Investing directly in a movie sounds glam – but it could be a perilous endeavor. Scouting the right talent, managing production costs and finding the right distributor are but a few of the hurdles that investors share as the production moves forward to fruition or perdition. The hardest to gauge is the personal whim of the moviegoer. Taste is fickle. A story with a broad appeal in one decade could fall flat in the next. If a movie does well, it may open the possibilities of a franchise; if it flops, it could claim numerous casualties, from studios to the careers of actors. (For more, see "The Economics of Summer Blockbuster Movies.)

Considerations Before Investing

The private equity/hedge fund vehicle appears to be the most common means for direct investment in cinematic ventures, with all that implies: Unsophisticated investors need not apply. The risks of such an enterprise can be substantial and often are better suited for the family office or institutional investor.

Due diligence throughout is critical. Offering documents must accord with applicable securities law. What is the producer's reputation? Experience? Backing one with nary a track record is akin to investing in a mutual fund with rookie portfolio managers. What is the film's potential market? Blockbusters tend to have a broad appeal; foreign films, documentaries and "small pictures"  have less appeal. But notable exceptions exist: Spike Lee's "She's Gotta Have It" and the 2016 Academy Award Best Picture winner, "Moonlight."

Films with a religious message or ones with a more intellectual humor could be a hard sell to the distributor, as well, since their audience is typically quite narrow. What if the film has no A-list talent? That could be a problem, though sometimes the film itself is the talent (think "Slum Dog Millionaire"). Name recognition could vary, too, depending on where the film is targeting its release. Learn about the director's vision. An outsized ego can prove fatal, as was the case with "Heaven's Gate" – which came nowhere near to recouping the runaway costs its perfectionist director Michael Cimino incurred.

Are the interests of the filmmaker properly aligned with the distributor and investors, or does much of the revenue inure to the benefit of the filmmaker? Is the investment a fair arrangement?

Where the Money Goes

Typically, revenues are first used to repay investors all of their investment and debts incurred. The process is akin to a return of basis or of the principal investment. Next would be profit sharing, or the return on the investment. Often, the split is even between the producer and investors. The film's stars, writers and director are paid from the producer's profits. Any investment proposals should be in writing and contain an arbitration clause for a more cost effective dispute resolution. Filmmakers would do well to have such a clause when dealing with financially stronger distributors in order to protect the former's interests.

The producer should have secured a completion bond,which is a surety bond that kicks in to pay for cost overruns, rather than having the investors shoulder the burden. Different fundraising options should be considered, depending upon the script and budget. Tax incentives properly pursued are another revenue-generator, so long as the incentive tail does not wag the movie dog.

The filmmaker should escrow funds during the fundraising stage of the film. This helps to ensure transparency and accountability. If insufficient funds are raised, then they should be returned to investors. All of these considerations point to the need for any investor to work with a professional with experience in the film industry.

The Way Forward

As an asset class, film would appear to be uncorrelated to the other types of investments. They are somewhat recession resistant; even in hard times, people still go to the movies or stream them.

Slate financing is the hedge funds' approach to risk management and return generation. This approach simply entails investment in a portfolio of films, rather than a single production. Through diversification comes a more proper balance of risk and return. What films are included in the portfolio may be a function of how the fund's co-financing efforts with the production and distribution company work through the film studios. Part of the challenge is untangling opaque financial accounts through due diligence in the quest for greater transparency.

There are plays in the movie industry itself, in the form of common shares. But individual investors need to understand where in the chain of production the companies lie and to what risks those companies are subjected to. For example, is the investment in a studio like Lionsgate (which nearly doubled its share price since the beginning of 2012) or distribution like Netflix or Coinstar?

The Bottom Line

Have movies been commoditized? Consider how easy it is to access a favorite movie. The theater is but the first of several distribution channels which include cable television, the internet and other streaming outlets. Ready availability of content has stolen a march on the movie theater experience and created more revenue streams and greater profitability.