Are Passion Investment Funds Becoming The New Alternatives?

Randall James Willette Fine Art Wealth Management Managing Director 17 November 2008

Are Passion Investment Funds Becoming The New Alternatives?

There is currently a trend toward passion investment funds which could provide a highly fruitful avenue for investment strategies particularly in the current economic environment.

As interest in passion investments by high net worth individuals has grown in recent years so has the emergence of investment funds focused on this unique asset class.  We at Fine Art Wealth Management first began studying art investment funds, collectibles and other passion investments in 2003 to fill the void of information available around such funds for wealth managers and their private clients. 

Today we are seeing a growing number of passion investment funds emerging including everything from art, wine and violin funds to collectibles such as iconic entertainment memorabilia.

According to the Merrill Lynch/CapGemini World Wealth Report 2008, globally in 2007 we saw HNWs and UHNWs spend and allocate a significant portion of their wealth on investments of passion. In 2007 luxury collectibles (defined as luxury autos, yachts, private jets, etc.) accounting for 16.2 per cent of passion investments and fine art, representing 15.9 per cent were the most popular choices for HNWs worldwide. Jewellery held third place with 13.5 per cent.  Wealthy individuals from emerging markets demonstrated significant influence over the global luxury market place even as financial market turmoil impacted the US during the second half of 2007.

Why Investments of Passion
Investments of passion are generally not considered a mainstream asset class by wealth managers as this market is rather opaque and highly illiquid.  However, there is currently a trend toward passion investment funds which could provide a highly fruitful avenue for investment strategies, particularly in the current economic environment.  

There is ample precedent of the role of art, collectibles and other investments of passion as a refuge for investors during times of economic uncertainty.  Bad news is good news for collectors and sellers, and so it has been for a very long time. Not only does capital flee the stock market, but economic uncertainty forces out into the market art and other passion investments that otherwise might never have changed hands.  

Now, as in past stock market crashes, certain sectors of the art market and collectibles can offer investors a safe haven.  The value of many collectibles actually rose during the Great Depression.  During the oil crisis of 1979, coins and other collectible prices increased dramatically.  Following the stock market crash of October 1987, the Dow Jones Industrial average took 15 months to recover its pre-crash level while investors cashing out of stocks put that money to work in the art market.  In 2000, as the stock market sank by a collective $3 trillion, artwork did not miss a beat.  The Mei/Moses Fine Art Index which represents a composite of annual auction prices was up 16 per cent that year.

While its true that  recent auction sales at Christie’s and Sotheby’s in Europe, US, Asia and the Middle East have fallen significantly below expectations due to pressures in the global financial markets,  this has been predominantly in post-war art.  This is also the sector that has benefited the most from global wealth creation.  Should the sources of this new wealth dry up, it is likely we will see the Post Modern and Contemporary sectors experience a significant correction.  At the same time, we are likely to continue to see record prices for top-tier master works by sought after artists in a flight to quality.

Meanwhile, experts in the wine market say the year since the credit crunch kicked in has not had a negative effect on the prices of fine wines.  In fact, the reverse has been the case, with the London International Vintner’s Exchange’s Index of top 100 wines up to 9.1 per cent over the year.  

The London listed stamp dealing investment firm Stanley Gibbons, which dates its origin back to 1856, logged an increase in pre-tax profits of 11 per cent to £1.2 million in the six months to 30 June 2008 compared with the same period a year before.  Sales rose by 12 per cent to £9.8 million, the firm said.  Stanley Gibbons is so confident about the upward potential of rare stamps that it offers investors opportunity to get some exposure to the sector while guaranteeing their capital.  

Correlation Benefits
Like all financial markets, the art and collectibles markets respond to multiple factors, including supply and demand, world events, global and regional economic developments, and the personal behaviour and interests of individuals. The illiquidity and inefficiency of the art and collectibles market, rather than being a detriment to performance has historically had the opposite effect.  The shorter term impact of negative world circumstances is less immediate and less pronounced on art and collectibles than on most other investments.  

During shorter intervals, there is volatility of prices within the art and collectibles market that moves independently of the markets for other assets.  This non-correlation of price movements can also be employed as an effective risk management tool to achieve attractive diversification benefits within an investment portfolio.  The longer-term positive trend in art and collectible prices is interrupted less frequently.  

The result is periods of outperformance which can enhance overall returns while reducing volatility within an investment portfolio.  

Alternatives are supposed to have very low correlation with traditional investment products. However, there is a growing view that this definition may no longer be suitable due to a fast changing investment environment and will need to be reconsidered over time.  As an example, in recent months there has been some evidence that hedge funds have failed to generate the uncorrelated absolute returns investors had expected from these investments.  

Impact of Economic Downturn
According to Merrill Lynch/CapGemini, the global art market and luxury industry segments tend to be latecomers to economic downturns. It is therefore no surprise that only now are we beginning to see an impact from the turmoil in the financial markets.  However, historically, investments in fine art and other high priced collectibles have been more immune to economic down turns, as their ultra-HNW buyers tend to be less adversely affected by such trends.  “Affordable (and aspirational) luxury goods”, which are more accessible to HNWs as well as to less affluent individuals, may suffer more of an impact if the downturn is sustained.  Despite these concerns, their analysis suggests that new wealth and growing consumer demand in Asia-Pacific, Eastern Europe and the Middle East will continue to outweigh the pressures of the economic slump.

Investors Who Are Passionate About Alternatives
One of the key measurements of a private clients financial management skills is their diligence in searching for alternative investment opportunities with high returns.  Many of the gains reaped by high net worth individuals in recent years have been a result of strategic diversification of their holdings by moving into a broad range of asset classes; further signs that HNWIs are willing to balance their portfolios by taking an informed, rational approach to their investments, regardless of prevailing market conditions.  

In spite of recent market turmoil, we expect this trend to continue although tempered by a demand for lower volatility as private clients become more risk averse.  Statistical arbitrage and heavy quant-driven trading strategies are going to find it tough and transparency will become essential to product design.  There will be aversion to anything complicated and non-transparent and, while clients will shy away from products of great complexity (e.g. they will not buy what they cannot understand) there will be growing interest in “real assets” such as art, wine and other collectibles.  

Equally important for the future growth of passion investment funds, we expect to continue to see institutional assets shifting from the traditional to the alternative despite the current market disruptions, dislocations and subprime contagion.  We will also see investors emphasize diversification within their alternative investment portfolios, among various established and new types of alternative strategies.


Given the growing interest in passion investments and the increasing number of HNWs who spend a relatively larger proportion of their income in this sector, it is interesting to analyse whether there is an optimal strategy from an investment perspective. Recently, there has been some interesting research analysing how passion investments add to the risk return profile of both private and institutional investors.  A research paper entitled “Emotional Assets” by R. A. J. Campbell of Maastricht University; C.G. Koedijk of Tilburg University and F.A. de Roon also of Tilburg University looked at a number of passion assets, such as art, wine stamps, watches, atlases and books which make up more than 50 per cent of HNW's investment into the luxury good sector.

Using a number of broad indices for a variety of passion assets, they have shown how asset prices have increased over the past 20-30 years.  All assets show a positive return over the period, with art, wine, books and violins all having obtained 9 per cent average returns in price increases over the past 20 years.  

Some collectible items showed a tendency to move in line with each other, with a high correlation coefficient, such as diamonds, and coins, books and atlases, and clocks and watches and stamps.    However, there is a significant divergence in the behavior of the various price indices to enable an investor to benefit from holding a diversified portfolio of passion assets.  The real benefits occur from minimizing risk whilst maximizing return strategy when a portfolio of stocks and bonds is held in combination with wine or books.  This study is a first into the inclusion of passion assets within an investment portfolio.

Fund Structures
Wine and the art market are the most sophisticated of the luxury good investment sectors and there are currently a number of such funds in which investors can buy into.  Recently we are also seeing the emergence of specialised funds around the collectibles market including entertainment memorabilia.  All these funds undertake a variety of trading strategies, similar to both private equity and hedge funds trading on the inefficiencies currently present in the market.  

In our effort to actively maintain coverage of art investment funds globally, we have identified two distinct investment strategies emerging; one a sector allocation strategy and the other more opportunistic.  The first strategy is designed to emulate the world’s top collectors who tend to focus on specific sectors of the broader art market. Art funds pursuing a sector allocation strategy seek to obtain their investment objective of medium to long term capital appreciation through the active management of a broadly diversified portfolio of art across the most established sectors including Old Masters, Impressionist, Modern and Contemporary.  

The second strategy translates the activities of the world’s leading art dealers and auction houses by identifying opportunistic financial transactions and direct investments that can result in superior shorter-term returns.  Funds that pursue an opportunity strategy pursue investments across a range of regional and niche opportunities including Asian art, Indian art, and Arab art as well photography and collectibles.  Transactions include trading opportunities to buy and sell works quickly to achieve an immediate return, as well financing opportunities and equity participations with significant upside potential.

Equally important in the evolution of art funds specifically, we are seeing them being actively managed globally across three key dimensions including: opportunity, value and risk.  A critical element to the success of any fund that invests in this unique asset is its ability to find attractive investment opportunities on favourable terms.

For most funds this is achieved by leveraging expertise across a deep network of international experts to identify targeted opportunities. In addition, opportunity can be further managed through the use of economic and behavioural research and the market intelligence of the management team.  Anomalies in pricing, market trends and economic data can reflect certain regional and sector opportunities and those funds that are most effective in managing this will stand out from all the others.  Similar to a private equity manager an art fund must not only engage in the right transactions at the right time and the right price, but also to enhance the value of each individual asset it manages.  Most funds seek to achieve this through a variety of curatorial and marketing activities commonly practiced by successful collectors and dealers.  

Finally, investments in art, collectibles and other passion investments (as with other investments) involves substantial risk of loss. Such funds must be able to manage the risks within their portfolio on several levels. Economic developments and market trends that could impact future buying or selling behavior must be constantly analysed and reviewed. Also, wherever possible, funds should seek to employ a non-concentration strategy to mitigate risk of exposure to a single opportunity.  The fund must be keenly familiar with the risks associated with the purchase of individual works, including questions of authenticity, title, condition, and provenance. This can only be achieved through the expertise, market intelligence and depth of experience of the management team.

In summary, those passion investment funds which will be the most successful will be those that have built an internal team and formed exclusive partnerships with dealers, curators, economists, art experts and investment specialists supported by quantitative and qualitative research to derive unique market insights.  

Course Offering
FAWM is delighted to announce the launch of a series of bespoke courses on Art and Investments of Passion to wealth managers and their private clients in association with WealthBriefing to be offered beginning in February 2009.  This series of six separately bookable training modules looks at the growing demand by sophisticated collectors and investors for structured solutions around art assets and how to integrate investments of passion into overall wealth management strategy for private clients.

For more information click here.

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