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The WB Art Interview: The Art Trading Fund
Fine Art Wealth Management
7 November 2007
August saw the launch of the Art Trading Fund, the first hedge fund to focus purely on short-term returns based on inefficiencies in the international art market.
What makes this art fund unique, however, is not only its short term strategy, but that it is also the first to use derivatives in the form of exchange traded options to hedge its investment against a fall in the market. To date, the use of derivatives with regard to art has been virtually unheard of.
In the second in a series of interviews with art fund providers on this growing alternative investment, Randall Willette from the art investment consultancy Fine Art Wealth Management interviews Chris Carlson, the investment manager behind this innovative new fund and asks about his view on the future of structured products with art as the underlying.
RW Chris, as one of the newest art investment funds to enter the market what made you decide to establish an art fund?
CC Initially it was the firm belief that in the coming years we will see a secular shift into true alternative investments. Fine art had seen considerable academic research produced concerning its investment potential over the past decade, it was also an established market, though opaque and inefficient. It also had the liquidity necessary to apply arbitrage based trading strategies, which are particularly suited to inefficient markets.
RW What is your role on the management team?
CC My background is financial; I worked as a portfolio manager for both hedge funds and investment banks. So my role within the management team is developing and operating the models we use to analyze our investment opportunities, analysis and management of our hedging mechanism – as well as sharing strategic and operational management with my two partners Justin Williams and Roy Petley.
RW What similarities do you see managing an art hedge fund compared with other alternative investments you have managed in your previous experience?
CC In any opaque and illiquid asset creating/developing a knowledge and information “edge” is crucial. Having a complete understanding of both the opportunity and its risks is essential to delivering strong consistent returns. Broadly, some of the inefficiencies are also similar: geographical pricing anomalies based on local supply/demand, information based pricing differences, and access premium.
RW What are the key differences?
CC Art is not an established asset; the methods of defining value are not obvious either on a fundamental or relative basis – though value can be defined very accurately. The methods of transacting are not homogenous so there are more contractual, custodial, and insurance issues than with even the most illiquid financial asset. Distribution creation is also of greater importance than in more established asset classes.
RW How much are you looking to raise? How close are you to achieving this?
CC We are looking to raise £50 million by the end of the year. We are 25 per cent of the way there now and we’ll have a final close on 31 December 2007. I’m confident we’ll achieve our target.
RW What would you say particularly distinguishes your art fund from the others?
CC Structurally, the Art Trading Fund is a regulated fund. Based in Guernsey and regulated by the Guernsey Financial Services Commission. It took a year to achieve this. What it means is that all our processes and risk management are consistent and there is independent oversight of everything we do.
Strategically, we focus on short-term returns based on inefficiencies within the art market. Our average holding period historically has been just over 5 months. This is very different from the traditional art investment model which focused on returns generated over 10 years or more. And the most obvious difference is that we offer hedged returns and significantly reduce the short-term investment risk.
RW What is this hedge comprised of and how does it work?
CC The hedge can be comprised of equity and fixed income securities with a statistically high correlation to the performance of the art market. The statistical analysis is overlaid with a fundamental pragmatism that weeds out anything without a fundamental basis for the correlation. The hedge is executed primarily through the options market, where the fund purchases out-of-the-money options (primarily puts) on the selected securities. The purpose of the hedge is to protect against sustained downturns in the economic cycle.
RW What kind of art will the fund invest in?
CC The fund will be allocated primarily between two strategies: a contemporary strategy focused relationships with living artists, and an Impressionism-Modernism strategy. We monitor the genres or sectors within the market carefully, monitoring for volume (liquidity) and price growth.
RW What is the term and minimum investment amount?
CC The term is three years, and the minimum investment amount is £100,000 – we are a Qualifying Investor Fund.
RW What expertise does your fund have in art?
CC The management team is very well balanced. We have Roy Petley who brings over 30 years of expertise within the art world both as a famous painter and advisor. We have Justin Williams who has successfully run galleries for the last five years. Outside of the managers we have an independent advisory panel comprised of specialised experts with impeccable backgrounds as art advisors, dealers, auctioneers or academics.
RW I understand you are the first art hedge fund to be domiciled in Guernsey. Why did you choose Guernsey?
CC The regulatory structure in Guernsey is well regarded in the investment community and the Protected Cell Company structure was ideally suited to managing a real asset like art.
RW What is the structure of the fund? Who are your target investors?
CC The fund is structured as a Protected Cell Company. Our target investors are institutions, high-net worth wealth managers, and individuals.
RW Given that you have developed a hedge for art market risk, will the next step be art derivatives? Do you believe there is a future for structured products with art as the underlying?
CC Absolutely. As I mentioned earlier I think they are just around the corner.