A number of investment funds have been launched in the past few years based on the premise that attractive returns can be achieved through the buying and selling of art. Most of the funds are similar: They pool investors’ money to purchase works of art, sell at a time staff experts determine is opportune and return the net profits to investors. The funds are primarily aimed at high net worth individuals who are looking to diversify their portfolios. Fund managers believe art is a viable way to diversify investors’ risk and should be considered the same way one might supplement a stock and bond portfolio.

Art as an Alternative Asset Class
The idea of art investment programs is not new. In 1904, French financier André Leval created a fund called La Peau de l’Ours (the Skin of the Bear). Combining funds of his own with those of 12 other investors, he purchased more than 100 paintings and sculptures. The entire collection was sold at auction 10 years later, garnering the investors a fourfold investment.

More recently, British Rail used Sotheby’s as an adviser to diversify its pension program with purchases of fine art and other valuable collectibles. Beginning in 1974 and through the 1990s, British Rail invested more than £40 million ($70 million) and earned an average 13.1 percent return per year.

Fund Managers
The new art funds are generally private concerns without oversight by the Securities and Exchange Commission. They can have no more than 100 investors per fund and each participant must be an “accredited investor.” Beyond that, each fund varies as to its fee structure, duration, required minimum investment and market focus.

As the Chinese, Russian and Early American art markets heat up, funds that specifically address those sectors have been established. Prajit Dutta, an owner of Gallery ArtsIndia and a professor of economics at Columbia University, chose to focus exclusively on contemporary South Asian works because he believes the growing market will bring good returns. “The Western art market is more difficult,” he explains. “It’s a more mature market.”

Dutta raised $4 million from 14 investors, many of whom were clients of his gallery. It took roughly two months from inception to formation and the whole fund was deployed in 11 months. Some works will be held for the life of the fund, specified at three years, other pieces have already turned over. Returns, minus fees, are paid to investors on an annual basis.

Larger funds, such as the London-based Fine Art Fund, tend to spread their risk across sectors of the market such as Old Masters, Impressionist, Modernist and contemporary art. Philip Hoffman, a former deputy managing director at Christie’s, who is the fund’s chief executive, declined to give actual totals but specified the fund’s minimum investment was $250,000 and his largest investor put in just short of $10 million. Initiated in January 2003, the fund closed in July 2005 with investors from 12 to 15 different countries. It is still not totally invested, but some works already have been bought and sold. Those profits will be reinvested back into the fund, but after three years they will be paid out annually until the end of the fund, set to terminate after 10 years.

Success Rates
In 2003, a number of funds attempted to come to market. ABN AMRO, a bank based in the Netherlands, even announced a “fund of funds” to spread investors’ risk across a number of different art funds. But the reality is that investors did not jump as quickly as fund initiators would have liked. While a few have closed, others such as U.S.-based Fernwood Art Investments are still fund-raising. Elizabeth Schrock, managing director at SunTrust Robinson Humphrey, says that the first funds must be raised almost exclusively from private individuals as the ventures are too risky for the big pockets of institutional U.S. investors. “Life institutional investors and large pension funds will be wary of the limited appreciation history as well as the lack of market liquidity and ‘mark to market’ valuation options,” she says. As a result of the limited market, ABN AMRO retreated on its “fund of funds” idea, stating that after further analysis, there were too few funds it felt met its criteria.

Of the funds that have closed, initial indicators are good. At the end of 2005, Dutta reports, “Our first year’s internal rate of return was 180 percent.” Hoffman says, “The assets we’ve been selling range from 30 to 80 percent cash on cash return within 12 months.” Both initiated fund-raising for second, larger funds in 2006.

Impact of These Funds
If successful, it is clear that these funds will have unintended consequences. One is the fact that these works of art often disappear, relegated to a storage facility for safekeeping. Hoffman assures that “some of the art is hung in our investors’ homes and some are lent to museums.” But the latter proposition gets quite complicated, as Peter Marzio, director of the Museum of Fine Arts, Houston, explains. “If we needed the object for a special exhibition we would try to borrow it,” he says. And though hanging one of these works in the museum might inflate its provenance and re-sale price, Marzio assures that trustees will not borrow objects just to inflate their value.

There is also the fear that those purchasing the best works will be pure investors rather than collectors who plan to eventually donate works to museums. “What’s at play with these investment funds is the impact that they have on the ecosystem of the art world, which isn’t just the market but also includes our cultural institutions and museums,” explains Alexander Gray of Gray Kapernekas Gallery in New York.

Rebecca Dimling Cochran is a freelance arts writer and curator.