When deciding which art fund to invest in, pay close attention to the background, connections and personality of the fund manager, advises Enrique Liberman, president of the Art Fund Association and chair of the Art Law + Art Funds practice group at Bowles Liberman & Newman LLP.
“The fund manager is your number one concern,” he says. “You need to ask: what is their ability to source great works? Remember that they need to be able to buy the artwork, hold it for up to the life of the fund (typically five to seven years), take out an annual management fee, performance fees of 20% of the realized profits, and the cost of managing and storing the fund’s collection and still deliver decent returns to the investors.”
“Therefore you’ve got to have somebody who, because of their connections, their knowledge and their expertise, can buy a work that’s worth $1m for around $700,000, so that you have a $300,000 cushion going in. They also need to be able to manage the piece effectively and find the opportunity to increase its value from when it was acquired. There are many strategies for achieving this from showcasing the artworks in important museum shows to using geographic arbitrage to source works from a country where an artist is less favoured and sell the work in the locale where there is the highest demand for the artist.”
Another priority is finding a fund manager who has a very low expense ratio and cost structure. The lower the management fee the better and the more the manager tries to cut back their costs and pass on those cost savings to the investors, the better.
“The fund should be structured to align its interests with the investors, so you should make sure that the fund manager is taking the lion’s share of their income based on the actual performance of the fund, not net asset value increases,” says Liberman.
“You don’t want a situation where, for example, there’s a $100m art fund and the management fee is 2% per year and the fund manager has only one or two individuals on staff. In such case, what incentive does that fund manager ever have to close the fund? He’s likely to keep it going as long as possible. Working solely for the management fee is something that fund managers should never do.”
When carrying out your due diligence, hire an attorney who has expertise not only in negotiating investments in private investment funds but who understands the luxury assets market. This means they will know what questions to ask.
It is also wise to ensure that the fund manager is running the fund in a way that minimises risks of effectuating the fund’s investment strategies: make sure that he has proper insurance, that he’s using the right storage facilities, and that he has a registrar who is monitoring where the artworks are going.
“You want to make sure that when the fund consigns works to auction houses or loans them to museums for exhibitions, that they have a very well-known and respected art law attorney who can help negotiate those deals and provide the protections in those documents that the fund needs,” says Liberman. “Owing to the fiduciary duties that funds and fund managers owe to their investors, this requires substantially more diligence and documentation than in the case of a traditional art transaction being undertaken by a typical collector.”
Another key point is to ensure that the fund is getting art title insurance to protect against any disputes with respect to the chain of title to an artwork that might arise.
“If a third party makes a claim of ownership over one of the fund’s artworks, that could really impact returns on your fund so you really need to make sure that that they are structured correctly,” says Liberman. “Many of these funds are not, because the fund managers are not the same as traditional private equity fund managers who have run these kinds of funds before and are sophisticated businessmen; many are luxury assets dealers who are experts in the art market, which is not the same as running a business or a fund.”
The bottom line is, make sure that the fund manager has hired the right kind of attorney – one who has real expertise in artfunds and in luxury asset markets – and that all the safeguards are in place. An art fund is a great way to enter the art market at a higher price point than you could otherwise afford; but the history of art funds is dotted with messy failures, so make sure you fully understand who you are trusting with your money.