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James R. (“Jim”) Hedges, IV was one of the early leaders in the hedge fund and alternative investments industry, and is the author of Hedges on Hedge Funds. He was the Founder, President, and Chief Investment Officer of LJH Global Investments, LLC, an alternative investment advisory firm which he sold in 2010.

Jim Hedges has been an active art collector and patron for over 20 years. With a specialized focus on photography by Andy Warhol, Jim has acquired and placed more Warhol photography than any other collector, private dealer or gallery in the world.

Jim has served on The Drawings Acquisition Committee at the Museum of Modern Art, as a National Council Chair for the Aspen Art Museum, a member of the National Committee of The Anderson Ranch, a Director of The Aspen Institute’s Arts Panel, as a Trustee for The Drawing Center, a Founder of The American Friends of the Tate Gallery, a Founder of The Aspen Conversations, a Trustee of The DIA Foundation, a Trustee of ArtPace, and member of the National Committee for the Whitney Museum of American Art. He is also a former Director of The National Public Radio Foundation (NPR).

Hedges has also assisted in the publishing of artist monographs including Sigmar Polke, Robert Mangold, Sol LeWitt, Ed Ruscha and numerous others. Hedges has supported artist’s retrospectives including Roni Horn at The Whitney Museum of American Art and Sol Lewitt, at the same venue. Support has also been provided to Carl Andre and Sol Lewitt exhibits at The Aspen Institute. Hedges has also made donations of numerous artworks to major institutions such as The Whitney Museum of American Art, The Museum of Modern Art, The Menil Collection, The Dia Foundation, The Tate Modern, The Hunter Museum of American Art, The Baylor School, and Girls Preparatory School.

In 2016, Hedges made a gift to The Archive of American Art at The Smithsonian of “The Jimmy Hedges Papers on Outsider Art,” the largest collection of curatorial research materials on Outsider Artists. The Archive will serve as a permanent resource for students, curators and collectors of Outsider, Self-Taught and Folk artists.

Hedges’ activities in the art world led Art and Antiques magazine to name Mr. Hedges as one of “The Top 100 Collectors in America.” He also served as President?of The Hedges Family Charitable Foundation. Hedges Projects has also published numerous editions with artists in Andy Warhol’s inner circle including Christopher Makos and Sam Bolton.

Matthias Knab: When I started the Opalesque in 2013, Jim already had his hedge funds of funds going for 11 years, so he started in 1992. So, Jim has been a veteran hedge fund investor who along the way also started to collect art. After collecting art, he then made a transition to invest in art. Tell me more about this transition from hedge funds, to a collector and investor in art?

Jim Hedges: When I started investing in hedge funds in the early 1990s, it was a place where people really went for returns. At that time, the hedge fund eco system was much different from today, it was a lot move relationship-driven. It was not very transparent, it had a lot of pitfalls, and it was difficult to understand. And a lot of those markers are the same in the art world today, where there is not a lot of transparency. It’s very much relationship-driven type of world as well, but with huge outsized return opportunities.

I actually started collecting art when I was very young, originally in photography and then moved on to different areas. In the course of actively collecting, over time you get more and more educated and you start identify things where there is relative value that looks interesting. Also, when was running my hedge funds of funds, a lot of my clients were also art collectors, and I learned from them as well.

Ultimately, what I found was that the art world was probably the largest unregulated financial asset out there in the world. We are looking at a sector that has about $50 billion a year of turnover with an enormous volume of transactions. However, there is also a dynamic where the real investable universe of art is actually fairly small. If you go and look at auction catalogs from Christie’s and Sotheby’s and Phillip’s, you’ll get the lion’s share of the names of artist who have defensible liquid markets for their work. So, there is a big universe of $50 billion volume per year, and then there’s a smaller universe relatively speaking in terms of the number of artists, or we may even describe them as securities.

Let’s think about some of the ways in which you can assess value – interestingly, the lessons I’ve learned in the funds of funds or in the hedge fund business are very much applicable to the art world – I will share with you a few examples. For instance, you can try to identify artists that have an undervalued position relative to their peer group. In the hedge fund or finance world, this is nothing other than the old notion of a relative value trade. So I studied different artists and their peers, and sometimes I could see that there were huge valuation disparities between this blue chip and another equally blue chip artist, but whose work just hadn’t seen the appreciation in the United States, for instance. And therefore, it was actually at a great discount.

So I went out and identified some of those types of artists. For instance, there’s Gerhard Richter, the abstract German artist and then there’s also Sigmar Polke, another artist of the same vein and same generation. So, what did I do? I went “long” Sigmar Polke and saw a great deal of price appreciation over the past five to ten years.

You can also apply the relative value principle when looking at the value associated with different bodies of work of the same artist in case that artist works across different media. An artist maybe a painter, but he or she may also make works on paper and drawings, or work as a sculptor, or may make photographs, et cetera. I very frequently have found great investment opportunities by looking at tier 1 blue chip artist and then assessing the relative value within in their portfolio of work and finding interesting segments that were dramatically undervalued.

For instance, I have also quite early become very active in particular in the Andy Warhol photography market. Warhol photography was central to the artist art making process. We talked about this in the previous Horizons issue. Warhol began in the 60s with photographs, Times Square photo booths strips where he would take subjects into a photo booth, create serial images of them and then turn those into paintings. He then began working with a Polaroid and later worked with a 35 mm camera all along those years. So, for three decades, 60s, 70s and 80s, the artist was utilizing photography as source material for making prints, making works on paper, making paintings.

So, I knew it was terribly important. I also saw that prints of which the artist made – maybe 250 pieces of a particular type of image – were trading at far higher value than the photographs, which were unique objects an not produced in multiples. As a relative value investor, it was very interesting to me that you could buy one of 250 that might cost $25,000 or $50,000 versus a unique object for maybe $5,000 or $10,000. That valuation disparity needed to correct, and indeed it has begun the process of correcting. I invested heavily in Warhol photographs and built a large collection which is said to be the largest private collection in the world of Warhol photographs. I’ve actually started to monetizing that over the course of years by selling at art fairs and through different channels.

You see, these are the types of things that are very interesting to me. I applied the same rationale to the artist Cy Twombly – obviously, one of the greatest artists of 20th century, one whose paintings go in many cases if not most cases, well north of $5 or $10 million. His works on paper are now usually over a million dollars, but his photographs have also been completely undervalued, underappreciated, and understudied.

I find that a certain contrarian view of looking at something is very applicable to many types of investing, including art. Cy Twombly photographs had been trading for $10,000 or $12,000 a piece, and they were wonderful objects which I thought should be priced more like their peers and more in keeping with the artists’ other body of work. And, lo and behold, since I began investing in Twombly photographs they have gone up more than fivefold and in some cases even much more.

So these are some or the things I like to look at or discover. What’s contrarian? What is the strategy where you can find something undervalued within a very valuable artist’s body of work? Or how is this artist doing compared to another artist, and looking for evaluation disparities that should probably consolidate in the future.

Matthias Knab: How does one participate in the art market? What other tools that are needed to do that?

Jim Hedges: Malcolm Gladwell’s book, Outliers, talks about the 10,000 hours that you need to log in order to become an expert, ight? So, in complex domains or skills, whether it’s flying an airplane or whether it’s learning a foreign language, et cetera, it requires a tremendous investment of time to achieve a certain level of mastery. The art world is actually fairly easy place to learn, because everyone can get started with things like art fairs, auction houses, galleries and obviously museums. Still, the main thing people have to do to get engaged is to actually spend time and study the material and learn as much as you can. And while studying, start also to develop a point of view about what it is you’d like to or feel most comfortable investing at.

What I have started to do is looking at data analytical tools in the art space. There is such a dearth of information available on the value of artwork that I think there’s a real opportunity. For example, I have been looking at resources that use machine learning to analyze historic performance and predict the valuation of a particular artwork. And in the process of using these machine learning tools, we are also able to identify momentum characteristics, we are also able to identify a group of other factors that will tell us when sentiment is changing, when there is momentum behind an artist body of work and things of that nature that will drive price appreciation. Similarly, it helps us identify when auction houses miss on their estimate, and that’s a very powerful information as well because we can tell if something is going to be bought in and not sell. We can also tell when something is going to go dramatically over the estimate because the auction house lowballed it in order to encourage a lot of bidding.

But taking a step back, if one wants to get into the art world as an asset class, as a store of value, as an alternative investment, the best way to do it is to identify both a capital allocation that would be appropriate, and then go and seek out expertise that will help you identify those artists that exhibit some of the characteristics I talked about – relative value to their peers, relative value within their own body of work (and again, that has the benefit that you can assess and identify very attractive values using machine learning), and of course, allocate the capital to build a portfolio over the course of time. In art – not dissimilar from venture capital or private equity – investing across a longer time span is actually a very effective tool of making sure that you insulate yourself against market volatility in the near term.

Matthias Knab: If one wanted to go into art and follow these relative value trades and interesting opportunities that you have just described, how much money do you think is needed? And then secondly, how should those collectors or investors actually diversify?

Jim Hedges: It’s very interesting to think about these questions because it’s a similar discussion that I had 25 plus years ago when talking about hedge fund investing with people. You have to decide how much capital you are willing to put to work in the space. You have to decide assess what you can buy. Then you have to look at the appropriate mechanism to get exposure – meaning to invest. When I started in the funds of hedge funds business in the early 90s, managers had high minimums and many were closed to new investors. And if you wanted access and diversification, you were frequently driven to a fund of funds vehicle. That became the mechanism through which many people participated in the hedge fund world.

The art world is sort of similar – a large financial asset class with lots of volume going on, but not many people are going to buy $100 million paintings as an investment. So, how does one participate in a diversified way that gives one access to superior material? I essentially work with people on of two different paths. Either I work on a managed account basis to build an allocation to art for a family or a private bank, usually starting off at around $5 to $10 million of capital being allocated, because at that level, you can build sufficient diversification and breadth of exposure.

I have also started to work on the launch of an art fund which will have the benefit of aggregating investor capital into a larger pool so that larger dollar items can be bought and greater diversification can be achieved. But at the end of the day, if somebody wants to invest in the asset class called art, you are probably looking to invest greater than a million dollars, and at that level more likely through a fund. But if you have the ability to aggregate $5 to $10 million dollars or more, you could get a custom portfolio, or in finance speak a “managed account”, which then would effectively serve as a direct exposure.

At this point I want to touch on another aspectof investing in art. What I’ve described up to this point has been focused on equity, meaning direct ownership of artwork. But you can also invest in the art world through debt, which also exhibits a very interesting dynamic.?

I had a business that provided loans to private dealers and private collectors for many years. We provided loans and banking services to these individuals that did not want to borrow against their securities portfolio or their private bank. So they did not want to tap other sources of liquidity, but they wanted to get some value for short term cash purposes to take in against their fine art portfolio.

But then, in the process of talking to people about art loans, I found that, number one, art loans were very often times being sought out by people that really just wanted to sell. And if somebody really wants to sell or really needs to sell, sometimes there can be a distressed investment opportunity. So while I was flying the flag of being an art lender and went ahead presenting them a certain set of terms, often they then would say, “Well, but I really want to achieve something else. I really like to sell the piece.” That then allows you to make an offer, and many times I have been able to pick up assets at very attractive valuations.

So, there is a continuum that broadens how you can invest in art. There is buying the artwork which is effectively a long-only equity play. There is lending money where artwork is your security, and you can lend at high interest rates that are being paid on a current basis. And then finally, that art lending business usually uncovers opportunities in distressed assets.

Matthias Knab: Art funds have been around for a while, and maybe even back in your hedge funds of funds days you may have looked at some of those. What is your verdict on this fund category today?

Jim Hedges: The thing with the art fund universe is that often they have not been operated as a proper asset management or investment product, which, as we all know, for many reasons have become more and more regulated and transparent. So, unfortunately you could see a number of things that are troubling that that don’t really fly in the investment world, like for example conflicts of interest. Many of these funds or the people behind them are also brokering products themselves, so they are taking commissions when they are buying and selling for the fund. Many of these people have structured their businesses in a way where enormous fees are attributed to the fund, whether it’s fees for shipping, insurance, storage or management fees. You can see some very burdensome fee loads, that’s no good. We live in a world of transparency where people expect a fiduciary to actually be a fiduciary. We therefore think that there is a lot of opportunity to create a fund business that is differentiated and having best practices in due diligence and underwriting, best practices in marketing and PR and looking to monetize the assets through partnerships and based on diverse strategies such as I have described them. That hasn’t really been done to date.

My background as an asset manager in the funds of funds space really informs my art investing activities. The importance of sound operational excellence is paramount in investing just as it is in the art world. The importance of underwriting securities properly, of assessing value, of assessing momentum, these are skills that are directly applicable to the landscape as well. So you really need to have somebody guiding the ship that has a financial orientation as well as an understanding and sophistication when it comes to the actual art.

I found the lessons that I learned over my almost three decades in the hedge fund landscape can be directly applied to this art fund activity. You need to be able to assess artists for their value. You also need to be able to assess the operational risks and cost associated with making the investment. And you need to be able to look at all different types of strategies, whether it’s owning outright the equity, lending money to art collectors as art loans or buying distressed assets. That flexibility of moving across the strategies is really central to a successful art fund.

Like many segments of the investment world that are not well understood, the art world is prone to sensationalism as well. You hear people talking about emerging artist that have huge run-up and value, and then people get involved in a very speculative way only to become part of a blow up, this is certainly a bad part of the market and something to avoid.

Similarly, you hear the stories about the $100 million, $200 million paintings and people think that’s indicative of the art market. But the art market I’m talking about investing in is one where you can really build a diverse investment portfolio that is multi- strategy across different sectors, different types of artists, with artists whose work is highly liquid and with a long-established track record.

There is a universe of probably a thousand artist that fit that criteria. And among those artists, you can utilize both subjective as well quantitative tools and machine learning to identifying great opportunities for value.