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FORUM VIEWSVOLUME: 3 • ISSUE NO. 1 BSE BROKERS' FORUM, MUMBAI, INDIAAPRIL 2014 (SPECIAL ISSUE)

Feature Article: Works of AFeature Article: Works of Art and Art Funds

102 Forum Views - April 2014

INVESTING IN WORKS OFART AND ART FUNDS

By CA Nitiin A KhandkarFounderBeyond Quant Equity Research Training

“Art has always been considered an investment of passion that offers in addition to aesthetic utility, potential of economic benefit too. However, art has only recently been considered a potential alternative investment as part of a portfolio of assets.”

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Unusual vis-à-vis Conventional

Asset ClassesMost investors are famil iar with

"conventional" asset classes, such as

equities, precious metals and real estate.

However, more and more investors the

world over, are now looking beyond

these conventional asset classes.

In this article, we will take a look at some

of the "unusual" asset classes, viz., works

of art, philatelic items and numismatic

items, and also the new investment

product named "art funds".

What are Works of Art?This term applies principally to tangible,

portable forms of visual art, such as:• Fine art, such as paintings or sculptures• Rare diamonds, or pieces of ancient

jewellery

Who invests in Work of Art?It is usually the super-rich or the High Net

worth Individuals (HNWIs), who invest in

such assets, simply because the ticket

size of such investments is way too high

for ordinary investors. There are said to

be private collectors across the world,

whose secret, private galleries contains a

number of rare painting, sculptures, etc.

Size of the Art MarketAccording to The European Fine Art

Foundation (TEFAF), the total size of the

global art market is estimated at $60bn,

based on public auction data and an

estimate of art gallery and private art

dealer sales during 2011. The market has

grown six-fold over the last 20 years

(source: JP Morgan).

Philatelic ItemsPhilatelic items consist of postage

stamps and miniature sheets (also

known as souvenir sheets).

The world’s first postage stamp was

issued by Britain in 1840, and was called

the "Penny Black".

The painting was assessed in 1962-1963,

for insurance purposes, at a value of

$100mn, and is estimated to be currently

worth a billion dollars!

A few of the most expensive paintings

include:• "The Card Players" by Paul

Cézanne, sold for $259mn in April,

2011• "Le Rêve" by Pablo Picasso, sold for

$155mn in March, 2013• "No. 5, 1948" by Jackson Pollock,

sold for $140mn in November, 2006

Such works of art would be out of reach

for almost everyone but the super-rich.

However,even paintings by Indian artists

like MF Hussain, among the modern, and

R a j a R a v i Ve r m a , a m o n g t h e

contemporary fetch fancy prices at

international auctions. Other leading

Indian painters include Nandlal Bose,

Anjolie Ela Menon, Satish Gujral, Mukul

Chandra Dey, etc.

Paintings of modern day Indian painters,

which are priced modestly when

compared to the contemporary

pa in te rs , can prove to be good

investments over a period of a few years.

Rare DiamondsRare diamonds include the historically

significant Kohinoor (105 carats) and

the Sancy Diamond (55 carats). The

Cullinan and the Hope diamond are

estimated to be worth $400mn and

$350mn respectively.

Benefits of Art Investing• Low correlation withreturns on other

asset classes. These assets can

perform even during economic

recessions and when prices of other

assets are depressed.• Art is a unique investment. There are

many non-monetary reasons for

buying. Till the time these items are

sold, they are an excellent hobby for

learning, and gaining knowledge

about different cultures and eras.• Art provides collectors with much

needed social status and prestige.• Philanthropic benefits by way of

financing young and up-and-coming

artists, or building a collection to

preserve cultural heritage.• Steady appreciation over a period of

time. Potential for good returns.• Easy purchase and sale through e-

commerce websites, or through

international and local dealers, in

respect of philatelic and numismatic

items.

Drawbacks of Investing in Works of

Art• Obviously, investing in these unusual

asset classes is not for everyone.• The market is restricted to a select

audience of art connoisseurs, art

galleries, etc. Prices may therefore

widely fluctuate depending on the

demand and supply. It may not be

easy to sell a work of art quickly, say

for raising funds in an emergency.• S im i l a r l y f o r ph i l a t e l i c a nd

numismatic items, market is still

somewhat small. Appreciation may

take time.

We now look at the highlights of the

various works of art.

PaintingsWe have all read about the "Mona Lisa"

painting, painted between 1503 and

1506 by Leonardo da Vinci, which has

been acclaimed as the "best known,

most visited, most written about, most

sung about, most parodied work of art in

the world".

Newly created wealth in emerging

markets like China, Russia and the Middle

East has led to the entry of new

participants in the art trade. In spite of

the tough economic environment,

collectors globally are paying record

Evolution of the Art MarketArt has always been considered an

investment of passion that offers in

addition to aesthetic utility, potential of

economic benefit too. However, art has

only recently been considered a potential

alternative investment as part of a

portfolio of assets. Studies show that art

can offer long-term return potential that

is uncorrelated with other asset classes.

sums for top works. However, the lack of

market transparency, illiquidity and high

object costs have generally kept

participation to a select class of wealthy

individuals.In a recent survey of wealthy individuals,

almost 50% of respondents own fine art

and, on average, art makes up nearly 4%

of the average HNWI's total wealth

(source: JP Morgan).

Returns on ArtThe Mei Moses World All Art Index, which

is based on resale values of paintings

sold multiple times at auction, shows

positive returns over the last 50 years,

slightly lagging the S&P 500. Art has

done particularly well on a relative basis

in recent years, outperforming U.S. and

international equities and U.S. fixed

income over the last 10-year and 15-year

time periods, as of 2011 (source: JP

Morgan).

Since the end of World War II, the value

of works of art has appreciated

enormously. This is predominantly due to

increasing rarity caused by an expanding

demand from museums and collectors,

and dwindl ing suppl ies (source:

www.thefineartfund.com).

Analysis suggests that art may add

diversification benefits to an investment

portfolio. Over the last 25 years, art, as

measured by the Mei Moses World Art

Index, had almost zero correlation with

U.S. equities, and was negatively

correlated with fixed income and REITs

(source: JP Morgan).

The Kohinoor

The Sancy Diamond

Old, rare postage stamps and stamps

with errors fetch fancy prices in the

market.

The most expensive postage stamp in

the world is the "The Treskilling

Yellow", issued in 1857, which is

estimated to be worth upwards of $5mn.

Other well-known, rare stamp is the

"Inverted Jenny" issued in May 1918,

by the United State Postal Service, which

had the picture of the airplane printed

upside down in error. This stamp is

estimated to be worth $3mn.

Newly created wealth in emerging markets like China, Russia and the

Middle East has led to the entry of new participants in the art trade. In spite of the tough economic environment, collectors

globally are paying record sums for top works. However, the lack of market transparency,

illiquidity and high object costs have generally kept participation to a select

class of wealthy individuals.

Again, while such diamonds are way too

expensive as investment for most,

investments in smaller, quality diamonds

or other precious stones can yield returns

over a period of time.

104 Forum Views - April 2014

dras t i ca l l y in te rms o f the i r

investment strategies, such as

making co-investments with other art

market players, focusing on sales by

distressed sellers or making bulk

purchases from artists or their

estates to secure better pricing.Art

fund managers employ more than

one strategy simultaneously to

realize gains continuously. • Portfolio Restrictions: Each art fund

adopts a set of restrictions that

governs the character of its art

po r t f o l i o . E xamp l e s i n c l ude

limitations on how much of the fund’s

capital can go into works by a

particular artist, into a single work of

art or into specific periods of art

history.

However, the art market is characterized

by a lack of regulatory authority, deficient

price discovery mechanisms, non-

transparency and the subjective value

and illiquid nature of fine art.

Proponents of art investment funds

argue that it is these very characteristics

that generate the significant arbitrage

opportunities within the market that

seasoned art professionals can exploit

for the benefit of the fund’s investors.

How does the Art Market view Art

Funds?The art market has generally viewed art

funds with distrust and opposition,

arising from a combination of individual,

high-profile failures among early art

funds and a lack of understanding about

art funds and the ways in which they

operate.

Art fund critics tend to brand art funds as

"flippers" or "market manipulators".

However, most art fund managers

employ long-term investment strategies

and work with galleries in protecting and

supporting the market for those artists’

works that they acquire. In many cases,

art fund managers hold their artworks for

periods far exceeding those of the

p r o m i n e n t c o l l e c t o r s w h o a r e

traditionally favoured by the market. Art

funds have even served to provide much-

needed funding to contemporary artists

seeking to produce their next large-scale

series of works.

Moreover, art funds pride themselves on

adopting comprehensive exhibition

programs for acquired artworks, which

Numismatic ItemsNumismatic items are banknotes and

coins issued by various countries.

Obviously, old, historic, rare coins and

banknotes fetch a premium in the

market. Rare banknotes have a solid

investment history. The market, both

national and international, has shown

significant and steady growth in sales

backed by past and present catalogue

and auction sales.

The highest ever price for a banknote at

auction was a world record price of

$2.25mn for a US Red Seal Grand

Watermelon banknote, in December

2006. Apparently, there are only two

such banknotes available in the world

today, with the only other known Red

Seal Grand Watermelon being stored

in the museum at the Federal Reserve

Bank of San Francisco.

105 Forum Views - April 2014

funds are here to stay.(Source:

http://artasiapacific.com, http://www.artfundassociation.com/)

India’s potential for Art FundsCurrently, there are very few funds in

India, which invest in art. The number of

HNWIs in India grew 22% year-on-year

to 153,000 at the end of 2012, according

to the Asia-Pacific Wealth Report 2013.

Given the growing population of HNWIs

in India, which has strong appetite for

non-conventional investment avenues,

we may have more art funds in India, in

future. However, last year Sebi ordered

closure of Osian’s Art Fund, which can

potentially affect investor sentiment for

art funds.

serve to showcase them for the benefit of

the viewing public, a trait that is not

always shared by private collectors.

What does the future hold for Art

Funds?The art fund industry is still in a nascent

stage and is continuing its efforts to

convince both the alternative investment

community and the art market that it can

produce attractive returns for its

investors while supporting the market in

which it participates. As the industry

continues to grow, it is important for art

fund managers to engage with the

broader art market in order to correct

any misperceptions in the market and

establish in no uncertain terms that art

• Size: Art funds have generally been

small in size, sayUSD10mn-100mn

range. The size of an art fund is

typically related to the particular

period(s) of art that the fund will

invest in.• Duration: Art funds are generally

structured to have a fixed operating

term, with predefined time frames for

making art acquisitions (usually 3-4

years from the launch of the fund)

and for selling off the funds’ art

portfolio (usually 5-7 years from the

launch of the fund).• Investment Focus: The first art funds

were fully diversified, covering works

of art across most of the primary art

markets, so as to minimize the impact

of adverse changes in one particular

market. However, the industry has

seen the development of funds that

focus on a single segment of the

market, such as American art or

Chinese contemporary art. • Investment Strategies: While all art

funds follow a traditional "buy and

hold" strategy, art funds can differ

Access Economics rates banknotes as the

number one investment in Australia over

the past 10 years.The Australian

Financial Review quoted banknotes as

the "top earners", representing an

excel lent way to diversi fy one’s

portfolio.The value of the One Pound

Riddle/Heathershaw Renniks 26

(R26) in un-circulated condition has

appreciated from $250 in 1989, to

$1,150 in 1998, and further to $11,500 in

2012 (source: www.johnpettit.com).

Back home, the Shivarai, a coin issued

by King Shivaji, is an ideal example of a

priceless, rare coin.

Investing in Art FundsA growing interest in the art market has

led to the creation of new investment

products that invest in art and give a new

breed of investors exposure to the art

market.

What are Art Funds?Art funds are investment funds dedicated

to the generation of returns through the

acquisition and disposition of works of

art. They are managed by a professional

art investment management firm, which

receives a fee and a portion of returns

delivered by the fund. Art funds are

offered privately to sophisticated and

financially capable investors and are not

open to investment by the general public.

The underlying characteristics of art

investment funds are diverse and vary

from fund to fund, in particular with

regard to the following:

Nitiin A. Khandkar is a senior Chartered Accountant and the Founder of "Beyond Quant Equity Research Training," an equity research training firm based in Thané (Mumbai).

In his current role as Equity Research Trainer, Nitiin offers:1. A comprehensive Training Program in Equity

Research, aimed at fresh graduates (CAs / CFAs / MBAs). He also offers a Distance Learning version of the training program to outstation / overseas trainees. Nitiin has also trained and mentored a few experienced analysts, with a view to improve their skill sets.

2. An Advanced Training Program in Stock Market Inves tmen t s , a imed a t non - f i nance professionals who would like to learn the art of bottom-up stock picking and avoid the pitfalls of equity investing.

Prior to founding Beyond Quant Equity Research Training, he had a multi-faceted career as head of sell-side institutional research desks, and as a buy-side analyst and PM in US equities. Nitiin has also marketed Indian IPOs to foreign institutional investors and private equity investors. Nitiin was assigned the Best IPO Analyst Award for 2009 by Zee Business. In the past, he has arranged one-on-one institutional investor road shows for a few listed companies. He has worked in India and abroad.

In addition to training, Nitiin remains passionate about equity investing, and currently manages equity portfolios of his family. Nitiin also advises start-ups/corporates on corporate strategy and raising funds from VCs/PEs.