Traditional Art Investing for Portfolio Diversification

Art is often seen as a beautiful painting or sculpture, sometimes taking its meaning a little bit out of this world (as can be seen below). And most of the times, it fits that description.

However, as is the case with everything, when something is rare, which is the case of unique paintings, sculptures, objects or any other form of art, it has some value attached to it. And what better way to measure the value of something than counting how many 100$ bills it compares to?

Art investing can seem a bit out of reach for most people. And that’s because it is. Well, that’s not really true anymore, but more on that later. Investing in art does present some advantages when compared to traditional bonds and stocks, and when it comes to the ultra-rich, portfolio diversification is as important as keeping positive returns, if not more.

Art is a whole different unique asset class that has nothing to do with how the economy is doing. It is not a business that will lose clients during a recession and it has no purpose other than looking good or showing how rich someone really is. Because of this, its correlation with the traditional markets is practically null, which means it doesn’t care whether the market is going up, down or sideways. For this reason, it is used a lot by high value investors as a means to diversify their net worth and avoid huge losses during a bear market.

We are experiencing weird times. In Europe, one of the more stable places on Earth, there is war and adding to that, inflation is soaring as a side effect of the pandemic and supply chain issues. Once again, art is a great to mitigate risk in this type of situation as the people holding art are not necessarily affected in the same way others are.

Obviously, like stocks and other financial products, not all art is valued the same, nor does it experience the same price movements. But if history is to be trusted (which should not be the case, always remember that past results are not reflected in the future, but for comparison’s sake, we will take them into account), then art is actually a good asset to hold. It tends to go up in price and there is a platform that makes the scouting much easier (I will touch on them later).

Now with all that said, someone reading would ask “How do I get exposure to art then?”. I will touch on that, but first, I’d like to point out the worse aspects of this asset.

There is one maybe not so obvious drawback when investing in art: its liquidity. Liquidity can be seen as a measure of how easy it is to buy or sell something. In other words, it begs the question “Are there people willing to buy/sell this?”. Now, someone might be thinking why does this matter, especially if it produces as good or higher returns than the S&P 500. And the reason is that you might need the funds associated with the art you own. Like with everything, if you spend money on a piece of art, that money can’t go to somewhere else, and that is an opportunity cost. Imagine being offered a great deal and not having the funds to accept it. This is the case with art. There are very few pieces that have financial value and with that, very few people with the pockets to acquire it. Most of the times, buyers and sellers of art choose to go to specialty auction houses, which obviously take fees, and they are not so small.

One other drawback (albeit a minor one), is the full value of each piece. This pieces are worth millions of dollars and that excludes the majority of the population in any country. However, recently, some players have shown a way to go around this issue…

Like I said earlier, the place where art is sold and bought is usually the big auction houses, Sotheby’s and Christie’s. Just like Robinhood, Trading212 and XTB came to revolutionize retail stock trading, Masterworks came to allow non-millionaires to buy fractionalized art pieces. Anyone now can own a piece of a Monet or a van Gogh.

Masterworks uses a stock like structure to offer their products. First, their team of analysts evaluates several contemporary artists and their works and filters them according to the likelihood of them gaining value over time. After this process, they file the artwork with the SEC (Securities and Exchange Commission) in order to be able to sell fractional shares of a LLC (limited liability company) that represents that artwork.

Masterworks creates a LLC for every piece of art they have on their platform and that makes it possible to then sell shares of the LLC that represents those pieces of art. These artworks are held for a period of 3-10 years. When they see it is fit to sell it, they do and the majority of the profits are returned to the people who held shares of the LLC that represents the work of art sold.

Buying art involves storage, transportation, insurance and other costs that make this different from other markets that now operate almost completely digitally. For this reason, there are some fees that the investor should be aware of. First, there’s a 1.5% annual fee based on the total value of your portfolio being managed by Masterworks. This fee is not paid in cash, it is instead taken as a form of equity, which means that every year you’ll lose 1.5% of value in shares of those LLCs that you bought.

The second fee they take is on the selling of the work of art. 20% of all profits are kept by Masterworks. There are no transaction fees and this is important because there is a secondary market within Masterworks if you do not wish to buy shares from Masterworks themselves. Everyone can buy or sell shares from other people in this market, and this is a big advantage because of the minimum investment costs on the platform.

Masterworks prices each share usually around the 20$ mark. However, buying directly from them usually requires a minimum amount of 500$, if not more. If instead of buying directly from Masterworks one chooses to buy in the secondary market, then the minimum investment can be as low as the cost of 1 single share, which should be around the 20$ previously mentioned. One important thing I have to disclose is that this secondary market is only available for U.S. investors due to regulatory restrictions, they claim.

Now for some information on the returns of the artworks offered by Masterworks, they have as of June 30th of 2022 bought 133 artworks, with a net annualized track record of 15.3% (this can be seen in the main page). This return is an average and some pieces are valued higher while others are valued lower. Masterworks offers great insight into the economics behind investing in each artwork as they have listed next to each of them the price appreciation of similar works (which is to say that it can be in line with that value but that is not a guarantee) and the Sharpe ratios of the artist’s work compared to the entire art market, the S&P 500, the U.S. housing market, U.S. corp bonds and gold. Sharpe ratios can be interpreted as the return of some asset while accounting for the risk of investment. The higher this value is, the better. Below is an example of what is shown in the Masterworks dashboard.

Overall, the art market is a fantastic way to diversify someone’s portfolio and while entry costs remain high especially for people living in developing countries, Masterworks innovated in a big way by making art much more retail friendly.

I touched on pretty much every aspect of this topic, albeit not in huge detail, but if there’s anything else you’d like to know about it, feel free to drop a comment below.

To start off with Masterworks, you need to request an invitation first and you’ll be put on a whitelist. To skip this process, you can use my invitation here.

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