enter the art market at higher price points than you can afford on your own, art funds offer an attractive solution – and as art gains ground as a viable asset, it’s no surprise that these funds are on the rise.

But how do you decide who to entrust with your money? According to Enrique Liberman, president of the Art Fund Association, art funds can roughly be grouped into three categories: “the good, the bad and the ugly.”

It’s no secret that some of the earliest art funds went spectacularly  up in smoke: take Fernwood Art Investments, for instance, which closed its doors after four years, prompting litigation by a minority group of the company’s equity investors.

Such ventures fall into Liberman’s “bad” category.

“In this category there can be anything from fraud to overpaying for the works. It can also be bad market timing –for example, if an art fund makes most of its investments or has to sell or wind down the fund at the wrong time,” he says.

However, lessons have been learned from these early failures, and Liberman is now seeing a trend towards increasing restrictions on capital deployment beyond the traditional portfolio restrictions of how much money the fund can invest in any one artist or any particular artistic medium or art historical period.

“We’re also seeing bandwidth restrictions – so, for example, if you’re a $50m art fund, you don’t invest more than $10 to $15m of that money in any given year. This ensures that you’re not buying a huge chunk of your portfolio at the top of the market and being left with insufficient capital to invest once the correction happens.  It’s important to keep some of your powder dry.”

A struggle for investment

The failure of some art funds is self-inflicted; other funds (Liberman’s “ugly” category) fail for reasons beyond their control.

These are the funds whose managers have great experience and access to excellent art investment opportunities, but which struggle because traditional capital sources still fail to understand art funds and the art market. The result is that many art funds strive unsuccessfully to raise capital.

“This can happen because many of the people that want to start art funds are experts in the market and for all intents and purposes should be regarded as having prior performance, but they are not viewed in that way because they’ve never run an art fund before or any kind of investment fund,” says Liberman.

“Many sources of capital say that they only want to invest with fund managers with prior performance records, which are audited and can be evaluated, and who have had a certain amount of money go through their funds. This can mean many potentially successful art fund manager are automatically eliminated from consideration by many capital sources.”

In this challenging landscape, only the “good” are likely to survive and offer decent returns.

“A good fund will have a great art fund manager who has a proper investment strategy, a proper way of managing the funds in terms of keeping costs low and sourcing great opportunities, and who goes to the market and raises the capital successfully. Fortunately, there are many art funds that meet that model,” says Liberman.

New developments

Liberman and his colleagues set up the Art Fund Association in 2009 as a direct response to the growing trend for art funds, and the need to share knowledge and experience within the art fund world and alternative investments industry so that more funds fall into the “good” category.

“We realised that there needed to be a trade association where art fund managers and professionals in the art market working with art funds could come together and foster best practices for the industry, discuss how to promote the industry and how to help guide it in its early stages,” he says.

During his time running the association, Liberman has seen several trends develop. One is a shift away from the traditional private equity fund structure whereby everyone stays in the fund until its maturity date – usually five to seven years. With the traditional private equity fund structure there are no early withdrawals. Liberman sees this as preferable because it ensures there are no forced sales carried out to let people in and out of the fund and management and performance fees are not based upon a net asset value that may not accurately reflect the true value of the fund’s investments.

However, since the market crash of 2008, investors have been wary of tying up their money for several years with no get out clause.

“Art funds by their very nature are illiquid – and that was a real problem with fund raising after 2008, so now we’re seeing more hybrids that resemble a private equity fund in that people aren’t really supposed to be able to come in or out and fees are charged on actual capital raised and profits realised – but at the same time you do allow some limited liquidity; you allow some people to withdraw; maybe 5-10% of the fund in any given year. This helps market the fund to investors: they feel that they are not completely trapped.”

The other trend Liberman has seen is the rise of private managed accounts as a result of fund managers pitching to family offices and high net worth investors who want to be in the art market. These investors are often reluctant to comingle their moneys with others and don’t want to be bound by restrictions on liquidity and on when they can sell. They often have a longer term horizon and actually want to directly own the art.

It is becoming increasingly common for these types of investors to team up with an art fund manager via a private managed account, similar to the way investment banks manage private wealth.

“Private managed accounts have really become a staple for art fund managers,” says Liberman.

What will happen next? He believes that if Goldman Sachs and Christies had gone ahead with their plans to start an art investment fund (the plans were scrapped in 2009) then art funds would already be further along in terms of mainstream recognition.

“Once you have a player with an established name launching an art fund, and once it has a few years of great performance on record, the traditional investment banks are more likely to understand that art really is an established alternative asset class, and an important part of diversifying clients’ investment portfolios.

“True, no one should ever tell you to put 50% of your net worth into fine art but you can put in 3% to further diversify your portfolio. There are plenty of reasons why art is great – for example, for hedging inflation. It’s uncorrelated to traditional investment markets and has consistent performance returns. There are plenty of real reasons why you’d want to have some artwork in your investment portfolio – and an art fund is a cost effective way to do it.”

A further confidence boost comes from the fact that the art investment market is continuing to develop: indices and other market tracking resources are available from the likes of artnet, Artprice and the Mei Moses index, making investment less of a gamble. Meanwhile, the growth in storage facilities geared towards helping preserve fine art helps keep your investment safe. A Goldman Sachs/Christie’s art fund may have helped art funds into the mainstream, but there is no doubt they are here to stay – and rapidly gaining both ground and respectability.

Enrique Liberman