Art Appreciation

Matt Rand, The Forbes Collector

NEW YORK - According to academic studies, fine art has been a better investment than the S&P 500 over the last 50 years. So why aren't there more art investment funds?

We've all heard those amazing prices that important artwork sells for. Andy Warhol's Orange Marilyn silkscreens, which sold for $2,400 new in the 1960s, have more recently fetched as much as $17 million. Malcolm Forbes' first Fabergé egg was purchased for $57,000 and now his entire collection of nine eggs and other Fabergé material just sold for an estimated $100 million. So why haven't investment firms created funds to invest in art and collectibles?

Get ready, because art investment funds are on the way. Only you won't be able to buy these through your discount broker. Like hedge funds or investment partnerships, the new art funds will be mostly for high-end investors and institutions. In fact, this month, the New Mexico state legislature will rule on Senate Bill 18, which would earmark a portion of state tax dollars for investment in fine art and musical instruments (no more than $50 million for each).

Dennis Doherty, co-head of Lyons and Hannover, a New Mexico investment firm that also tracks auction prices for art investors, hopes to manage New Mexico's art investment fund if the bill goes through. Doherty is confident that his company can "deliver more than 15% per year to the state over a ten-year period." That's a pretty bold statement given that not even the most optimistic investment strategists believe that you can reasonably expect much more than 10% from stocks long term.

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If New Mexico follows through and invests in art, it would be one of few such ventures since 1974, when the British Rail Pension Fund decided to take a chance and hedge its investments by putting more than $75 million into fine art. Over the next several years, it acquired--with Sotheby's help--art ranging from Old Master paintings to Chinese porcelain. By the early 1990s, when the fund finished selling the bulk of its holdings, its art had on average earned 13.1% per year.

There are other art funds in the works. The largest is the U.K.'s Fine Art Fund, begun by former Christie's deputy managing director Philip Hoffman. That fund's goal has been to raise in the neighborhood of $350 million from investors in order to purchase art. Hoffman says that "we're just finalizing the first round, and then we'll begin buying." There are no annual dividends, but investors can borrow the fund's artworks for a small rental fee, as long as the value of the work doesn't exceed 1.5 times the investor's original investment. The fund plans to diversify into Old Masters, Impressionists, Modern and even contemporary art.

New York-based Fernwood Art Investments is preparing an offering of two $50 million art funds in the next six months. If you've got the minimum investment of $250,000, you can have a piece of the fund, but don't expect to take any of the paintings home. Michael Plummer, the President and Chief Operating Officer of Fernwood Art Investments, says that "we are planning to actively manage the collection, in terms of working to exhibit it in institutions and publicly in ways that will enhance its value over time: in other words, add to its provenance."

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There are even some specialty or sector art funds in the works. The Forbes Collector has learned that a certain former museum director, well-known for his close ties to the contemporary art market, is preparing a new fund to invest solely in that exciting area. With demand for works by blue-chip living artists far exceeding supply, more people are speculating on the work of younger, untested ones, says New York art publisher Larry Warsh, a veteran collector who got in early on the work of '80s art stars Keith Haring and Jean-Michel Basquiat. According to Artprice.com, Basquiat's paintings have risen 183% in value in the last five years alone.

But betting on the next Basquiat is not unlike betting on the next explosive OTC stock. Not everyone will be as lucky as Warsh.

Our advice? Steer clear of these funds. For one thing, Brit Rail's impressive returns were derived mostly from the top 10% of its holdings. But liquidity can be an issue for the laggards. Jeremy Eckstein of Lyons and Hannover, who served as actuary for British Rail's art investments, explains that you can't say "Hey, Old Masters are up and Impressionists are down. Let's phone up the broker and switch." Unlike stocks or bonds, art has murky pricing data and notoriously high transaction costs. A buyer's premium at a major auction house adds 20% on the first $100,000 and 12% on everything over that. And if that isn't deterrent enough, then consider the extra costs fund managers will incur in adequately storing, conserving and insuring the art. Hoffman contends that his Fine Art Fund will hold these costs to a total of 2% of an investor's total contribution.

Another significant challenge for most of these new art funds is diversification. Smart buying in each individual art niche has more to do with connoisseurship and connections than tracking a stock's daily gain or loss. Finding a fund manager who intimately knows a variety of art areas might be tough, although all fund representatives we contacted have been careful to mention the range of independent experts they've hired.

As we've pointed out before, buying art for quick returns is a bad idea. We recommend developing your interests and passions in a particular collecting area, whether it's Old Master drawings or contemporary photography. If you do your homework and buy pieces that inspire you, you won't be so disappointed if the market goes south.

The Masterpiece Myth
In collecting folklore, it is common knowledge that masterpieces are where the money is. After all, the British Rail Pension Fund gained most of its returns from well-known Impressionists and Old Masters.

But Professors Michael Moses and Jianping Mei of New York University's Stern School of Business have found otherwise. "That's wrong. Absolutely wrong. Our data show dramatically that masterpieces tend to underperform. They tend to underperform the general art market, and substantially underperform the low-end market," says Moses. Why? Well, Moses explains, "Just like a stock. Let's say you have a biotech company doing okay--but then it comes out that they have a cure for cancer. The stock price runs up, and then afterward, that stock tends to only perform along with the market, because the story is already out. A Botticelli has been pretty well-known for a long period of time, so the story is out."

This doesn't mean you have to settle for napkin doodles by top artists or hang out in the art schools, trying to sniff out the next Picasso. However, you may want to look more closely at under-explored areas such as contemporary Chinese art or Spanish Colonial art, rich and complex genres that tend to be overlooked in a market focused on Europe and the United States.

Excerpted from the February 2004 issue of The Forbes Collector