A New Hedge Fund Strategy--Art

Just when you thought that hedge funds had run out of ideas and arbitrage opportunities, managers are finding new areas to speculate in:

In September 2004, Philip Hoffman did something unusual: He bought a painting he actually likes.         

It was a work by Ed Ruscha, a pop art icon whose paintings hang in the National Gallery in Washington. Hoffman says he loathes some of the art he buys. In fact, he says he barely glances at paintings that have cost millions of dollars to acquire.         

Hoffman, 44, is a new breed of investor in the $5 trillion art market. From a townhouse near Hyde Park in London, he manages an investment fund that buys and sells paintings rather than stocks or bonds. Since 2004, a dozen or so similar funds have tried to lure investors as the price of art has soared. So far, Hoffman's is the only one that's raised enough money to start investing.         

Melding art and finance, art funds aim to trade Picassos and Rembrandts the way hedge funds trade U.S. Treasuries or gold --- and collect hedge-fund-like fees in the process. Hoffman's Fine Art Fund, for example, charges an annual management fee equal to 2 percent of its assets and takes a 20 percent cut of profits once the fund clears a minimum hurdle.                

Hoffman, a former finance director at London-based auction house Christie's International Plc, says his fund isn't about beauty, truth and passion; it's about making money.         

"We take a completely cold view,'' Hoffman says.                

Hoffman's investors need cool heads, too. He requires a minimum investment of $250,000, and investors can't withdraw their money for three years.         

Wow, I wouldn't have guessed that that the art business is a $5 trillion dollar/year market.  In fact, I'm a tad skeptical.  That being said, fine art may be the ultimate Giffen good, a good that attracts more buyers as the price rises.  The ability, therefore, too pool a lot of money together, and bid up art, may be a workable strategy.

We'll still reserve some skepticism (of course).  For one thing, an art hedge-fund doesn't serve the same economic good as a financial hedge-fund, which, by exploiting an arbitrage, also eliminates it, thus making markets more efficient.  It also doesn't behave like a stock fund, which assays to allocate capital to the most efficient users of it.  In this case, investors simply entrust a manager to guess which painting will appreciate in value, not unlike entrusting someone to gamble on sports teams for you.  Oh wait, someone already had that brilliant idea.

Most likely, some funds may do ok, but as an asset class, it won't be very good.  The problem is that, it will be difficult for investors to know which managers are good, and who is lucky.  The ones that are good, may end up over-capitalized, and may find it difficult to make a good return in this relatively illiquid market.

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