Art funds of funds are generally privately offered investment funds dedicated to the generation of returns through the investment in other art funds. Art funds of funds neither acquire nor dispose of works of art but rather construct portfolios of underlying art funds that meet the investment criteria of the fund of funds’ investors.

While there have been only a few art funds of funds to have launched to date, most notably ABN Amro’s limited entry into the space in 2004 via its Singapore office, as the number of art funds and investor interest therein continues to grow, the number of art funds of funds are expected to significantly increase.

 

Art funds of funds are managed by professional investment management firms that are usually comprised of a mix of experienced art market professionals and professional investment advisors from more traditional hedge or private equity funds.

Art funds are not all the same, and they vary differently in terms of investment strategy, portfolio restrictions, management, volatility and risk/return profiles. As a result, individual investors seeking to create and monitor a successful and diversified portfolio of art fund investments are faced with a complex, time-consuming and costly undertaking. For this reason, art fund of funds managers exist to perform the due diligence, construction and supervisory functions on behalf of prospective investors, effectively spreading the costs among a large number of investors.

Art fund of funds managers perform a number of tasks for their respective fund of funds such as:

• identifying potential art funds and their managers to invest in
• raising capital for the fund of funds
• managing investor relations
• handling administrative compliance for the fund of funds
• constructing a portfolio of art fund investments to deliver stable returns
• monitoring the performance of the art funds in its portfolio

 

The fees charged by art fund of funds managers are primarily tied to performance, which serves to align the interests of such managers with those of the art fund of funds’ investors. Typically, fund of funds managers charge (i) a fixed management fee based on the net asset value of the fund of funds’ investments, typically around 1%, and (ii) a performance fee equal to a percentage of any profits made from the fund of funds from its underlying art fund investments that exceed a predetermined threshold “hurdle” rate. From the perspective of an investor in the fund of funds, such fees are in addition to the management and performance fees to be charged by the underlying art funds that constitute the fund of funds’ investment portfolio. While many argue that such “double fee” structure makes investing in an art fund of funds prohibitively costly, the value provided by art funds of funds managers in terms of their performance of due diligence, portfolio construction and monitoring services in many cases greatly exceed the dual-fee costs of investing through an art fund of funds.

 

Investors seeking to invest in art investment funds are faced with the difficult and time consuming process of identifying and evaluating different art funds and their managers. Unlike investments in the equity of publicly traded companies, the ability to gather true and complete information about available art funds is beyond the scope of even the most seasoned professional investors. As a result, art funds of funds utilize their familiarity with the art fund industry and its principals to efficiently select those art fund investments that meet the particular investment criteria of prospective investors. Art funds of funds then continuously monitor and manage the art fund investments made on behalf of its investors, which it can do with greater skill and efficiency than most investors.

In addition to the services art funds of funds perform on behalf of its investors, art funds of funds provide investors with greater access to art funds than they would individually be able to attain by investing directly in such art funds. Investors wishing to invest in art funds are subject to certain minimum investment amounts which make investing in a diversified pool of art funds an expensive proposition. However, by pooling the funds of various investors, an art fund of funds can spread such investor monies across a wide basket of art funds, thereby providing a greater degree of diversification than what individual investors could procure on their own.

Art funds of funds can also assist investors by utilizing their relationships with art fund managers to negotiate reduced management and performance fees for its investors and to provide access to new art funds launched by art fund managers no longer accepting money from new investors.

 

Art funds of funds are subject to a number of laws and regulations. The following general discussion relates to those funds of funds seeking to raise capital from U.S. sources. Offshore art funds of funds with non-U.S. investors are subject to different regulatory regimes depending upon their and their investors’ location.

• Registration of Art Fund of Funds Managers. The Investment Advisers Act of 1940 requires that persons who give investment advice relating to securities for compensation to U.S. clients must register as an investment adviser with the U.S. Securities and Exchange Commission (the “SEC”) if it does not meet certain exemptions promulgated under the recently adopted Dodd-Frank Wall Street Reform and Consumer Protection Act. Fund of Funds with less than the requisite assets under management thresholds for registration with the SEC may still be required to register pursuant to the laws of the states in which they maintain offices or raise money from investors. The registration of an art fund of funds manager as an investment adviser brings certain advantages from a marketing standpoint as many pension funds, family offices and institutions take comfort from the fact that the art fund of funds manager is regulated by the SEC but it also bring disadvantages in the form of regulatory compliance and restrictions on charging performance based fees to certain “qualified clients”. It is worth noting that registered fund of funds managers are subject to stringent record-keeping rules promulgated by the SEC as well as periodic SEC examinations looking into, among other things, charged performance fees and conflicts of interest disclosures.
• Avoidance of Registration of the Art Fund of Funds itself. The 40 Act requires that investment companies, another word for a mutual fund, register as such with the SEC and comply with the burdensome set of rules relating thereto. To avoid being characterized as an investment company, art funds of funds must comply with the two established exceptions – namely have less than 100 investors in the fund of funds or up to 499 investors that are all “qualified purchasers”.

• Avoidance of registration of the Art Fund of Funds’ equity interests. In order to avoid registering an art fund of funds’ securities with the SEC as an initial public offering pursuant to the Securities Act of 1933 (which is rarely advisable), an art fund of funds must offer its securities privately pursuant to a Reg. D private placement. To satisfy the private placement exemption, the art fund of funds must limit its offering to “accredited investors”, make full and fair disclosures of all material elements of the investment in the art fund of funds by way of a private placement memorandum and subscription agreements and file a notice with the SEC and “blue sky” notices with applicable state securities regulators that sales of the art fund of funds’ equity interests are being made in reliance on Reg. D.

• Compliance with ERISA. The Employee Retirement Income Security Act of 1974 (“ERISA”) regulates the investment by pension funds in art funds of funds by way of its “plan asset” rule. In essence, an art fund of funds accepting 25% or more of its investments from benefit plan investors (such as ERISA investors and IRAs) are subject to various Department of Labor rules that in most instances an art fund of funds would not wish to be subject to. Such rules include limits on investor lock-ups, valuation procedures for the fund of funds’ assets and indemnification requirements.

• Compliance with Anti-Fraud Regulations. Art fund of funds and their managers are subject to the anti-fraud provisions of the Securities Act of 1933, the Securities Exchange Act of 1934 and the Advisers Act which prohibit fraud in connection with the offer and sale of the fund of funds’ equity interests and in connection with the advisory relationship.