Recent results from Masterworks highlight that the only winner is the company itself, owing to an extremely one-sided fee structure. The premise of fractionalisation of art has promise, but I think there are ways to execute it differently so that it works in practice. ➡ If you're unfamiliar with Masterworks, please read this post first.
On 12 February 2020, Masterworks purchased the Jean-Michel Basquiat painting, The Mosque (1982), at Christie’s London Post-War and Contemporary Art evening sale for $5,171,240 (or £3,951,729 against a low estimate of £4 million). Seems like a steal for Masterworks at that point.
Jean-Michel Basquiat's The Mosque from 1982.
Part 1 - The investment pitch
Masterworks said that "This poetic and autobiographical work by Jean-Michel Basquiat is a truly unique and captivating painting created in the most important year of his career". And it's true, it's an incredible example of his 'stretcher paintings', named for the twine-bound wood stretchers that protrude beyond the corners. Christie's lot essay says it nicely, with the quote that "From crypt to cave to the skyline of 1980s New York, The Mosque sees Basquiat collapsing time and space with typical polyvocal brilliance".
When Masterworks offered shares in the painting to the public, it estimated that similar works had achieved a 17.5% compound annual growth rate (CAGR) from 1992 to 2020 - ie they had appreciated in value by 17.5% every year. To put this into context, the S&P500 achieved a CAGR of 10% over the same period.
An extract from the Securities Exchange Commission filing for the offering for the painting. It contains a rationale for investment in the work.
Masterworks sold 284,420 shares in the painting to the public at $20 each. They started selling the shares in March 2020 and were 'fully subscribed' (sold out) by July 2020. While we assume that members of the public bought all these shares, it is of course possible for Masterworks itself (or employees of) to purchase shares and help the offering sell.
At this point, there are also too many articles reporting distrustful and aggressive sales tactics by Masterworks and internal rifts. In February 2022, the sales team was generating $1 million per day in shares from investors - when expansion is directly funded by the public, there are clear misaligned interests.
Part 2 - The sale and the returns
Four years later, Masterworks sold the painting for $8,000,000 to an anonymous buyer. An investor who bought a share for $20 in 2020 was given $25.25 in 2024. This represents an annualised rate of return of about 5.8% (although Masterworks quotes a slightly higher rate of 6.3%, because they look at when subscriptions in the painting closed and not when they opened). Meanwhile, over the same period, the S&P500 achieved a rate of return of more than double, 13.85%.
This highlights a fundamental issue with art investing. You expected 17.5%, you got 5.8%, and had you invested in the stock market you would have got 13.9%. Tough luck.
Well not if you're Masterworks. The company makes revenue in several ways from each transaction:
11% true-up on the purchase price of the painting - that is, 11% of the purchase value of the painting (here, $517,160.00);
20% profits interest upon the sale of the painting (here, $395,454.20); and
1.5% per annum for administrative services fees (here, $422,129.50).
That is, Masterworks made $1,334,743.70 from the transaction! This represents 47% of the profits from the sale, leaving the remaining 53% to be divided among the potentially thousands of investors.
As a reference point, actively managed ETFs charge average management fees of around 0.5-0.75% and they don't take a profit share (an ETF, or exchange-traded fund, is a basket of securities like stocks). Masterworks' fee structure is designed around the so-called 'two and twenty' approach from Hedge funds (2% management fees and 20% performance fee), plus the true-up of 11%.
There is also the more nefarious possibilities that Masterworks sold to a related party (as the buyer was undisclosed), or received kickbacks or other perks as part of the purchase from the auction house or the sale to the buyer.
It is also a shame that an incredible, influential painting like The Mosque was hidden away in a freeport in the US for those four years (the SEC filing states that "As of September 28, 2020, the Artwork was located in a fine art storage facility maintained by the Delaware Freeport, LLC"). Masterworks has removed the one mitigating factor for art ownership - that you might actually just have something cool to look at, irrespective of what happens with its price.
So who wins in this scenario? The everyday investor, no. Culture, no. Masterworks, yes.
But the problem gets worse when you consider that they still have almost $1 billion of art under management, which they purchased at the peak of the art market during 2020-2022. They have only sold a tiny proportion of this (around 5%). Many artists have seen their prices curtail significantly, such as Banksy, which Masterworks owns 10 of (for a total value of $44.9 million, or 5% of all assets under management).
Just taking Banksy as an example, the falloff in valuations is evident in his print market (which is closely tracked owing to the number of editions that are on the market). This graph from Banksy-Value shows the price movements in his iconic print, Girl With Balloon:
Sales returns for Banksy's print, Girl With Balloon, since 2018, showing the 2021 bubble.
Part 3 - The solutions
The frustrating thing for me is that I don't think that the fractionalisation of art is a bad concept - it just needs to be done in a less exploitative way.
Here’s how some things that Masterworks, or another company in the space, could do differently:
Lower the fee structure. Masterworks takes profit for themselves at every point of the transaction. The true-up of 11% on purchase, the profits share of 20% on sale, and ongoing fees of 1.5% every year the painting is held. Yes buying and storing art is expensive, but not that expensive. It's a widely greedy arrangement.
At least show the art. Build a gallery and invite investors to look at their art. Work with print makers or publishers like Avant Arte to issue prints for the investors' walls that they can proudly display. Build a network that can be celebrated.
Stop selling shares in individual works. Art works best as a collection after all. Bundle up groups of works into funds in which shares can be bought. That is, hedge the risk and spread the upside.
More interestingly, you can create funds with different risk levels - a safe fund that contains mostly blue-chip artists (like Basquiat and Kusama) or funds that contain varying levels of exposure to blue-chip, contemporary and emerging artists.
Have a third party oversee the sales and purchase transactions and certify that they are arms length. This one is probably the most controversial as price opacity is one of the hallmarks of the art world. But I'm not asking for the public to be informed, just a third party. I’m sorry, we can’t trust you.
Finally, be clearer about the message. Make it about the art and not pure financial performance.
I continue to track Masterworks' performance because I am fascinated by the company as it paves new ground in the industry. However, it is becoming a behemoth on uneven footing at the moment and that scares me. Just because you're a pioneer, please don't burn the bridge for others.
George
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