In my social circle, the general consensus is that investing in art is something for other people. Specifically, people blessed with vast financial means and considerable leisure. Accessible art investing is not.
Not yet, at least. Masterworks, an upstart digital platform that allows members to take fractional stakes in investment-grade works of 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 just two qualified offerings – an Andy Warhol from the late 1970s and a Banksy from the turn of the 21st century – it hasn’t realized its potential yet. But Masterworks is accepting new members now, and the upside is evident for prospective investors without the means to purchase million-dollar paintings on their own dime.
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 five to 10 years. 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 $20 per share, but – as with any investment – share prices may fluctuate based on changes in the value of the underlying asset.
Vetting & Onboarding Members
Members must be confirmed to purchase shares in a Masterworks holding. Applying to become a Masterworks investor is far more involved and intense than opening a regular old securities account. Applicants must bring substantial investable assets to the table and pass two interviews.
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 – and you’re willing and able to invest a considerable sum.
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.
Although Masterworks advises investors to expect a five- to 10-year holding period for each work, the platform welcomes offers for its works at any time. If a collector or other potential buyer expresses interest in taking a piece off Masterworks’ hands, Masterworks puts the matter to a shareholder vote. If shareholders approve the transaction, Masterworks begins the process of offloading the work and distributing returns to shareholders.
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.
It’s unclear whether this 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.
Planning for the Future: Liquidity Windows & an Artwork Share Exchange
Masterworks shares are presently illiquid. Under normal circumstances, investors must wait to offload their shares until fellow shareholders have accepted a buyer’s offer. Masterworks says it’s “working with appropriate regulatory agencies to create the means for investors to sell their shares to other investors” during planned “liquidity windows.” That would go a long way toward assuaging the concerns of investors with shorter time horizons. However, Masterworks hasn’t publicly given a timeframe for this initiative.
Masterworks has publicly indicated it plans to deploy a mechanism for exchanging shares outside the sales process. Essentially, it’s an internal share exchange investors with shorter time horizons can use to exit an investment before Masterworks sells the artwork securing it. Masterworks hasn’t given a firm timeline for this project either, and it’s not clear what’s involved, so investors shouldn’t expect anything imminently.
- Built-In 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, involves nearly $2 million in shares outstanding – well out of reach of the typical retail investor.
- 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.
- Investors Can Vote on Offers. Masterworks commits to putting all serious buyout offers to a shareholder vote. While publicly traded companies are also supposed to put things to a shareholder vote, many don’t bother to do so in practice. With a far smaller investor community, Masterworks makes the voting process more impactful for the average shareholder.
- 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 more than 250% since 2000.
- Not a Liquid Market. While Masterworks is taking real steps to democratize art investing, the solution has limits. Among the most significant drawbacks is the present lack of liquidity. Under normal circumstances, there’s simply no way for investors to offload an investment before the work sells. It’s not clear whether Masterworks makes any exceptions to this rule, perhaps by purchasing shares directly from investors. Masterworks plans to launch an internal share exchange, but its debut isn’t necessarily imminent.
- 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 Intense. Masterworks requires all prospective investors to submit to a fairly intense membership application process that provides no guarantees of acceptance. Applying demands more time and effort than opening a typical brokerage account, including multiple in-depth interviews.
- Few Investment Opportunities. As of late 2019, Masterworks has only two qualified offerings available for purchase. Prospective art investors don’t have their pick of the litter here.
- High Management Fees. Masterworks’ ongoing 1.5% annual management fee is significantly higher than fees charged by well-regarded index funds. And the 20% take on profits feels excessive – though it’s understandable that Masterworks needs to preserve its upside.
- Requires a Long Investing Time Horizon. Masterworks investors must commit to a holding period of five to 10 years and potentially longer. This is not a suitable investment for folks with short time horizons or those seeking the flexibility to modify their positions without selling out entirely.
- Unproven Platform. With just two qualified offerings and no successful sales, Masterworks is a fundamentally unproven platform. On paper, it could be a game-changing innovation that democratizes an exclusive alternative investment. But it could also fail.
Masterworks 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. 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?
Would you consider investing in art through a platform like Masterworks?