Hedge fund sees art as exotic asset class

The team behind what is said to be the first ever genuine art hedge fund are not quite the bohemian types one might associate with such an exotic asset class.

“I love the beautiful, sophisticated things in life, but for me art is just a commodity, it’s a cold thing,” says Justin Williams, a director of London-based Artistic Investment Advisers.

He adds: “I have collected well, but I see art as a P&L [profit and loss account] on the wall.”

While such sentiments may sound clinical to art lovers, they at least shed light on the rationale of AIA’s Art Trading Fund, which is more about monetising industry inefficiencies and hedging risks than about acquiring priceless masterpieces.

AIA, which hopes to raise £25m ($50m) before the fund’s July 1 launch, appears to have timed its emergence to perfection. Investors, both institutional and retail, appear to be constantly on the lookout for new asset classes, having accepted the wisdom that diversification is the only free lunch.

Meanwhile, records seem to be shattered in the art world almost weekly as nouveaux riches Russians and Indians join western elites in pushing prices ever higher. The US Mei Moses art index, which tracks global auction sales, rose 18.3 per cent last year, with post-1945 works surging by 45 per cent.

But the Art Trading Fund is not simply a one-way bet on the art market, as many investment clubs have been in the past.

“We are the only hedge fund because the others do not have a hedge,” says Chris Carlson, a fellow director and former co-manager of the equity proprietary trading desks of Deutsche Bank and UBS O’Connor, a hedge fund.

“People have bastardised the term ‘hedge fund’. Without a hedge you are just an investment club.

“We have looked at the art market over the last 30 years and looked at what kind of economic indicators have a high correlation to the performance of the market.”

AIA claims to have found between 10 and 15 different economic indicators and securities that, combined, have exhibited a 96 per cent correlation with the art market over the past 30 years. By shorting these through 10 per cent out-of-the-money puts, it believes it can construct an effective hedge.

Carlson is reluctant to reveal the full basket of hedges, but the equities of Sotheby’s, the US auction house, and Richemont, the Swiss luxury goods group, are in there.

Economic growth and disposable income at the 90th percentile in the big art-buying countries are other highly correlated indicators, which can be shorted via derivatives. Carlson says a £25m portfolio can be fully hedged at a cost of 70 basis points a year, although he believes that the fund will not need to be fully hedged at all times, as there tends to be ample warning of looming danger.

“There is a lag of between six and 18 months between the economic indicators turning and the effect on the art market,” he says.

“But we will always have some hedging in place in case of an unforeseen geo­political or economic shock to the marketplace.”

The works of art within the fund will also be selected on the basis of whether they are likely to generate steady, predictable returns. The fund has signed up a roster of 10 established artists, with the help of Roy Petley, an impressionist who has sold works to several members of the British royal family. It has the right, but not the obligation, to buy these artists’ output.

“We are not trying to find the next Damien Hirst. We are looking for established artists with a five-year track record, and where we have seen numerous sales of similar subject matter and size,” says Williams. “We are buying into their cash flow and can brand them on a global basis.”

AIA will also source impressionist and post-impressionist works coming to the market as a result of death, divorce and debt. It believes it has an advantage over the traditional galleries and auction houses in this market as it will be able to offer rapid transactions, out of the eye of public scrutiny and without the risk of a sale falling flat at an auction house, which can dent future sell-on values.

Again, the fund is not looking for “headline grabbing deals”, but rather pieces with prices in the £100,000 to £500,000 range, where volumes are relatively high.

As for selling these works, Carlson betrays his hedge fund background as he points to inefficiencies just waiting to be exploited.

“Most art markets are very localised,” he argues. “Every gallery is an exchange; there are no global gallery groups. It should be more efficient but plainly it is not. We can benefit from geographical arbitrage, monetising inefficiencies.

“Our model generates returns over a three-to-six-month period, in contrast to the traditional art investment model that focuses on 10-to-15-year holding periods.”

The fund, which will be a three-year closed-ended Guernsey-listed vehicle, will aim for annualised returns of 30 per cent. It will charge a 2 per cent flat fee and a 20 per cent performance fee on returns over Libor. The minimum investment is £100,000.