The Test of Time: Art as an Investment

During WWII roughly 2.7 million tons of bombs were dropped on Europe by U.S. and British forces in the fight against the Nazis. By the end of the war, 70% of Europe’s industrial infrastructure had been destroyed and its economy was in shambles. Thousands of businesses disappeared, millions of debts were erased, and hundreds of cities lay in ruin under layers of rubble and ash.

Stocks, bonds, and real estate were wiped out across the continent. Despite this widespread devastation, one asset class managed to survive this period mostly unscathed—art. Even in a time when life, liberty, and property were being discarded at a rapid pace, art was preserved by the Allied and Axis powers alike.

This in and of itself says a lot about art’s importance in human culture and its ability to act as a long-term store of value. I have never written about art as an investment before because, historically, art has been out of reach for retail investors like myself. You needed to be rich and have connections to buy art. But then, I heard about Masterworks.

Masterworks is the first company to bring crowdfunding to the art world. What FarmTogether does for farmland and Fundrise does for real estate, Masterworks does for art. However, unlike other crowdfunding platforms, you don’t need to be an accredited investor to invest with Masterworks. Masterworks only requires a $10,000 minimum investment and that you pass a suitability review with one of their sales professionals.

I regularly get requests to do sponsored posts on this blog, but I typically refuse because most of the products I get pitched aren’t useful for most retail investors. However, after learning more about Masterworks and going through their investment process, I realized the value of their platform. This post will summarize that value and why you should consider investing a portion of your portfolio in art.

Why Invest in Art?

If you go to the Masterworks homepage, the reason to invest in art is laid out in the open in the upper right corner for all to see.  Since the year 2000, contemporary, blue-chip art has outperformed the S&P 500 by over 200% in total, or over 4.5% annually.

Unfortunately, the market historian in me knows this comparison isn’t completely fair. In 2000, U.S. stocks were still inflated from the DotCom bubble. Any performance comparisons starting at that point will always make U.S. stocks look worse than they actually are.

Putting that aside, blue-chip art still compounded at a rate of about 8.5% annually over the last 18 years. To me this is good enough performance to consider an allocation to art by itself. However, the performance wasn’t what sold me.

What actually made me pull the trigger was this table of annual return correlations between art and various other asset classes:

I don’t know what you see, but I literally see nothing. Zilch. Zero. While in many other contexts a zero would be a bad thing, when it comes to adding an asset class to your existing portfolio, a correlation near zero is a dream come true.

A correlation of zero implies that art produces a return stream that is independent of the other traditional asset classes in your portfolio (i.e stocks, bonds, real estate, etc.). More importantly, this return stream is also positive. So you have an asset with a positive expected return that doesn’t behave like the rest of your portfolio!

When stocks fall, art might fall too. Or it might not. When bonds sell off, art may follow suit. Or, once again, it might not. While most risky asset classes tend to move together especially during times of uncertainty, art marches to the beat of its own drum. This is why it can play a stabilizing role in your portfolio and why I really like it as an asset class.

But how big of an allocation to art should you consider? I would say something in the 5%-10% range. Enough to make a difference, but not so much to reduce your liquidity or expose your portfolio to arbitrary shifts in the demand for art.

As I have written about many times before, the bulk of your investment portfolio (85%-90%) should be in income-producing assets. The rest you can leave for non-income producing assets like gold, Bitcoin, and art. Why? Because non-income producing assets are priced solely based on what someone else is willing to pay for them in the future. Since there are no underlying cashflows, price is based on perception.

While perception also plays a role in how income-producing assets are priced, cashflows should still anchor these valuations. At least in theory. This is why I don’t have more than 15% of my portfolio in assets that are not income-producing. This includes art as well.

Thankfully, Masterworks doesn’t typically recommend an allocation above 10% for new investors either. This is one of the reasons why I trust the Masterworks process for art investment. I will cover that process now.

The Masterworks Process

To make your first investment with Masterworks, you just need to follow these five steps:

  1. Sign up.
  2. Schedule a call with one of their sales professionals using their online scheduling tool.
  3. Have the call where you discuss your investment history and learn more about Masterworks.
  4. If approved, link your bank account online using Plaid, or you can pay via wire or credit card.
  5. Review art offerings and make an initial investment of $10,000.

The process was simple and the user interface was easy to follow. Once your account is approved you should be able to see the current offerings for sale under the “Offerings” tab.

For example, here is one previous offering from the artist Jean-Michel Basquiat:

This panel shows different information about the offering including the initial offering price (i.e. the valuation you are investing at), the price appreciation of similar works, similar sales over time, and additional investment documents.

If you click on the “Similar Sales” chart, a new window pops up that shows you the sales of similar pieces by this artist in the past.  In addition, the definition of a “similar” piece is defined in the text:

In the case of this Basquiat piece, similar includes “paintings that are acrylic on canvas, or acrylic and oil, oilstick, pastel or spray paint on canvas, that were created in 1982.”

However, similar sales can be much more similar. For example, consider this offering by Christopher Wool:

If you look at the similar sales it is literally all words and text on aluminum:

The similar sales data for this piece is particularly interesting (from an investment perspective) because it shows basically identical work being sold for higher prices over time.

Regardless of what data you look at, Masterworks’ user interface allows you to get rich detail on the pieces they offer to investors. And if this isn’t enough, they also provide their investors access to a searchable price database as well. This database contains over 60,000 data points from over 70 years of art sales.

But if you don’t feel like doing a ton of art research on your own, rest assured that the Masterworks selection process is rigorous enough on its own.

How Masterworks Selects Art

The Masterworks offering selection process is based on two things:

  1. Qualitative factors about the art
  2. Quantitative measures about the artist

Given my lack of expertise, I cannot say much about the qualitative part of Masterworks’ offering selection process. However, I can discuss the quantitative measures they look for in an artist. These measures include:

  1. Momentum (i.e. how many sales and at what prices?)
  2. Loss rate (i.e. how many negative returning sales)
  3. Median return
  4. Auction bidding activity

All of these factors are analyzed by Masterworks to determine whether an artist’s work is likely to be a good long-term investment. For example, high momentum or a high bidding activity at auction suggests that an artist has grown a devout following within the community. In addition, a lower loss rate suggests that an artist is less likely to see a severe negative outcome when a piece goes up for sale.

Combined with the qualitative factors, Masterworks reviews these quantitative attributes before offering up a particular work on its platform. Some of their data is publicly available through various auction houses and price databases, while other parts of it are completely proprietary.

Masterworks utilizes both kinds of data to come to a reasonable conclusion about an artist and whether their pieces are likely to be profitable in the long term. In addition, Masterworks’ fee structure, which includes a 20% performance fee, incentives them to acquire works of art with high expected appreciation. The more money you make on a piece, the more money Masterworks makes as well.

[Author’s update 2/12/21: I have been asked by enough readers about Masterworks’ fees that I have added this update to address them. Masterworks charges 1.5% annually plus a 20% performance fee. Yes, I have spoken out against this fee structure before when discussing hedge funds. However, Masterworks isn’t a hedge fund. They aren’t buying and selling public securities and then underperforming a cheap index fund (like many hedge funds do).

Masterworks is providing liquidity to an otherwise illiquid asset class. The fees they charge can be thought of as a servicing fee to invest in art. A lot of resources (art curators, industry connections, data analysis, etc.) go into this process, and the fees cover those resources. Yes, aggregate returns will be a few percentage points lower because of this. However, as mentioned earlier, I don’t invest in art solely for the return. I do it for the low correlation to traditional risk assets. If you have more questions about this, feel free to reach out.]

While I make no claims to be an expert on art, Masterworks’ selection process has given me more confidence in the kinds of art they are making available to investors on their platform. See important information.

The Bottom Line

What started as a discussion of art’s importance in society ended with a look at how Masterworks is making art accessible to retail investors like you and me. Their price database, their in-house expertise, and their simple user interface give me faith that their journey as an investment platform is just getting started.

Of course, owning art isn’t necessary to build wealth. You don’t need any single asset class to be a successful investor. But, if you want an uncorrelated return stream that has stood the test of time, then use my referral link, skip the waitlist, and start your Masterworks journey today.

Today, I am proud to say that I am a partial owner of four paintings which comprise less than 10% of my net worth. It’s not a huge investment, but it is one I believe in for the long term.

Happy investing and thank you for reading!

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This is post 226. Any code I have related to this post can be found here with the same numbering:

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