Art funds follow hopes of market recovery

Ask any investor, and he'll tell you the best place to enter the market is at the bottom. Buy low and sell high, right? The institutional crowd knows this lesson best, and after a rocky year in traditional financial markets, many are now drawn to what seems to be the market bottom for a more unusual asset class: art. The market for art appears to have a lot of promise, particularly given that the art market has suffered even more than the traditional domain of financiers.

With auction markets showing signs of recovery -- or at least wanting to recover -- capital is surging into funds focusing on these asset classes. In addition to the high net worth investors who have tended to invest in these assets and the specialty funds that operate in these spaces, institutional investors are showing more interest in the world's oldest media sector.

The art market has had a brutal run over the past year. Following the collapse of Lehman Brothers, prices at auctions fell 70% or more, with the once white-hot contemporary art sector suffering most severely. Over the long-term, however, the performance of the art sector remains strong, with prices generally not dipping below 2005 and 2006 levels. For collectors bringing pieces to auction that they bought in 2002 and earlier -- a common theme this year, -- there have been substantial returns.

Collectors and investors who entered the market toward the end of the boom, on the other hand, have not fared as well. They saw values plunge almost immediately and the slow action at the auction houses has prevented those willing to accept the losses from exiting their positions. Many houses refocused their lots this year, opting for less expensive pieces that would be easier to sell. Liquidity became a major problem this year. Had many collectors been able to sell what they wanted to unload, the drops in valuation this year would have been far worse.

Signs of Recovery
Early November may have signaled a turning point for the art market. While presale estimates tended to be low, bidders were back, and they were buying ... to a point. Both Christie's (CRUPF) and Sotheby's (BID) held contemporary art auctions this week. The former was indicative of the art market we've come to accept over the past year, and Sotheby's provided a glimmer of hope for 2010.

On Tuesday, the two top lots at Christie's, Andy Warhol's "Tunafish Disaster" and Jean-Michel Basquiat's "Brother Sausage" failed to sell. Art dealer Robert Mnuchin was forced to take the Warhol home, as art collector Peter Brant did the Basquiat, where it will undoubtedly return to being a contested asset in his divorce from model Stephanie Seymour. Both carried presale estimates of nearly $10 million, which may have been too optimistic.

Yet, there were some successes. Works by Jasper Johns and Peter Doigt beat their high-end estimates, and a wooden sculpture by Jeff Koons came close to the high end of its range.

The situation at Sotheby's, a night later, was profoundly different. The house's final tally was $134.4 million, soundly beating its presale estimate of $97.7 million. The star of the night was Andy Warhol's "200 One Dollar Bills." Despite a presale estimate of $8 million to $12 million, it sold for $43.8 million. Fifty-two of the 54 lots offered found buyers.

Phillips de Pury, a smaller auction house, failed to cast a final vote on the direction of the art market. The contemporary auction it held Thursday night generated only $7 million, but it consisted of lesser pieces by major artists. Pieces by Warhol, Koons, Richard Prince and Ed Ruscha went under the gavel but the thrill of a major auction didn't materialize.

Money Talks
So, the art market could be on the brink of a return, but the trend will elude confirmation until early next year. The Sotheby's results, along with some of the highlights from the Christie's sale, offer enough incentive for investors to take another look at the asset class.

Geordie Manolas, managing director at First State Media Group, tells Reuters, "Attitudes are starting to change and we're talking to large institutions which have the ability to write some large, meaningful checks." His fund invests in music publishing rights and recently picked up Sheryl Crow's catalogue.

Another fund, the Fine Art Group, purchased a piece by David Hockney for approximately $850,000 not to long ago and reports an average annualized return on the assets it has sold of 30%. Institutional investors are responsible for about 20% of the fund's assets, and CEO Philip Hoffman hopes to raise $100 million for a new venture by the end of the year.

He tells Reuters, "The institutions wanted to see a five-year track record and properly structured teams." He expects the money invested in art funds to reach $350 million by the end of 2009, up from $200 million a year earlier.

Of course, there are failures as well as successes. Art Capital Group worked with photographer Annie Leibovitz to restructure the $24 million loan it had offered her. As a result, it has to continue to carry the debt (and attendant risk), and it wasn't able to help the loans backers, including Goldman Sachs (GS), to get out. Essentially, an illiquid investment asset must continue to be held.

The entry of new art funds into the market certainly signifies the zeal that some investors have for this market. Bernard Duffy, managing director at Emotional Assets Management and Research, just launched a new fund focused on art, antiques and other collectibles (such as coins, stamps and rare books).

Bernard Duffy, managing director at Emotional Assets Management and Research said the sector is also benefiting from a backlash against hedge funds' sometimes impenetrable complexity. It won't begin to deploy its capital until it raises £15 million, which may not be far in the future, as he says more than 10 private banks are willing to talk, along with several appropriately wealthy investors. "These are tangible assets," he says. "You can touch them, you can feel them."

While this is a promising development, it still doesn't compare to the art boom that ended in 2007. During that period, formal art funds weren't the only vehicle that investors used to make major art purchases. A gallery owner in New York told me that it wasn't unusual to see collectors pool their capital to make impressive and valuable pieces accessible. The ability to amass substantial war chests quickly helped push prices higher.

We aren't back at this point yet.

Investors Want to See
As art funds work their way back into favor, especially with institutional investors, they will have to overcome some sizeable barriers. In addition to managing expectations around valuation and liquidity, fund managers will have to address transparency.

Pierre Valentin, a partner at Withers, a law firm where he specializes in art, believes this is a problem. "Transparency is not a strong point with these funds," he says. This problem is exacerbated by the efforts and expertise required for valuation and reporting progress to a fund's limited partners. This can turn some investors off to the opportunity.

The knowledge required to make a prudent investment in the art market is both vast and not easily acquired. Due diligence efforts, consequently, may be frustrated. In the wake of the Madoff Securities and R. Allen Stanford disasters, investors want to know exactly where their money is going and advisors need to be able to deliver answers.

Investment and fund managers from the mainstream alternative investment community generally remain unconvinced of art funds' potential. Paul Farrant, a director at private client firm JM Finn, says, "We watch with amused interest."

But, avoidance (and condescension) could cause the traditional financial advisors to miss a substantial opportunity. Over the past 10 years, we've seen that art values can skyrocket. Private sales and a robust auction environment can provide sufficient liquidity. All that's left is to figure out if the art market is recovering or if it's merely trying.

Even if we're seeing premature interest, it's usually followed closely by the real thing.

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