skates seminar 2 michael plummer

© Artvest Partners LLC 2012

ART AS AN INVESTMENT: THE FUNDAMENTALS – 15 MAY 2012


III. UNDERSTANDING ART INVESTMENT VEHICLES


WHAT IS THE VALUE OF GLOBAL ASSETS UNDER MANAGEMENT IN ART FUNDS?

A. US $550 Million

B. US $1.00 Billion

C. US $2.25 Billion

D. US $3.50 Billion


WHAT IS AN ART FUND?

ART FUND

Structured investment vehicle

Offering documents

Third party investors

PRIVATE INVESTMENT PARTNERSHIP (PIP)

Group of individuals who pool resources

Closed to outside investors


WHY INVEST IN AN ART FUND?

PROS

Allows for overall portfolio diversification with a relatively small individual capital commitment

Does not require investor to have art collecting expertise

Mitigate cost of security, transactions, insurance, storage, research, tax, etc.

CONS

Lack of transparency & track record

Undisclosed conflicts

Currently, limited art fund options


UNIQUE ESTATE PLANNING BENEFITS AS PART OF INVESTMENT STRATEGY

Collector

Sale of Art

34% Capital Gains Tax*

66% Net Proceeds above

Cost Basis

Death

55% to Heirs45% Tax of Value of Estate at Time

of Death

Collector

Fund

Capital Gains Deferred until

Earlier of Fund Selling Art or Cash Paid to

Collector

Death (If before Capital Gains

Tax Due)

No Capital Gains Incurred

55% to Hiers45% Tax of Value of Estate at Time

of Death

Shares in FundArt Sale

For significant collectors based in the US, section 721 of the US tax code allows for a collector to invest a work of art, rather than cash, in a fund for shares deferring the 28% - 34% capital gains tax and thereby earn returns on that deferment until there is a qualifying “liquidity event”

In certain circumstances, there is an opportunity to mitigate all capital gains tax – if the collector dies before the capital gains tax is due

*Combined Federal &- New York State Capital Gains Tax Rate

STANDARD CASE DEFERRAL / AVOIDANCE OF TAXES


EARLY ART FUNDS

PEAU DE L’OURS

Founded in Paris in 1904

Acquired 100+ works before liquidating in 1914

Net of fees, annual IRR was 14.6%

1970s

Several art investment ventures were launched

By 1985, ventures aside from the British Rail Pension Trust had all collapsed

BRITISH RAIL PENSION TRUST

Between 1974 and 1980, invested £40 M in 2,400 artworks and collectibles

The fund liquidated these assets between 1987 and 2000

Net of fees, annual IRR was 11.3%


SAMPLE ART FUND

FUND STRUCTURE

Management Fees: 2%

Hurdle: 5% net

Carry: 20%

Duration: 5 years

Cash returns: From end of year 3 onwards

SALES

Between years 2 and 5

To private collectors

At auction

To dealers

OPPORTUNISTIC APPROACH

Funds are typically opportunistic with sales prior to year 3 as

part of their active asset management strategy

RETURNS

Re-invested to the end of year 3

Distributed to investors after year 3


ART INVESTMENT CYCLE

0 1 2 3 4 5 6…8YR

Supplementary Harvesting Period

Potential Profit Growth (%)

Ramp-up

Time

Value Creation

Harvesting Period

End Distribution Phase

(target date)

Initial Distribution Phase

(target date)

End(eventual liquidation)


OPPORTUNISTIC GAINS IN A DOWN MARKET

PIERRE MATISSE GALLERY: OVERVIEW

Sotheby’s partnered with Acquavella Galleries, Inc. to form Acquavella Contemporary Art, Inc

Sotheby’s put forward the entire $153.1 million in May 1990 to acquire all the common stock of the Pierre Matisse Gallery

Gallery assets comprised 3,500 works of fine art of the 20th century (Matisse, Picasso, etc.)

The purpose of the partnership was to liquidate the inventory with each partner having an equal ownership stake


OPPORTUNISTIC GAINS IN A DOWN MARKET

PIERRE MATISSE GALLERY: RESULTS

By December 31, 1993, $278.5 million had been distributed to Sotheby’s in accordance with the partnership agreement

Additionally, at the end of 1993, $45.7 million of inventory remained, the proceeds of which would fall to the bottom line

The compound annual growth rate for the investment over the period May 1990 to the end of 1993 was ≈ 25%

From 1993 to 2006, an average of $2 million of the remaining inventory was sold annually

At the end of 2006, $20.3 million of inventory remained to be sold


ART FUND DUE DILIGIENCE

Asset Allocation

Liquidation Strategy

Fund Structure & Governance

Transparency

Investment Strategy

Risk Controls

Valuation & Reporting Methodology

Manager & Advisor Compensation

Potential Conflicts of Interest

Market Access & Expertise

Track Record


ART FUND STRUCTURING – KEY ISSUES

Governance & Conflicts

(i.e. Fixed Income, Leverage, etc.)

Areas / Sectors of Focus

Use of Other Investments

Innovative Opportunities

(3rd Party Guarantees, Funding Artists, Lending)

Acquisition Strategy

Value Enhancement & Revenue Generation

Risk Mitigation

Holding Period & Exit Strategy


Financial Expectations & Expense Forecasting

Operations, Administration & Logistics

Staffing, Advisors & Resources

Valuation & Reporting

ART FUND STRUCTURING – KEY ISSUES (CONTINUED)


POPULAR ART INVESTMENT STRATEGIES

Buy & Hold

Global Arbitrage

Distressed Acquisitions

Collection Buyouts

Sector Specialization

Promotion/Showcasing/Scholarship

Leverage Acquisitions

Leasing

Financing & 3rd Party Guarantees

Deal Participation


THE ART FUND LANDSCAPE

Data: Artvest Partners


6

31

1

31

26 Private Investment

Partnership

Active Art Fund

Start-Up Phase

Never Launched

Fraud

Full Cycle

**

***

*All funds between 2003 – 2012** Only Private Investment Partnerships that have received press coverage were included *** Multiple Funds run by the same manager are counted as a single fund

Funds Announced vs. Funds Active *


HONG KONG HAS BECOME INCREASINGLY IMPORTANT TO WESTERN AUCTION HOUSES



1 9

15

7

Status of Active Art Funds

Start-Up Phase

Acquisition Phase

Asset Management Phase

Liquidation Phase


GOOD PRACTICE & RISKS


RISK

Loss of capital

Too much value concentrated in a single object or category

High auction house fee structures will reduce investment returns

Dealers will try to saddle the Funds with lesser quality product

Fund will not be able to liquidate all of its investments during life of the Fund

Opportunity costs should returns be less than projected

Funds will invest or have to sell at wrong moment in art value cycle

Small group of market insiders can distort activity and results, and enrich themselves at the expense of less knowledgeable investors

MITIGATION / RESPONSE

Art rarely goes to zero value

Implement concentration limits

Fund should negotiate preferential fee structure with auction houses

Strict investment guidelines and rules of engagement;

Active Fund management; buying at right stages in art business cycle

Term of Funds should allow for extensions

Importance of combining market expertise and term extensions

Clear rules and investment practices, staying clear of known artificial markets


HONG KONG HAS BECOME INCREASINGLY IMPORTANT TO WESTERN AUCTION HOUSES



2003 H1

2003 H2

2004 H1

2004 H2

2005 H1

2005 H2

2006 H1

2006 H2

2007 H1

2007 H2

2008 H1

2008 H2

2009 H1

2009 H2

2010 H1

2010 H2

2011 H1

2011 H2

2012 H1

0

5

10

15

20

25

30

35

40

45

Art Fund Companies by Country by Year

Other

UK

Asia

Europe

North America


REPORTED ART FUND RETURNS

Fund Name Fund’s Estimated Annualized Returns

Annualized Returns on Assets Sold

Aicon Art Fund I ≈ 39%

Artemundi Global Fund 24.33% 19.86%

Art Photography Fund 7.98%

British Rail Pension Fund 11.30%

Castlestone 3.85%

China Fine Art Partners ≈ 26.00%

Dionysos Art Fund 12.41%

PFF Fine Art Invest Fund 5.60%

Sharpe Art Fund 10.26%

Terry Art Funds ≈ 20.00%

The Collector’s Fund 28.50%

The Fine Art Fund I: 25.40%II: 26.70%



KNOWN FUND FAILURES

Marble Art Investment (UK – Fraud)

Ronald Coles Investment Gallery (Australia – Fraud)

Osian Art Fund (India – Losses)

Cannonball Art Fund (Singapore – Losses)

Art Trading Fund (UK – Losses)

Fernwood (US – Fraud)

Meridian Art Partners (US – Never Launched)

Societe Generale Asset Management (France – Never Launched)

The Savigny Art Fund (US – Never Launched)

Emotional Asset Management (UK – Never Launched)

ABN AMRO (UK – An Illusion)


THE FUTURE OF ART FUNDS

Despite some notable setbacks, interest continues to grow in art funds:

Several funds in the US and UK have raised 2nd and 3rd generation funds

Continued global uncertainty and low returns on other investments will drive interest

More funds will mean more investment options

As existing players build track records, institutional investors will begin to participate more actively


VIII. LIQUIDITY ISSUES & LENDING LANDSCAPE


The Art Market is Highly Illiquid

During market pullbacks, already limited liquidity becomes even more scarce

In difficult economic times, the lack of liquidity becomes one of the most daunting issues facing an owner wishing to sell

May '05

Nov '05

May '06

Nov '06

May '07

Nov '07

May '08

Nov '08

May '09

Nov '09

May '10

Nov '10

May '11

Nov '11

May '12

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

0.1355851052253590.1272727272727270.141509433962264

0.1071428571428570.115107913669065

0.2168674698795180.227272727272727

0.405228758169935

0.2117647058823530.192307692307692

0.171875

0.2210.21551724137931

0.294117647058824

0.177570093457944

Percentage of Art Unsold Impressionist & Modern New York Evening Sales



ART LIQUIDITY

Artist

Tier 1 Tier 2 Tier 3

Artwork

First Rate High Moderate Low

Second Rate Moderate Low Very Low

Third Rate Low Very Low Illiquid



2011 – 2012 TYPICAL LENDING RATES

0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20% 22% 24%

PrivateBanks Asset-Based LendersAuction

House

Rates vary significantly based on the type of lender



BORROWING OPTIONS

Private Bank Specialized Lender Auction House Advance

Rates 300-400 bps above LIBOR 12% - 24% per yearvaries by client

ranges from interest free to Prime + 3%

Conditionsfull-recourse

borrower sometimes retains possession

non-recourselender takes possession

auction house takes possession

Caveatbanking relationship

other assetslimited to certain sectors

title insuranceworks must be sold through

the auction house

LTV 50% 30% - 50% 30% - 50%

Term 1+ year (renewable)6 months to 1 year

(renewable)3 months to 1 year



THINGS TO WATCH OUT FOR IN AN ART FINANCING CONTRACT

Yield

Terms

Estimates

Loan To Value (LTV)

Collateral

UCC Filings vs. Possession

Access to collateral incl. default


WHEN TO GET ART-SECURED FINANCING

When the art market is weak and estate tax is due

To Avoid Capital Gains Tax

When interest rates are low

When returns from another investment opportunity are likely to outweigh the interest on the art loan


30

Auction Advocacy

Private Selling and Sourcing

Art Investments

Art Financing

Market and Value Analysis

Art Wealth Preservation: Tax & Estate

WWW.ARTVEST.COM


skates seminar 2 michael plummer

Economy & Finance

fine art

work of art

art investment ventures

limited art fund options

acquavella contemporary

popular art investme

opportunistic gains

tax of value