Equally important, a number of new entrants are looking further down the track to focus on even greater opportunities in 2010. Since our last report there have been a number of developments which could significantly influence the demand for art investment by both institutional and private investors.

First, there is a growing view that the magnitude of the global stimulus plans could lead to a spike in inflation. Though these emergency measures may have been essential to prevent any further contraction of financial markets, they could have serious, unintended inflationary consequences down the road. Consequently, as governments continue to flood the market with capital, the risk of a sudden inflationary flare-up has become a primary concern for many investors, according to new research by Credit Suisse Asset Management.

Inflation hedge

Unlike other tools available to manage the impact of inflation on portfolios, art can provide an effective hedge against inflation while also serving to enhance the overall risk/return profile for a portfolio. One of the best examples was the British Rail Pension Fund which invested $100 million or 2.5 per cent of its portfolio into art back in the mid-1970s. The fund’s collection achieved the primary objective of realising a rate of return of more than the rate of inflation, which was unprecedentedly high. This was quite visionary at a time, when, just as today, the financial system was facing exceptional stress.

Institutional investors are expected to increasingly explore the role that real assets can play in their portfolios through opportunistic, tactical and strategic investment. A key concern for pension fund and endowment portfolios is diversification of the asset mix and protection against inflation in order to match future real liabilities. While many investment professionals agree that real assets provide diversification benefits, there has been surprisingly little research into the appropriate allocation of real assets – not to mention art – for a given investment mandate.

Second, while the financial crisis and economic uncertainty clearly has had an impact on high net worth individuals’ investments of passion and lifestyle spending, they are taking advantage of uncertainty in global financial markets by investing in art and other tangibles. According to the 2009 World Wealth Report, published in June by Capgemini and Merrill Lynch, HNW individuals actually gravitated to art as a primary passion investment in 2008, increasing their pre-crisis levels as a means of “flight to safety”.

Third, while the quest for alpha, or outperformance, remains the dominant theme for most art funds, the demand for indexed strategies is driving innovation, as investors seek products that are more transparent. Art Market Research and Castlestone Management are the first to team up to create a new index specifically to track post-war art and is intended to enable investors to gain exposure in the art market in a similar way to that which is provided by an exchange traded fund.

Assets invested globally in exchange traded funds have reached a record high of $862 billion on the back of a partial recovery of stock markets and the continuing strong demand for passive investment, according to data from Barclays Global Investors. Launched primarily as equity vehicles, ETFs have now spread across a wide range of assets, from fixed income, commodities and currencies to hedge funds and private equity.

Fourth, as some art strategists start to pinpoint the timing of the rebound in art prices, distressed art collectors have become the target of some art funds. Recently we have seen the Fine Art Fund Group and Artistic Investment Advisors, the investment advisor to the Art Trading Fund looking to exploit opportunities created by distressed sellers of art.

While the success of this strategy remains to be seen, FAWM believes the current dislocation will continue to bring attractive business opportunities in the fields of distressed art trading, rescue financing and turnaround investing.

Finally, while the worse appears to be over with regard to the financial crisis, a great deal of uncertainty still remains over the Alternative Investment Fund Managers Directive . On 30 April 2009, the European Commission published a draft directive to establish a common regulatory and supervisory framework for investment managers of funds promoted to investors in the European Union and not currently subject to European-level regulation. While the impact on art funds has yet to be fully determined, it is worth emphasising that the AIFM is at a very early stage of the legislative process and many of the details have yet to be published. They have already been criticised by influential voices for both being too extensive and not being extensive enough and there is no doubt that the proposals will be revised and refined in the coming months.

However, there is also little doubt that the way in which the European funds marketed in Europe are regulated is on the verge of a significant shakeup.