GUEST ARTICLE: Art Investment Vehicles And Challenges Of Europe's AIFMD Regime

Rand Willette and David Eckner 15 January 2016

GUEST ARTICLE: Art Investment Vehicles And Challenges Of Europe's AIFMD Regime

European Union regulations on alternative investments, now in force, mean operators of art funds need to pay heed to the fine print, as this article explains.

Among the slew of regulations to have affected wealth management recently has been the European Union’s Alternative Investment Fund Managers Directive, which became UK law in July 2013. The AIFMD is, its framers say, designed to reduce risks in alternative investment areas such as hedge funds, by demanding more disclosure of information to clients and regulators and setting requirements in areas such as custody. The AIFMD was prompted by the financial crash of 2008, although critics argue that hedge funds were not to blame for the crisis and that the rules are heavy-handed and protectionist against non-EU jurisdictions. Even so, the directive is now law. In this article, Rand Willette, founder and managing director of Fine Art Wealth Management, and David Eckner, executive manager of the Center for Business and Corporate Law at Heinrich Heine University of Düsseldorf, examine how art funds are affected by the rules. 

The editors of this publication are delighted to share these expert comments with readers and invites responses. 

As interest in art as an alternative asset class has grown in recent years so has the emergence of art investment vehicles. These vehicles seek to capitalise on the inherent inefficiencies of the art market and provide the potential to identify, create and execute transactions in works of art at highly attractive terms. Art fund managers seek to approach art investment in the same manner as any collective portfolio manager such as UCITS management companies or alternative investment fund managers. Proven techniques and disciplines common to the management of every asset class are employed and modern portfolio theory, sophisticated risk management tools, and quantitative and qualitative analysis form the basis for investment strategy and process.  

By employing the expertise and market intelligence of a fund manager, supported by robust financial and art market research, art investment funds seek to provide investors access to high potential opportunities typically captured only by the world’s top art collectors and dealers. These funds are designed for sophisticated and qualified investors seeking high levels of return in an inefficient market through an optimised exposure to art. 

Regrettably, the amount of capital raised by art funds has remained low relative to mainstream alternative investments such as hedge funds and private equity funds as they lack the size and scale required to attract institutional investors. Although private investors are gaining appetite for passion investments, the past few years have brought risk management and governance concerns over such funds into sharper focus. This due diligence process comes along with the challenges of art fund managers faced with the potential implementation of the AIFMD. 

AIFMD-compliant art fund managers
Whether through direct (or indirect) application of or opting into the AIFMD, art fund managers are faced with numerous issues when complying with the requirements of the directive. 

These issues concern, inter alia, the operational requirements and fiduciary duties, delegation of fine art portfolio management, the valuation of art works, art risk and liquidity management as well as AIFMD-compliant custody of fine art. The entirety of issues for art fund managers relate to asset class-specific circumstances, i.e. they stem from the uniqueness and distinctiveness of fine art as an alternative asset class. 

The key characteristics and, inter alia, challenges of fine art as an asset class - not only in collective investment structures - are foremost the lack of liquidity due to long market cycles of artworks, which can be between thirty to forty years, the negative cost-income ratio during the holding period, the non-transparent market environment, potentially high volatility, especially of Post-War and Contemporary art, a high art title risk exposure as well as valuation issues of fine art. 

Among the aforementioned range of difficulties which cannot be discussed in detail, the delegation of fine art portfolio management and custody of fine art under the AIFMD are of particular relevance. Given the AIFMD’s delegation requirements, legally invalid delegation agreements may be identified in situations in which the AIFM simply acts as a transaction settlement agent prior to having external parties such as art dealers or galleries advising and deciding on art investments. Hence, an AIFM must not blindly apply external advice.
Notwithstanding, external advice and decision may be bought without running the risk of invalid delegations in the case that final investment decisions remain with the alternative investment fund manager, for example by aggregating the external service with the overall art portfolio’s return and risk characteristics. 

Furthermore, in light of the requirement to designate an eligible depositary for the AIF’s assets, the relationship between the AIFM and the depositary with regard to proper custody of the fund’s assets is important. Given that fine art is not a financial instrument, the depositary’s safekeeping duties are adequate ownership verification and record keeping. Albeit a duty of the depositary, the onus lies (also) with the AIFM. For instance, the ownership verification of works of art produced prior to 1945 may result in time- and cost-consuming provenance research, accompanied by expert opinions of various art market participants such as specialised provenance researcher, art historians, lawyers and art appraisers. As the art investment industry faces such AIFMD transposition issues for the first time, it remains to be seen how the art market adapts to the requirements and develops consolidated practices and procedures.

Art investment vehicle trends
Current trends point toward increased exposure to direct investments in art, particularly among family offices. Sophisticated investors tend to direct investments in order to regain control and shift to psychic returns, as they become dissatisfied with fund fee structures and traditional equity markets. 

The rate of direct investment in art by family offices is growing as they start to look more and more like private equity, venture capital, and hedge funds. However, multi-family offices managed by a third party management company may run the risk to be treated as AIF/M whereas single-family offices may be exempted. Nevertheless, compelling is that family offices do not have to pay the "2 & 20" typically garnered by fund managers. All this suggests a trend that has momentum and will have some profound effects on the art fund space over the coming years.

Since 2009, family offices have become significantly more interested in making direct investments following the profound impact of the economic crisis. According to studies carried out by Wharton Global Family Alliance, a unit of the University of Pennsylvania's Wharton School in Philadelphia, US, that focuses on wealthy families and their businesses, families have almost doubled their investment allocations to direct investments in companies and property. 

We have also seen the emergence of managed accounts from art fund managers seeking to provide investors with higher levels of transparency and control, greater liquidity, and more flexible fee schedules. As art fund managers wrestle with ways to attract new capital infusion, one increasingly popular solution is to offer private single owner accounts particularly for investors with larger pools of capital to invest in art. While managed accounts are introducing new support challenges for the art fund industry, they do present a valuable opportunity for art funds to attract clients and assets.

A managed art account is a specifically tailored dedicated investment vehicle, often set up as a limited liability corporation. All assets within the managed account are held in the name of the managed account holder. The managed account trading strategy generally mirrors a manager's reference art fund, but the investment mandates can be bespoke and tailored to meet the investor’s individual requirements. Furthermore, depending on the structure of managed accounts in casu, it cannot be guaranteed whether managed accounts qualify as AIF, requiring their operators to seek a licence under the national AIFMD transposition regime.


As the industry evolves, it is clear that the winners will be those art fund managers who have the operational flexibility to adapt and provide products that meet investor’ needs. The AIFMD as the European core regulation may provide advantages for art fund managers as – despite operational issues on adapting to the regulation – a potential “Fine Art AIF” increases the attractiveness for (professional) investors seeking the benefits of art investments as a portfolio diversification and inflation hedge tool. 

Moreover, the AIFMD’s European passport regime provides art fund managers with potential liquidity through cross-border marketing and distribution. With an AIFMD-compliant art fund manager, fine art as an asset class may further attract investors, but may also create synergies and a novel financing instrument for participants beyond the alternative investment fund industry, such as museums, individual and corporate collectors as well as other members of the art market.

About the authors:

Randall Willette is the founder and managing director of Fine Art Wealth Management, a professional membership-based advisory firm that provides independent consulting to wealth managers and their private clients on wealth structuring for art assets. Prior to establishing the Company in 2003, he was executive director and head of art banking for UBS Wealth Management in London responsible for helping to build its global art banking franchise in Europe and America. While there, he developed and implemented a global marketing strategy for UBS art banking, integrating art assets into the bank’s overall wealth management strategy for private clients and established standards of best practice in art due-diligence for the bank.

David Eckner, LLM (King’s College London), JD (Düsseldorf) is executive manager of the Center for Business and Corporate Law at Heinrich Heine University of Düsseldorf (Germany), lecturer in securities law, regulation and creative industries at Heinrich Heine University of Düsseldorf (Germany), the Institute for Financial Services (Liechtenstein) and Tilburg Law School (the Netherlands) as well as research associate with the German fund management unit of HSBC Trinkaus. David regularly publishes and presents on investment law and regulation as well as on the impacts of regulation on fine art investments.

Register for WealthBriefing today

Gain access to regular and exclusive research on the global wealth management sector along with the opportunity to attend industry events such as exclusive invites to Breakfast Briefings and Summits in the major wealth management centres and industry leading awards programmes