When Bottom-Fishing is a Bad Idea

Here’s a story from Bloomberg about a money manager called Castlestone Management Ltd. opening an art fund. [Update: An earlier version of this post used the adjective “suspicious” to describe the Bloomberg story. That was a poor choice of words and unfair to Castlestone. Angus Murray, the principal of Castlestone has written a response that will be posted below.]

The Collection of Modern Art fund is open to people with as little as $10,000 to invest and will buy the work of artists such as Banksy, Damien Hirst and Willem de Kooning, Castlestone said today in a statement. It is the only open art fund for individuals and will start investing at the end of May with $25 million under management, the firm said.

“With a low threshold this is an unusual investor base,” said Anders Petterson, founder of ArtTactic, a London-based art- market researcher. “Opportunities are presenting themselves, and if you have a fund that can take advantage of them it will be fantastic.” [ . . . ]

The new fund will buy art while it’s cheap, hold onto it for eight years and then sell the portfolio when the economy has recovered and prices are higher, Castlestone Chief Executive Officer Angus Murray, the fund’s manager, said in an interview.

“We are being opportunistic,” he said. “Art is an area where assets got oversold. Our investment strategy is to buy it at a sensible price and then sell it for more later, rather like private equity.”

During the height of the art boom, several funds emerged but few have shown any real ability to produce returns. What makes these funds suspicious in general is the fact that there are already a number of firms out there seeking to buy art that is undervalued and hold it until they find buyers willing to pay a premium. The firm takes the profit on those holdings, which can last from months to many years. They rarely have to divulge their investment returns because these firms–sometimes known as art dealers–are usually privately owned or partnerships.

An art fund might improve on this model by increasing the size of the pooled capital. But so far, no one has shown that a dealer’s margins are scalable. Otherwise, we wouldn’t witness the occasional intemperate email from Larry Gagosian about how hard he has to work to move the canvases.

More to the point, alarm bells should ring when someone points to private equity as a model in 2009. A product of the credit crisis, the private equity industry is suffering through a severe bout of indigestion that will separate the disciplined operators from the easy-money opportunists.

When sums as low as $10,000 are being solicited in the art world the clanging should get even louder. Why would lowering the barrier to entry help the investor now when prices are lower and $10,000 can get you a decent work of art again (maybe?) Investing in art–buying low, selling high–doesn’t scale very well. So raising a larger pool of capital won’t allow one to make more money from art. If it did, the auction houses would not be laying off so many folks.

Angus Murray responds:

There are some financial facts and investment fundamentals that might have been missed in your article. Collection of Modern Art is an open-ended mutual fund that is valued monthly by an independent administrator (I accept that just like a property fund this will never be perfect) and managed by and SEC registered and FSA regulated investment management company that has been running since 1996. It has been set up with and will be opened to investors on May 31, 2009 with an existing portfolio of art in the Fund. The works of art will have all been valued independently by two auction houses and the Fund will have audited accounts dated March 31, 2009. The reason that the Fund has been opened to retail clients investing amount as low as $10,000 (advised by financial advisors) is based on Modern Portfolio Theory. Art should have a maximum weighting of approximately 7% of a portfolio to add to diversification and enhance returns. If the minimum investment was $100,000 you would need an investment portfolio of approximately $1,500,000. Unless you wish to only allow the very wealthy to be able to buy art as an investment you need a low minimum amount. More importantly the Fund does have an investment horizon of 8 years that is similar to the model of a private equity fund but allows monthly redemptions. What is different is the fundamental structure relative to that of a private equity fund as not leverage is used within the Collection of Modern Art. Private equity funds used excessive leverage (debt to equity ratio or gearing). This is the main reason that their returns suffered recently when asset prices declined. The cost of buying and selling art and the nature of the investment result in a long term investment time horizon. Castlestone Management has been short listed by Hedge Fund Review 2009 for the Best Global Macro Hedge Fund and I hope as a result of our professional (and factual) understanding of finance combined with the experience of the art experts that we have employed will be mutually rewarding to our investors. Sincerely, Angus

Castlestone May Buy Banksy, Hirst With Art Fund for Individuals (Bloomberg)