Art and wine funds: The Passion Portfolio

A jade stool said to date from the Han Dynasty was sold for RMB220 million ($34.9 million) last year. It was later discovered to be a fake. It was claimed to be easy to tell that the supposedly 2,000-year-old chair was counterfeit, because people of the Han Dynasty (206BC-220AD) rarely used chairs and preferred to sit on the floor. The year before, a Qianlong Chinese porcelain vase sold at Bainbridge auction house in the UK for GBP43 million, thought to be a record for any Chinese artwork. The authenticity of that piece has not been established, but the buyer refused to pay for it, and speculators believe it was because the provenance of the asset was doubted.

"If we look at Chinese art - porcelains or Chinese traditional art, there are very significant risks involved," says Sam Harding, head of Asian Markets at the Fine Art Fund Group.

Indeed, as China starts to play an increasingly important role in the global art market, ensuring that the work they source is genuine is one of the greatest challenges fund managers of art vehicles have to face. Experienced advisors who conduct due diligence on these assets have struggled to keep pace with the unprecedented expansion in this category over the past three years - and forgers have been taking advantage. "There's a lot more of a risk with the authenticity of the artwork in China because there have been very effective forgeries and a significant number of works selling at auction that have later been shown to be forgeries, or around which doubt has arisen," Harding continues. "If you're going in with real knowledge, then it's an interesting market, but it's not one of enter into lightly."

Funding boom

The Fine Art Fund Group is an investment house with around $100 million in assets under management and one of the few remaining survivors of the world's first wave of art funds, which emerged between 2000 and 2005. Following a second wave, between 2005 and 2008, when a number of vehicles were launched across India and South Korea, the art fund industry is once again experiencing a revival - and this time it's being driven by China. While the nation is proving an attractive - if risky - hunting ground for investment targets, most of the activity has in fact been on the fundraising side, with China's art fund and investment trust market reaching just over $320 million last year. Of the 44 art funds estimated to have been in operation globally last year, 21 were set up in China, focusing on genres ranging from traditional early modern paintings to Chinese ceramics, and contemporary art.

"In the last few years, disappointment in the performance of financial assets and the global economy has led clients to look for new alternatives. It's probably no surprise that you've seen an interest in wine, gold and commodities as a long-term store of value and in some cases a potential long-term hedge against inflation," says Randall Willette, founder and managing Director at Fine Art Wealth Management, an independent consultancy that advises fund managers on setting up and investing art vehicles. Willette's observation is corroborated by a Deloitte report into art and finance, which found that 56% of private banks had experienced stronger demand for ‘hard' tangible assets since 2008-09. This is thought to hold especially true for Asian - including Chinese - investors because of their relatively limited choice of financial instruments, which partly explains the popularity among them of real estate investments. There has also been a steady increase in high-net-worth individuals in China - there were 535,000 in 2011, a 13.2% increase on the year before - which, along with family offices, are prime candidates for investing in art. In fact, art investment accounts for 18% of Asia-Pacific HNW individuals' so-called ‘investments of passion', according to the latest Cap Gemini and Merrill Lynch Wealth Report.

Investor-collectors?

This new breed of Chinese investors appears to be approaching art assets in a different way to investors in the West, however. "Rather than keeping works in their collections for decades or generations, the new Asian collector is typically more willing to sell an item after owning it for a relatively short period of two to four years," says Jeff Rabin, co-founder of Artvest, another art advisory firm, and former Christie's executive. Such short holding periods appear to indicate a more detached relationship with the asset class than that which has historically been observed in the West, where investing into art has long been the preserve of collectors, and emotional involvement has oft played a significant role. Yet although Deloitte found that most private bank clients who invest in art are motivated by the potential investment returns (49%), portfolio diversification (39%) and art as a hedge against inflation (29%) rather than anything more esoteric, the emotional connotations of art are a continuing reason for the lack of institutional interest in related funds.

"It has been considered as a so-called emotional asset class, so at this point we don't necessarily see it as a space where institutional investors are going to come in in a serious way," says Fine Art Wealth Management's Willette, who who was formerly head of Art Banking for UBS Wealth Management in London. The problem for some is that it lacks the fundamentals that other financial asset classes have to enable them to predict investment performance. While a number of indices have been developed over the past decade for tracking art funds, numerous issues have been raised about the validity of the data involved, leaving the industry with no single commonly respected benchmark or index. Another issue deterring institutions such as pension funds from participating is that few funds have a long-term track record managing a vehicle greater than $100 million - in fact most firms manage $3 million to $50 million - which is far below most institutional standards. This has caused some to question whether the market can develop beyond its current form unless this starts to change.

A tailored fit

Having a barrier to entry to the institutional LP market isn't the only capital raising challenge art funds have faced of late. Despite the fact that HNW individuals' appetite for passion investments increased in 2010, fundraising has been difficult for start-up vehicles thanks to an increasingly discerning LP base demanding greater transparency and track record from fund managers. The issue for art funds is that they often lack these things - as Willette says, "most lack the performance history and management track record and in some cases the investment discipline demanded of sophisticated investors in Europe and the US." But a proportion of the funds that have raised capital have responded to their environment by moving towards the concept of privately managed client accounts, and there has been a marked increase in enquiries for such accounts over the past two years.

Unlike in private equity, where the LPs commanding such concessions are typically big-ticket sovereign wealth funds, the clients granted a separate art account are ultra HNW individuals who pay $2-3 million. In exchange for their capital, LPs get direct ownership of the assets, separate management and a customized fee structure.

In spite of these concessions, Chinese art funds are thought to be raising an estimated $300 million between the second half of 2011 and the first half of 2012. But given that the market is currently unregulated, can the current growth rate continue? The case of India may serve as a cautionary tale for China. By 2007, there were more funds coming out of India than any other country in the world, and $65-$75 million was under management by local vehicles. However, there was no regulation in place to properly supervise the funds, and when the market regulator SEBI decided to change this in 2008 - bringing art funds in line with Collective Investment Schemes - the vehicles began to suffer under the closer scrutiny. When the country's largest art fund, Osian, collapsed the following year, the prosperity of the local industry came to a halt.

"The poor investment performance of art funds in India is not a bad example to consider when examining what can happen when an over-heated art market in a developing economy outpaces the investment discipline and financial regulation required for sound risk management," says Willette.

The legal and regulatory frameworks surrounding the art market remain undeveloped in China. Introduction of regulation appears badly needed at this point, to avoid adversely affecting the industry at a later stage of its evolution. Closer scrutiny from the Chinese authorities could also serve to encourage more investors to the asset class, as the unregulated nature of the art market was a factor cited by 72% of the private banks surveyed by Deloitte as an obstacle to offering art investment services. Despite the current enthusiasm for investing in art in China, success in this area in the future is no foregone conclusion.

"We're already starting to hear signs of the economy slowing down a bit in China, so it'll be interesting to see how that translates in terms of the investment market," says Willette. "It appears that art funds have been moving at a pretty rapid pace in China and one would have to ask themselves how long can this be sustained."

China's thirst for wine

Wine funds have also experienced increased demand in recent years. According to the latest Cap Gemini and Merrill Lynch Wealth Report, Asia-Pacific high-net-worth individuals hold 18% of their investments of passion in the form of wine and other collectibles (such as rare coins), compared to 14% in 2009, and 15% globally.

The majority of funds in the market focus on trading the best vintages of Bordeaux wines - a practice which has occurred for centuries in some form or another. What is different about the current market dynamic is that whereas the appetite for wines used to come from Western Europe and the US, now it is China which is leading the demand.

As with art fund managers, the wine industry appears split as to whether the institutional market is ready to embrace the concept of investing in the asset class, however. "Family offices and private investors invest in our fund," tells Miles Davis, a partner at UK-based Wine Asset Managers (WAM). "Pension funds will never invest in wine funds, because the whole market's too small for them. It's only for niche investors really."

The experience of The Wine Investment Fund tells a different story however. The closed-end vehicle, which has a five-year investment period, counts several institutional investors among its LPs, including family offices, fund-of-funds and an Asian pension fund. "I wouldn't say pension funds will never look at wine funds but it is a difficult market to crack," counters Chris Smith, investment manager at The Wine Investment Fund. As well as offering larger-ticket subscriptions to its Asian investors [more than its $20-25 million average], the Wine Investment Fund has also been urged by some Chinese investors to offer a shorter holding period than its five-year standard as they would prefer quicker returns and greater liquidity.

Ultimately the demands from Chinese LPs could start to be heeded more often. "Longer term, the demand that will be coming out of China will be so enormous that wine investing will be a good area to be in," adds Davis.

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• Topics
• Fundraising
• Investments
• Greater China
• China
• Fundraising