Honest Masterworks Review: Why I Didn’t Invest In Art Here

Honest Masterworks Review: Why I Didn’t Invest In Art Here
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Updated on November 22nd, 2022

With easy capital sloshing around the economy over the last few years, a plethora of online investment platforms all vying for your money have popped up, including Masterworks.io.

This Masterworks art investing review is very different than 99% of the articles that clog the search engines because I’m not getting paid to write favorable things about it, unlike the glut of sponsored articles drowning out any negative viewpoints. My article will point out all the various reasons why you should NOT invest with Masterworks.

The optimist invents the airplane and the pessimist the parachute.

Gil Stern

October 2022 Update: I had a conference call with Scott Lynn and his CIO Allen Sukholitsky. They were nice and they tried to sway me to change my mind on their product, but I just have too many reservations.
I placed some of their responses to my criticism throughout this article in the appropriate sections to try and be as fair as possible.
I have no vested interest in whether you invest with them or not I’m only trying to point out all the reasons why I decided not to.

Honest Masterworks Review: Why I Didn't Invest In Art Here
I tried to get a screen grab where they were both smiling 🙂

How Can I Invest in Art Online? Masterworks

You’ve probably seen the Masterworks.io ads all over social media: invest in works of art! Diversify your portfolio! Invest in blue chip art shares! We’re the place for buying fine art online! Not only do they do heavy promotion on Instagram, Facebook and Twitter, there is also a personal finance army that is pushing affiliate sales of how to invest in fine art, using Masterworks.

Is Masterworks Legit?

Masterworks is one of the newer alternative investment platforms that have sprung up in the last couple of years, picking up gobs of undiscerning capital flowing through the economy with the stock market at records highs and a non-stop spigot of stimulus checks. Their message is that you can buy art as an investment and they advertise that you can invest in “shares” of fine art, $20 at a time. This is the first and only art crowdfunding site in existence at this time.


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Is Masterworks a Scam?

In this article I lay out my various concerns with this alternative investment in art company including the marketing of returns, the business model, fee grab, concerns with the company founder, tax implications and marketing tactics. For a sophisticated investor, Masterworks is basically a fee scam and this will probably be the only article you will see that talks about the disadvantages of the platform due to the sheer number of blogs that promote it for their own commission interests.

Is art a good investment in 2022? What are the pros and cons of investing in art with Masterworks?

Historical Perspective: is investing in art a good idea?

My first gripe is their misleading promotion of historical returns. Right on the front of their homepage, they display this performance chart of contemporary art versus the S&P 500.

Honest Masterworks Review: Why I Didn't Invest In Art Here
Contemporary Art Investment Performance

I want to point out that their appropriate benchmark wouldn’t actually be the S&P500, as it would be something illiquid and securitized like private equity. The only reason why I use the S&P500 in comparison examples in a later section is because they do so on their front page with this return chart and it’s the most obvious and easy investment for a retail investor to make. I told them they should display private equity returns for comparison instead which they thought was a good idea and will probably add to their webpage soon.

So, is artwork a good investment? They sure make it out to be. But this chart led me to two questions.

I asked them why they only offer contemporary art and they said that art produced after World War II is the best performing style. Maybe we should replace the S&P500 chart up there with the Nasdaq100 since tech stocks have been the best performing stock style over the same time period as their chart.

The reason they gave me for why contemporary art is the best performing style is that newer art appreciates faster than older art that appreciated a lot decades ago, which makes sense, and that art buyers that buy it for display often don’t like the same types of paintings their grandfather would have had on their walls (old, out-of-style).

Presumably there will come a point in time when the contemporary category is out of fashion and a more recent style performs better which Masterworks will move towards.

I was also wondering why the starting period was only from 1995. I already suspected the answer and confirmed it when I managed to dig up another one of their return plots for the same asset class. Their performance chart still looks good, but looks a lot better when you omit that 1990-2000 dip.

Honest Masterworks Review: Why I Didn't Invest In Art Here
Source: Citibank

The problem with charts of illiquid investments like these (not just art) is that they suffer from selection bias and academic research that studied the period from 1972 to 2010 confirmed that the long term returns of art, in particular, are less than half of what Masterworks and others are suggesting. In fact, it could be even substantially less:


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… we find that paintings with higher price appreciation are more likely to trade. This strongly biases estimates of returns. The selection-corrected average annual index return is 6.5 percent, down from 10 percent for traditional uncorrected repeat sales regressions, and Sharpe Ratios drop from 0.24 to 0.04. From a pure financial perspective, passive index investing in paintings is not a viable investment strategy once selection bias is accounted for.

Korteweg, et al

Another study examined 1 million pieces of art sold at auction over 50 years found:

… performance similar to that of corporate bonds – at much higher risk.

Renneboog and Spaenjers

Maybe these figures don’t represent specifically the contemporary category, but you have to wonder if this style of art has only been in fashion in recent history and won’t represent the future.

But what selection bias means is that only the pieces of art that get sold are included in the performance figures. What happens to art that is purchased, but then isn’t sold because its value dropped? What if the reserve price isn’t met at the auction? What if the art owner never even bothers to bring it to auction because their art expert consultant said that it wouldn’t fetch enough at auction to make it worth the fees? What if a piece of artwork is sold privately? Those poor return results don’t drag down the average when they are omitted.

This kind of pricing information is very different than looking at a performance chart of the S&P 500 because you have fungible shares trading every day and aggregated up to an index.

Maybe it should be obvious, but not every piece of art appreciates. In fact, the data show that the best returns come from just 2% of artists that have the most resale volume. If you’ve ever been to an art museum, you’ll surely be familiar with the names that do well. Obviously, these are the types of pieces that Masterworks will try to acquire, hold and sell, but they are buying well after the artist is a blue chip name and those mind boggling returns of artists who rose from obscurity to fame like the misleading examples on the front of their website won’t apply.

Furthermore, I’m always skeptical of outperformance claims made about an entire asset class that not only produces no internal cashflow but actually has costs associated with holding it.

A different annual return source looks at its mean annual return, which is like a speedometer through time. This chart shows that art has had spurts of growth, coinciding with the same time periods of other asset and stock market bubbles, and that mean annual return has been declining over the last ten years.

Honest Masterworks Review: Why I Didn't Invest In Art Here

And even the ArtPrice100 art investment index shows that the top 100 artists did very well but the remaining artists fared much worse.

With our art market indices, we strive to make them as comprehensive as possible; they include hundreds of thousands of transactions that represent all post-war and contemporary transactions at public auction, both at major auction houses and smaller auction houses. We make this index data available to investors as a way to inform their understanding of the performance of the art market, in aggregate.

Allen Sukholitsky, CIO Masterworks.io

And let’s come back to that 14% figure advertised at the top. Their own data shows that the annualized returns for contemporary art since 1985 was 11.5%. So if you ignore the bad periods, art really outperforms.

Honest Masterworks Review: Why I Didn't Invest In Art Here

And lastly, the Sotheby’s Mei Moses Index from 1950 to 2021 showed a compound return of 8.5%.

Honest Masterworks Review: Why I Didn't Invest In Art Here

There’s a bit of a trust issue of using the return series of the firm that is also selling you the product because there is an incentive to use a methodology that looks the best. Frankly, there doesn’t appear to be a consistent source for historical investment artwork returns, but picking a basket of the top performing artists isn’t likely to represent the returns that an individual investor will get on the Masterworks platform, because as an investor you have to make selections and there is no index.

Art Investing: You Can’t Get Index Returns

This business has only existed since 2018 so the first clue is that these charts are not THEIR historical returns, but some collection of art pieces that have sold since 1995, or 1985, or 2000, whichever performance period you prefer. You would have had to have owned a representative slice in each of those paintings to match that return, which you couldn’t even do before a firm like Masterworks even existed. There is no exchange traded fund (ETF) in the art world.

And it’s not easy to get that diversified art exposure. They’ve not only purchased about 85 paintings since their firm’s inception, which is a tiny representative sample of the art return charts, but their SEC filings state that there are minimum investments on new issues (that they occasionally waive at their discretion).

To gain exposure to the works Masterworks purchased years ago, you can buy those ‘shares’ from their secondary market. The secondary market is certainly a plus, but existing owners likely suffer from the endowment effect and for a market that is thinly traded, the price they offer their shares at are likely just returns that prior investors feel they should have earned, and will likely use the reference numbers on the front of the webpage.

Furthermore, there is no automation for buying a collection of works on their platform either. You will have to run around their site and scoop up shares from current offerings and past offerings as they become available. I think they should really offer this as a product feature. Since each painting is a collateralized legal structure, perhaps there is some reason why they don’t, but it seems that they could create another limited partnership that just invests in a representative sample of all the art on their platform, perhaps equal weight.


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Art Selection Skill

So since you can’t buy an index, you as an investor, have to pick the pieces of artwork you want to invest in and this requires art selection skill. Of course, the choices available for the investor will be pre-selected. Allen had this to say:

The paintings that we make available for investment are those that we believe will generate attractive investment results for our investors. Our acquisitions team, which purchases the paintings that become available on our platform, is comprised of individuals with backgrounds from the major auction houses, galleries, and dealers. Before investing, each investor speaks to one of our advisors, who discusses the opportunity, risks, and suitability of investing in various paintings.

Allen Sukholitsky, CIO Masterworks.io

I don’t doubt that they have qualified experts putting valuable pieces of art into the platform (although I haven’t personally researched the players on their team), but each piece will appreciate at different rates, just like picking different stocks would. And will every piece do well? What will be their long term batting average? We have only limited data to work with at this point (more on this later).

Again, you can’t get the blended return of everything they buy and sell so your average returns will differ from their advertised average returns. You may pick a winner or you may pick a dud. Maybe their dud will still do well, or maybe it just sits in the warehouse for 20 years and your only way out is the secondary market.

Portfolio Diversification

You could make an argument for diversification with a reduced portfolio correlation, and they do:

Honest Masterworks Review: Why I Didn't Invest In Art Here

But if you look at where that correlation calculation came from (page 13) you will find that the source of the underlying data was from Masterworks themselves, not some independent art index that Citi procured from elsewhere. It’s iffy.

Furthermore, researchers with multiple art related published papers commented:

…it seems impossible to make absolute remarks about the merits of adding art-related assets to stocks portfolios. Moreover, our results suggest that previous conclusions regarding the correlation between art and stocks should be taken with some skepticism.

Charlin & Cifuentes, 2016: Source

So it seems like the diversification angle may not be robust. And here’s why:

Macroeconomic Asset Inflation

Pretty much everything appreciates well in low interest rate environments: Real estate, stocks, baseball cards, and art. Naturally, from the same Citi paper they reference:

Over time, art prices have tended to move more closely in line with changes in real interest rates, that is, interest rates after inflation. Periods of falling and/or low real interest rates have often coincided with rising art prices. This relationship is rooted in the nature of art as an investment. Art does not pay an income stream to its owners. Indeed, it has a slightly negative income stream, as owners have to pay for insurance, storage, transportation, and maintenance. When real interest rates are high or rising, the opportunity cost of owning art is higher. Owners are passing up the returns they might otherwise have earned on interest-bearing assets. However, this consideration fades as real rates fall, hence art’s often-stronger performance in such times.

Citigroup

So when the stock market and real estate are going up, so is artwork. Ditto on the downside.

The global opportunity cost of capital was nil for 14 years, from the Great Financial Crisis up until 2022, so you have to wonder how art will perform with normalized interest rate policy over the next ten years. Notice none of those art performance charts that I managed to dig up show what happened in the 1970s when interest rates were skyrocketing. I don’t think that is a data omission coincidence.

Art isn’t a capital driver in that it doesn’t produce business activity or increase the GDP. The capital is just locked away for a time while hoping that there will be a bigger fish to come and take it off your hands later. This is highly dependent on how the economy is doing and the level of asset inflation, which also applies to other assets without earnings such as crypto. The roaring 20’s bubble is deflating in 2022, so will art fare better or worse going forward?

Illquidity

Illiquidity is not necessarily a bad thing as it can force you to hold through the ups and downs of investing if the eventual return of the asset class is good. This is also not unique to Masterworks, as you will encounter illiquidity in private real estate or private equity deals. But there is still an implicit cost since you can’t get your money out as you please. An investor would demand a higher rate of return to compensate him or her for that inconvenience.

Each fractional art ownership interest is supposed to be held for around 5-10 years and as mentioned before, there is only an internal secondary marketplace with limited sales volume to sell before then.

The biggest problem with illiquidity is a lack of price discovery. You could hold an investment for ten years and not have a clue what your investment is actually worth. When you invest in the S&P500, you can find out every day what your investment is worth and cash out on the spot if you want to.

This makes retirement planning very difficult to project and whether you are on track or not if you hold a lot of artwork in your portfolio. If a big expense comes up where you need to cash out early, it’s going to cost you to get out.

Allen stated:

Our art is revalued on a quarterly basis and we provide investors with quarterly NAV reports so our investors have more frequent pricing information than they would for their own homes, for example. Other illiquid asset classes, such as private equity, are also valued on a quarterly basis.

Allen Sukholitsky, CIO Masterworks.io

On the conference call Scott said that they have a 6 person in-house team that quarterly decides the value of each painting based on sales data of the same artist, like a comparable in real estate. You can click on artwork on their webpage to see examples of recent sales, for instance. Then once per year they have an external company (he said he would get back to me if he was allowed to disclose the name) that provides an official appraisal. The price estimates displayed on their website have very wide bands showcasing the difficulty of pinning down the true value of a one-of-a-kind painting.

I suggested to them to incorporate some kind of non-binding bid section for prospective buyers interested in some of the artwork they have. It could be hidden behind the scenes or right out in front with anonymous IDs and valuation floors could incorporate some of that information.

Possible Tax Nightmare

If you’ve ever had to deal with a K-1 tax form, you’ll know the pain that comes with including one in your tax return. Now for solid businesses that are generating cashflow and paying it out quarterly, I have found that it can be very much worth the hassle and can end up paying for itself, depending on the investment.

Unfortunately each piece of artwork on the Masterworks platform is bundled into an LLC and you are sent a K-1 tax form at the end of each year. Presumably, you won’t owe any taxes until the painting is sold because the investment isn’t generating income (renting paintings out to museums would be a good idea to do that, I think!).

We do not charge investors for these expenses (or any other expenses that would normally be borne by investment vehicles) – they are all included in our unitary equity-based management fee. Investors would not owe taxes (or include any expenses on their return) until their paintings are sold, but we encourage all investors to consult with their tax professionals regarding their own unique circumstances.

Allen Sukholitsky, CIO Masterworks.io

I examined one of the semi-annual reports for one of the paintings and it stated inside “We had no federal and state income tax assets, liabilities or expenses as of and for the for the 6-month period ended June 30, 2022,” so presumably this means that the K-1 form will have all zeros in a typical year and it wouldn’t be a burden to file the form with your annual taxes.

I did not examine all 85 filings to see if any of them had any statements that differed from this, however. From Allen’s statement the expectation is that the forms will contain zeros in a typical year until the painting is sold.

I have no idea how complex the K-1 form will be after a sale and I requested a copy of one to get an idea. If you create your own “index fund” of art and one or two are being sold off each year, it could get ugly however. If you use an accountant, they usually charge $100 per K-1 inclusion, which is another expense to consider and should make you think twice about investing $100 into 30 offerings.

Higher Capital Gains Rate

One last point on the tax topic, art is a collectible and has a higher long term capital gains treatment (28% + 3.8% net investment income tax) than stocks do. Allen replied:

An investment opportunity with higher fees and higher returns, may be considered more attractive than one with lower fees and lower returns. Since inception, our platform has generated net annualized returns of 15.3% on a dollar weighted basis, through June 2022. For that same period: S&P 500 (10.9%), hedge funds (5.3%), private equity (4.0%), and US bonds (-1.8%).

Allen Sukholitsky, CIO Masterworks.io

I agree if we could predict future returns with accuracy we could optimize asset classes respective of taxes, but that’s not a reality. As mentioned before, since we are in the age of quantitative tightening, this is a game changer for assets that don’t generate an internal return or are used for loan collateral (with interest rates rising, there is more incentive to sell paintings than take collateral loans against them).

Masterworks Business Concerns

Here we talk about the obscene fees, the founder and principal, marketing, storage, experience and conflicts of interest.

Limited Data

As of September 2022, they’ve sold 6 paintings since they bought their first painting in July 2018.

This is a deal flow business. They don’t make a big payday until they sell and it would be in their interests to buy and sell many paintings over shorter periods of time if they can get a large gain on each one, not only for their cut of the profits but also for their marketing efforts. I don’t know what criteria they use to balance that decision, but operating costs of the business is likely a big factor.

Back in 2021, when I first wrote this article, they had sold their first painting and got a huge return on it. I was amused that it became the basis of their marketing campaign:

Honest Masterworks Review: Why I Didn't Invest In Art Here
Returns, plural?

This brings us back to the selection bias problem. Which are the pieces of artwork most likely to be sold, the ones that appreciated rapidly and the profits can be used to pay operating expenses while roping in new investors, or the ones that didn’t?

What Are Masterworks Fees?

They run their business almost at the same cost as a hedge fund: they charge 1.5% annual expenses plus 20% of all future profits from the art sales.

Allen replied:

Since inception, our platform has generated net annualized returns of 15.3% on a dollar weighted basis, through June 2022. Also, please note that all Masterworks “fees” are a combination of fees and reimbursement of all ordinary expenses. We are unaware of any other platform in which the investor does not directly or indirectly bear, in addition to management fees, securitization expenses, organizational costs, distribution and underwriting, legal, compliance, accounting, audit, tax, filing fees, financing costs, sourcing costs, trading costs, etc.

Allen Sukholitsky, CIO Masterworks.io

So the question is, will their after-fee forward returns outperform other asset classes indefinitely? You have 6 data points to decide. As shown in an earlier section, the long term returns of contemporary art are 11.5%, according to their own data.

Try to understand the hurdle you have to jump over to beat the S&P 500 here.

When they go to sell the art at auction, the auction house takes 10% of the sales price, Masterworks takes 20% of the profit, and then there is the 1.5% fee for 10 years. The 1.5% fee is in the form of dilution, which means that it applies to the sales price, not the initial price.

The Administrator will earn an administrative services fee in the form of Class A shares. These fees will, when issued, effectively further reduce the tangible book value per Class A share over time. Additionally, if the value of the Class A shares increases over time, the number of Class A shares to be issued upon conversion of the Class B shares will also increase over time resulting in additional dilution to holders of our Class A shares.

Masterworks Offering Statement

But let’s do some math on what your net return would be after fees and taxes.

Masterworks Investment Profit Scenarios

Say the painting costs $1,000,000 and you buy 10% of it. After ten years the painting triples and sells for $3,000,000, a 11.6% compounded return, great!

The art auction house gets $300,000 for their fee and Masterworks gets 20% of $2,000,000 for the profits, or $340,000. So now there is $2.36 million left over for investors.

You originally owned 10% of the painting, but because of the annual dilution, you now only own 8.5% of it, which means your ownership stake is worth $200,600 or a gross return of 100%, or 7.2% annualized.

Because artwork is a collectible, you’ll pay 28% in taxes instead of 15% long term capital gains tax, so subtract $28,168 and your net, after-tax profit is $72,432, or 5.5% annualized.

Compare that to the after-tax return of 6.3% if stocks double over ten years. 🙁

Let’s assume annual returns of 15.5%. We’re cooking with gas now and the $1,000,000 painting sells for $4,225,000. The art auction house gets $422,500, Masterworks gets $560,500 and investors are left with $3,242,000. That original $100,000 investment is now worth $275,570, or a gross return of 10.6% and an after-tax net return of 8.5%. That’s about on par with the after-tax returns of stocks over the long term.

Let’s go for the gusto here and make the assumption that you are the Warren Buffett of the art world and a painting you select from their platform will earn a compounded 20% a year. That $1,000,000 painting will sell for $6,192,000 after ten years. The art auction house gets $619,200, Masterworks gets $914,560 and investors are left with $4,658,240 and the investor’s stake is now worth $395,950 for a gross return of 14.75% annualized, or 12% after tax.

20% down to 15%. The fees are a real drag on gross performance.

Remember, Masterworks advertises that their platform has averaged 15.5% after fees on the 6 paintings they’ve sold over 4 years of operation! I’ve heard of artwork being purchased by billionaires, but never creating billionaires. Do you think all of the 85+ paintings they’ve purchased will appreciate north of 25% a year indefinitely? It’s virtually guaranteed that their long term returns to investors will be significantly less going forward as they run out of paintings in inventory that have appreciated at above average rates, so keep that in mind.

And again, I want to point out that a lot of the cost structure is not unique to Masterworks and you’d find similar fees in private equity, private structured products or hedge funds. It’s just the nature of the business that you are indirectly paying for storage and maintenance costs of a piece of artwork that is material to your bottom line.

What about Private Sales?

You’d think that the investor could save some money if Masterworks were to avoid the auction houses and stick to private sales. Well maybe not. From the disclosures: “If we sell the Painting in private transactions, there may be sales commissions payable to third parties who arrange for the sale transaction or, if no seller’s agent is engaged in connection with such sale, Masterworks may charge a sales commission in connection with such sale. While we believe we may be able to substantially reduce the transaction costs of selling the Painting, they will not be entirely eliminated.”

So even if there is no auction house involved or an agent involved in a private transaction, Masterworks “may” (uh, will) gladly take a fee anyway.

Immediate Dilution Of Your Art Investment

But wait, there’s more. I’ve actually been holding out on you here if you were still on the fence.

Read any of the offering statements and you will find out that you lose 10% of your investment immediately to an upfront load fee (they call it a “true-up”). They sell shares worth $20, but then only use $18 of that to buy the painting, and keep whatever is left after they setup the legal structure and pay for appraisals, etc..

The painting has to appreciate at least 11% just to break even. It’s just like the “load” mutual funds of the 90s, but with twice the fee.

Remember that Warren Buffet artwork example above? Let’s re-do that after accounting for the true-up fee. Now the $1,000,000 fund raise only nets $900,000 to buy a painting. The same 20% a year appreciation ends up with a painting sold for $5,572,562, or $4,212,244 for investors after fees. The $100,000 investment is now worth $358,040, 13.6% compounded, or 11% after-tax.

32% of the gross return is extinguished all-in-all. Yikes.

The fee side of the business acts as a huge anchor for extraordinary returns that could materialize from fractional art ownership.

Who is Scott Lynn? Founder and CEO’s Past Business Ventures

The marketing gimmickry described in the next section won’t be much of a surprise when you find out that Scott Lynn has founded some shady marketing businesses in the past (Virtumundo) that were involved in spamming and sleazy banner ads (he proudly states on his Linkedin profile that he invented the “punch the monkey” ads).

Honest Masterworks Review: Why I Didn't Invest In Art Here
Honest Masterworks Review: Why I Didn't Invest In Art Here

None of this necessarily means that the art business won’t be successful, but you have to wonder about what corners will be cut with your money when the founder has created businesses with questionable ethical practices in the past.

Marketing Gimmicky

Cherry Picking Results

When you peruse their website, they show pieces of artwork that have appreciated 50, 100, or even 500 times since purchase. So what?

Did you know that if you had invested $1,000 into Amazon at their IPO, you’d have $1,200,000 today? Should we jump in our time machine now or later to plunk down some money?

The fact that some pieces of artwork have greatly appreciated is irrelevant to their returns or your returns since they will be buying ‘blue chip art’ that has already gone through that massive growth period.

It would be like eTrade posting charts of Amazon, Google, and Apple on their front page: “Open an account with us, you could have bought these stocks and got 1,000% returns!” eTrade had nothing to do with it and neither did Masterworks.

Blockchain

Masterworks originally was going to sell their artwork on the Ethereum blockchain. Or at least that is what they said there were going to do. I suspect it was all marketing hype attempting to capitalize on the Blockchain momentum in 2018. Allen responded:

From the beginning, we believed that following the U.S. securities laws was critical to providing investor protections and bringing a heightened level of transparency to the art market. We initially thought that blockchain would make the ownership structure more efficient for investors, particularly insofar as it appeared at the time that such an approach would facilitate enhanced secondary liquidity. However, we decided to stick with the traditional approach of securitizing the art via SEC-qualified offerings of “Shares”. Each of our offerings has extensive documentation on the SEC’s website, which allows anyone to learn about the paintings and artists whose works are available for investment on our website. More importantly, it provides them with all the protections of U.S. federal securities laws – something that does not exist in the context of most alternative investments which are marketed only to “accredited investors” pursuant to Reg D.

Allen Sukholitsky, CIO Masterworks.io

It’s obviously much preferable to have the SEC offerings, but if from the beginning, I don’t think blockchain would really have been considered at all since there are no investor protections. Their press release announced that the blockchain project had already been “launched,” not coming soon, or being considered.

Remember that Scott Lynn has been in the marketing business for decades. I’m sticking with my theory that it was used to generate marketing buzz because that was when I first heard about this business. It worked on me, and it likely worked on thousands of other people.

Faux Demand

On their signup page they mention there is a 160,000 person wait list (faux demand) and they have a special link for affiliate promoters that claims their readers get to skip the wait list (special treatment).

Does a velvet rope part when you click the link too? Quick, slip the Masterworks bouncer a twenty!

I asked them about the wait-list and they basically said that they are the small fish that aren’t worth putting through the compliance legal process.

It’s marketing gimmicky attempting to appear like it’s a privilege to give them your money.

Can Anyone Invest in Masterworks?

In theory, yes, but in practicality, not really. There wouldn’t be a “wait list” if it were true.

With most online platforms you just sign up, fill out the typical investment waivers and forms, deposit some money and off you go. This platform requires you to apply to the platform which requires a “screening call.” Except that it’s a giant sales push to get you to invest in 3 different art pieces the day of the call. Which brings us to the next point.

The Masterworks Minimum Investment

Is there a minimum investment for Masterworks? Their website talks a lot about buying $20 worth of art but a dozen of their offering statements state that minimum investment amounts per investor is $10,000-$15,000, per offering, which they can waive at their discretion. I’m actually not sure why there appears to be limits that they can waive whenever they feel like it. Why even bother to add that sentence in the first place then?

But I’ve read countless personal accounts where people said that their interviewer told them they had to invest at least $10,000 to start. I guess that explains the huge waiting list. Doesn’t sound as “democratized” now, does it?

I think the pushy sales call is designed to tease out who the wealthy investors are and fast track them into the signup process. It’s cheaper to manage your platform with a smaller subset of people as there will be fewer customer service staff to maintain.

That’s fine, but why advertise to the guppies at all then?

Key Man Risk

Inside their disclosure they share “Masterworks relies on a single investor, Scott Lynn, for substantially all of its capital and liquidity. If Scott Lynn were to cease funding Masterworks for any reason, Masterworks may not be able to identify additional sources of capital.”

This is less of a concern now that they have gotten outside investors to buy in with Series A funding. I didn’t see any offerings after they closed this deal, but I will check if they removed that language on their next one.

Storage Of The Artwork

The Observer reported that Scott stores the artwork with his own personal collection. That may have been true in the beginning when the business was just starting out and there was 1 or 2 paintings, but obviously not when there are 85+ of them.

Many art collectors use the same professional third-party art storage facility that Masterworks uses. Scott’s collection is not intermingled in any way with Masterworks.

Allen Sukholitsky, CIO Masterworks

It’s still curious that they don’t advertise on their website about the state-of-the-art (pun!) storage facilities. He told me in email that art is stored in the Delaware Freeport and Uovo, which would be typical for art storage (avoiding import taxes).

Possible Conflicts of Interest

Scott Lynn personally owns $100 million in artwork. It is conceivable that he could sell some of his own artwork to (or buy from) Masterworks clients at an unfair price through a private sale, although we are assured this does not happen:

We have never bought or sold a painting from or to Scott Lynn or his family members. Scott also derives no personal use or benefit from Masterworks artwork collection.

Allen Sukholitsky, CIO Masterworks

I’m not convinced there are rules that say they cannot in the future however. Supposedly they have a committee, but with Scott Lynn being the big man, are they just yes-men or truly independent?

Deal Flow Business

Masterworks only makes money on the sale of artwork and they are using other people’s money to purchase the paintings so from a business standpoint it makes sense that they attract as many investors and buy as many paintings as possible.

Fractional art investing is a revolutionary concept, but ultimately any time a firm securitizes a product, they buy wholesale and sell retail. You are the retail. Securitization ultimately drives up the price of the product because little pools of money come together from small investors to form a big pool and a new large buyer.

What’s to stop them from being the top bidder in every auction if they can attract enough capital to their platform?

Allen responded:

Our entire business, as well as our fee structure, relies on our investors making money. We are highly disciplined in terms of asset selection and price negotiation. Our biggest challenge as a business is being able to source objects that meet our disciplined selection criteria.

Allen Sukholitsky, CIO Masterworks

But that’s not entirely true because of the asset management fee and the up-front load. They can still make money if a painting is sold at the same price they purchased it at and the longer they hold it, the better for them.

I’m not saying that’s what they are trying to do, but businesses that charge fees on assets under management have strong incentives to grow larger and larger to earn more fee revenue irrespective of retail investor returns, especially if there is no competitor to take their market share.

As is true of every business, we intend to grow and scale our operations. Unlike many businesses, however, scale has tremendous advantages in the art market and we strongly believe that our investors (along with us) will benefit from that growth.

Allen Sukholitsky, CIO Masterworks

When I asked for clarification on the economies of scale, basically the gist was having relationships with more art collectors, seeing more opaque data than competitors and being the big fish in the pond and able to buy and sell a lot of deals.

That’s all good and dandy, but I’m not sure you can be guaranteed to be buying underpriced art if there isn’t a competitive bid process. Since that angle can’t be guaranteed, in the end, the only benefit the retail investor gets is if the asset management fee is reduced. Given that there are no competitors yet, I don’t see that happening any time soon.

Art Itself Has Unique Risks

Tastes

One-of-a-kind anything’s are such an illiquid market that really cater to the eye of the beholder. Paintings that sell for millions of dollars have a very limited buyer pool and when people have millions of dollars to spend on an item for enjoyment, they have a lot of options as it comes to homes, boats, cars and planes. Tastes change over time. A painting that appreciated 10x over the previous ten years may not appreciate at all for the next ten.

Contemporary has been in style for several decades now, but maybe that changes during your holding period.

It’s a gamble betting a bigger whale comes along later.

Counterfeits

Counterfeit works of art have plagued the art world for decades and you have to put a lot of trust into their art professionals that they are skilled at their job. I have no reason to suspect that the Masterworks team aren’t skilled art buyers, but fakes can even fool professional art dealers, and sometimes they are even willing participants to get sales flow from commissions.

It’s a business that requires a lot of trust and provenance but Masterworks is using your money to buy paintings. There is no minimum skin-in-the-game requirement for them, so if a painting turns out to be fake and worthless, they won’t lose any money. They only lose the equity they built up from the management fee, which is a paper gain.

The concern with this is if they start growing rapidly, they will be incentivized to buy more paintings and its not outside the realm of possibility that the artwork investigations could be rushed and a few fakes slip in.

The expected hold time is supposed to be 7-10 years, so you might not find out that your investment is completely worthless after a long time when they pull it out of storage and new expert appraiser determines it was a counterfeit. Or if it was sold and the new buyer determines it was counterfeit, your LLC could get sued and your money clawed back.

A low risk, to be sure, but a risk nonetheless.

Insurable Risks

If there is an art heist, the insurance will only cover the value of the purchase price, not the theoretical appreciated value. So if the cat-burglars come knocking, hope they steal the newest pieces of artwork, not the examples that have been appreciating for ten years on your dime.

Additionally, if a piece of artwork is purchased by Masterworks from a seller that doesn’t have a legitimate claim to the artwork (stolen in World War II, stolen from a museum or sold by a family member who didn’t legally own it), it’s a total loss to you:

Insurance coverage for the Painting does not cover title claims and may not cover all possible contingencies, exposing us to losses resulting from the damage or loss of the Painting.

Disclosures

Again, low risks, but risks that cannot be ignored.

Is Masterworks a Good Investment? Masterworks Investing Review Conclusion

There aren’t many art investment companies, and Masterworks.io is one of the only options for individual investors to buy fractional pieces of artwork. But is masterworks worth it?

If you can get beyond the shady business practices, marketing, founder’s past business activities, fee grab where they act as an art hedge fund, and unique art risks, then Masterworks investing offers that opportunity to buy a fractional ownership in “blue chip” fine art.

For me, I think there is just too many red flags. I was excited about the idea of adding a new investment asset class to my portfolio, but for everything I presented here, there are just too many obstacles. While Masterworks isn’t a scam, they do have a scammy business model where they fee your investment to death, which overwhelmingly favors their interests. If you do well, then they do well, but if you don’t do well, they still do okay.

In conclusion, if you want to buy art as an investment or learn how to invest in art online, using Masterworks will likely lead to a disappointment in outcomes that deviates from their marketing pitch.

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Ryan

After graduating with $75,000 in student loan debt, Ryan began a professional career in finance, aggressively saved and invested and became a self-made millennial millionaire in early 2019. He holds a Master's degree in Computational Finance, a Master's degree in Economics, and a Bachelor's degree in Mathematics. His two passions are investing and traveling.