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Hedge fund's new frontier: art

Date: Thursday, May 31, 2007
Author: Carrie Tait, Financial Post

Int the face of a spectacular run-up in global markets, savvy investors are plunking down dollars in more unconventional assets. And, in some cases, they are using complex, perhaps daring and dangerous, methods to maximize their bucks.

Take art, for example. Investing in this exotic and illiquid market is nothing new. But cobbling together an art hedge fund adds a new twist, and it is the exclusive domain of Art Trading Fund, an outfit halfway through a ?25-million ($53-million) fundraising drive. Roy Petley, an artist who counts the late Queen Mother among those who have bought his work, is on the five person team working on this new fund.

Combine Mr. Petley's art smarts with the calculating approach of a more traditional risk arbitrageur, Chris Carlson, and the art world has a new beast scouting galleries and trading derivatives to offset risk.

To these investors, managing an art fund is no different than taking care of a basket of assets filled with uranium plays or telecom companies.

"You're a trader -- whether it is widgets or whatever it is," said Mr. Carlson, a UBS and Deutsche Bank alumnus who handles the firms derivative strategy. "We've applied a model that has worked in a lot of other asset classes and we've applied it to art."

Over the past 10 years, returns in the art market have outpaced gains made by the S&P 500, according to the Mei Moses art index. The statistics in this index -- created by two professors at New York University's Leonard N. Stern School of Business -- reflect the prices of about 8,000 pieces of art which have been bought and then re-sold in auction houses reaching as far back as 1875.

Using this index, art returned 18.27% last year, while the S&P 500 gained 15.79%. Five-year returns also favour art investors, but go back 25 years and the S&P 500 comes out on top.

The Art Trading Fund, which is based in the U.K., has signed up a stable of 10 "world-renowned" artists to create masterpieces for the fund and no one else. The fund audited their sales results over the past three years to ensure the group has a steady track record of returns. Each artist churns out between 50 and 100 pieces a year, and the fund has the right, but not the obligation, to buy those works. About 10% of the fund's 30% expected returns will come from these living artists, said Justin Williams, another one of the fund's art experts.

The rest of the returns will come from shopping around. "We buy stuff really well, usually as a result of the three D's: death, divorce and debt," Mr. Williams said. "Then we sell it via at least three exit options via dealers, auction houses or our gallery network."

The fund's average holding time for each piece of art is 5.2 months, he said, using historical data collected from their time as a private business. "We are challenging the traditional 'buy-and-hold' model. We are trading."

Paintings, drawings, watercolours and sculptures will all make their way in and out of the fund's collection. Impressionist, post-impressionists, modernist and contemporary creations are all within the Art Trading Fund's mandate.

The hedging strategy -- something Mr. Carlson is careful not to reveal in too much detail-- uses puts and other strategies to offset the risk of the art market. The fund back-tested its strategy by 30 years, and Mr. Carlson said its plan has a 96% correlation to the art market.

Companies which peddle luxury items like Richemont Securities AG -- makers of glittery Cartier jewelry and watches, for example -- prosper when the art market is thriving. By placing bets that the fortunes of companies like Richemont and Sotheby's, one of the world's dominant auction houses, will fall, the Art Trading Fund is hedging against its art investments.

Russian debt and U.S. ten-year treasuries are also part of the firm's hedging strategy, Mr. Carlson said. And perhaps those hedges will come in handy.

"In the United States ... [art] prices are now 35% higher than the speculative bubble peak in 1990," Artprice said in its 2006 report. "Artprice's global index was up a further 25.4% over the year, just 5% below its peak level in 1990."

Works by Canada's famous Group of Seven has been part of the spectacular rise in price. Out of the 280 movements Artprice follows, their work is among the 10 movements that posted the sharpest price inflation over the past decade, gaining 405.25%.

Pablo Picasso has topped the art market for 10 years straight, with investors handing over US$339-million for the 2087 lots that came up for auction in 2006, according to Artprice. Andy Warhol clinched second place, while Gustav Klimt vaulted into third place from his 359th finish in 2005.

The Art Trading Fund, which expects to officially open its doors around July 1, isn't frightened by today's price tags. The numbers, after all, can only capture what is happening in the auction houses and can be calculated in different ways. "Art prices are well below their peak in the late 1980s when adjusted for inflation," said Mr. Carlson.