Masterworks, an upstart digital platform that allows aspiring art collectors to take fractional stakes in investment-grade works of blue-chip art, is trying its best to change that. It’s following in the footsteps of cryptocurrency exchanges and investment-grade wine clearinghouses – places where it’s reasonably easy to buy and sell alternative investments without spending a fortune.
Masterworks isn’t quite there yet. With about two dozen qualified offerings, Masterworks’ inventory isn’t representative of the fine art world’s vast diversity. But the platform is adding new pieces of art at a regular clip and maintains a growing secondary market for investors looking to buy and sell holdings after the initial offer period closes. For prospective investors without the means to purchase million-dollar paintings on their own dime, the upside is clear.
Intrigued by Masterworks’ promise? Here’s what you need to know about how Masterworks functions today and how it could look tomorrow.
How It Works
Each Masterworks investment follows the same basic pattern. The Masterworks team handles much of the work behind the scenes, but investors get glimpses into – and sometimes actively participate in – these distinct phases.
Sourcing the Painting
Masterworks looks for paintings its team believes are likely to increase in value over the coming three to seven years, the benchmark holding time recommended by Masterworks. (Investors aren’t required to hold for this long, however.) Masterworks uses sales data for comparable works – for instance, contemporaneous works by the same artist or in the same school – targeting appreciation rates between 9% and 15%.
Buying the Painting
Once the Masterworks team identifies a suitable acquisition, they attempt to buy the painting at the fairest possible price. Masterworks claims its advanced auction strategies and personal relationships with auction houses give them an edge in the market.
Qualifying the Offer
Before Masterworks can sell interests in an acquired work, it must file an offering circular with the SEC and work with the agency to qualify the offering. This phase is colloquially known as “testing the waters” and requires Masterworks to prove there’s sufficient demand to fulfill the offering.
Once the offering is qualified, Masterworks can officially market shares to the general public. Qualified investors can purchase shares on the Masterworks platform. Initial pricing is always $20 per share. As with any investment, secondary market prices may fluctuate based on changes in the value of the underlying asset.
Based on publicly available transaction history data from Masterworks, shares rarely price below $20 on the secondary market and often price significantly higher. However, Masterworks doesn’t guarantee this will remain the case in the future.
Vetting & Onboarding Members
Members must be confirmed to purchase shares in a Masterworks holding. Applying to become a Masterworks investor is more involved and intense than opening a regular old securities account. Applicants must complete a thorough onboarding process that includes a live interview.
Masterworks doesn’t specify any investing minimums or spell out precisely what it’s looking for in its investors. But you should expect to demonstrate you’re serious about investing in art.
Displaying the Painting
Masterworks operates a members-only gallery in New York City’s SoHo neighborhood, where it displays works from time to time. When not on display, Masterworks’ artworks live in a museum-grade secure storage facility.
Monitoring & Tracking the Investment
Although art isn’t as liquid or transparently valued as high-volume exchange-traded securities, Masterworks does what it can to track the value and performance of its investments. They display this information in your account dashboard along with details about your holdings.
Selling the Painting & Distributing Returns
Following the closing of a sale, Masterworks distributes returns proportionally to shareholders after deducting its management expenses. Masterworks’ first offering circular reveals three distinct expense classes likely to apply to all future works:
- True-Up Fee. This fee is intended to offset the cost of acquiring and maintaining a work during the pre-offering period. The amount of the fee is the lesser of 10% or the painting’s estimated historical appreciation rate during the pre-offering period.
- Administration Fee. This fee covers Masterworks’ ongoing expenses during the holding period. It’s set at 1.5% of the value of total shares outstanding per year.
- Reimbursement for Extraordinary Expenses. This is a catch-all category that covers expenses Masterworks incurs during the holding period that it can’t reasonably expect to offset through the administration fee. Because of the inherent uncertainty of “extraordinary expenses,” Masterworks can’t estimate their impact ahead of time.
After its first offering circular, Masterworks rolled out a more straightforward expense structure with just two components:
- Annual Administrative Fee. Masterworks charges a 1.5% annual administrative fee that it says covers all “distribution costs, regulatory expenses (filing and ongoing audit expense), storage and gallery space, insurance, and other expenses.”
- Share of Profits. After they sell the work, Masterworks takes a 20% share of profits, if any.
According to Masterworks, this pricing structure is industry-standard. It’s unclear whether the new structure retroactively applies to its first work, but Masterworks has not revised or withdrawn that work’s SEC offering circular, so investors who’ve already purchased shares in that work should assume it does not until advised otherwise.
Selling Shares on the Secondary Market
Although art is often regarded as an illiquid investment, Masterworks shares are liquid, at least in theory. The platform operates an internal secondary exchange where buyers and sellers connect to exchange shares at agreed-upon prices. The market is nowhere near as lively as an established securities exchange, but it works, and Masterworks investors rarely sell at a loss.
Participation is limited to Masterworks members and liquidity is limited, but secondary buyers needn’t have invested in their target works’ initial offerings to purchase shares after the fact.
- Built-In Investment Portfolio Diversification. Art is a nontraditional investment that may perform relatively well when the broader markets don’t. Art was a noted safe harbor during the market turmoil of the late 2000s and was among the only asset classes to eke out positive performance during 2018, another underwhelming year for the equities markets. In other words, for sophisticated investors, art offers sorely needed portfolio diversification.
- Far Less Expensive Than Buying Whole Pieces. Investing in fractional interests in high-end art is far less expensive than buying whole pieces. Masterworks’ first offering, for the Andy Warhol piece, involved nearly $2 million in shares outstanding – well out of reach of the typical retail investor with a sub-seven-figure net worth.
- Easier Than Traditional Art Investing. Investing with Masterworks is also far more accessible than traditional art investing, which is a time-intensive process that requires specialized knowledge – or trusted contacts with specialized knowledge. Masterworks handles all the legwork for its investors, whose sole responsibilities are to understand what they’re investing in and bring sufficient capital to the table.
- Masterworks Uses Proprietary Price-Reduction Strategies to Boost Returns. Masterworks’ proprietary auction strategies and relationships may – but aren’t guaranteed to – produce below-market acquisitions. That could wind up being good news for investors.
- Impressive Historical Returns. Past performance is not indicative of future returns, but Masterworks is correct that investment-grade art has historically outperformed broader market benchmarks. According to Masterworks, return on investment in the “blue chip” portion of the art market – defined as the top 100 artists by sales – has outperformed the S&P 500 by approximately 180% since 2000.
- Not a Fully Liquid Market. While Masterworks is taking real steps to democratize art investing, the solution has limits. Among the most significant drawbacks is the lack of a vibrant secondary market. Masterworks investors can buy and sell shares on the platform’s internal secondary market, but the size of the investor pool remains small, so mutually agreeable transactions aren’t guaranteed. This will change, hopefully, as Masterworks grows.
- Investing in Art Has Inherent Risks. Art is an alternative investment. Unlike the exchange-traded stocks and funds in your 401(k), art valuation is opaque and subjective. Individual works may experience serious price volatility, as well. In short, even with Masterworks’ relative ease of use, this isn’t an investment for the faint of heart.
- The Membership Application Is Involved. Masterworks requires all prospective investors to complete a thorough onboarding process that provides no guarantees of acceptance. Applying demands more time and effort than opening a typical brokerage account, an interview that apprises prospective investors of the risks of investing in nontraditional asset classes.
- Relatively Few Investment Opportunities. As of January 2021, Masterworks has about two dozen qualified offerings available for purchase. Though this figure is set to increase with time, prospective art investors still don’t have their pick of the litter here.
- High Management Fees. Although it’s not out of line in the world of less-liquid nontraditional assets and certainly understandable that Masterworks feels the need to preserve its upside, Masterworks’ fee structure – an ongoing 1.5% annual management fee and 20% take on profits – is significantly higher than the fees and expenses charged by well-regarded index funds. They’re more in line with the fees charged by hedge funds, which cater to the ultra-wealthy.
- May Require a Long Investing Time Horizon. Art is best viewed as a long-term investment, so it’s not surprising that Masterworks recommends a holding period of three to seven years. Though investors are free to try to sell their shares on the secondary market earlier on, Masterworks shares still may not be suitable for folks with short time horizons.
Masterworks‘ unique business model has real potential to revolutionize the way people buy and sell high-end art. For aesthetics of relatively modest means, it represents the first real opportunity to invest in fractional art holdings at scale and capitalize on high-profile art sales. You could fit the number of Americans with the means to purchase million-dollar paintings into a handful of sports stadiums. Millions can afford to set aside a few thousand dollars.
Still, whether Masterworks can deliver on its promise is an open question. If its promised share exchange gets off the ground, the platform may prove unstoppable. But it’s too early to say for sure.
Either way, if you’re intrigued by Masterworks’ promise, why not request an invitation and see what all the fuss is about?