How Masterworks Makes Money

Management and performance fees based on investments in high-end art

The high-end art market is one that does not come to mind for most conventional investors. In fact, the mere idea of owning an iconic artwork from a renowned artist such as Andy Warhol, Pablo Picasso, Claude Monet, and many others has been isolated to the realm of dreamland. For many, thoughts of owning a well-known piece of art are probably a dominant theme when thinking of ways to best spend hypothetical lottery winnings.

The reality of high-end art ownership is that it has most commonly been restricted to the world’s richest individuals. This is where Masterworks.io enters the fray.

For those who are unfamiliar, Masterworks.io is aiming to democratize the $1.7 trillion art market by selling fractional shares of famous physical artworks to investors of all types from around the world. Due to a recently announced round of financing, Masterworks has reached unicorn status with a valuation of more than $1 billion.

Key Takeaways

  • The high-end art market has traditionally been the realm of only the ultrarich. Masterworks is changing the game by making art investment accessible to all types of investors.
  • Alternative asset classes such as art often represent lower levels of volatility and risk since they are relatively uncorrelated with conventional assets such as equities and fixed-income securities.
  • Masterworks makes money through a combination of management and performance fees similar to other investment managers.
  • Recent funding has bumped the valuation of Masterworks into unicorn territory, which means it has a value of more than $1 billion.
  • The niche space in the art market, combined with a wealth of data and expertise, gives Masterworks many potential avenues for revenue growth.

Art as an Investment

In the finance world, art is considered an alternative asset class. This means that it falls outside of the conventional investment categories of equities, fixed-income assets such as bonds, and cash. Other popular types of alternative investments include private equity, venture capital, hedge funds, and managed futures.

Most alternative investments are rather illiquid compared to conventional counterparts. The level of sophistication required to trade alternative investments, high capital costs, and less stringent forms of regulation often means that these types of investments are restricted to accredited investors, or those with a high net worth.

One of the main reasons why investing in alternative asset classes is so intriguing is that assets such as art may be relatively uncorrelated with the investments in a broader portfolio. Essentially, this translates into the idea that alternative assets lower the risk of a portfolio because prices are driven by a completely different set of underlying fundamentals.

According to research conducted by Masterworks, contemporary art has significantly outperformed the S&P 500 over the past 25 years, with an annualized return of 14% compared to the market return of 9.5%. More interestingly, over the past 25 years, it is estimated that contemporary art has experienced losses only 8% of the time measured over a two-year investment horizon compared to 16% for the S&P and 36% for gold. The maximum annualized loss observed over two-year investment horizons was 11.4% for contemporary art and 18.2% and 14.7% for the S&P and gold, respectively. The low level of correlation with other major investment classes suggests that art will continue to grow in importance for those looking to spread out the risk associated with their investments.

According to a report from Citibank, the art market remained resilient in 2020 amid the turbulence of the COVID-19 pandemic. In the first seven months of 2020, the art market outperformed 10 major asset classes, with contemporary art achieving the strongest gains. Low interest rates, ongoing digitization, and growing recognition of art as a diversifying asset could further support its prospects. The resilience of art as an investment could draw new investors toward the Masterworks platform.

How Does Masterworks Make Money?

Masterworks looks to utilize its proprietary data and research experience to determine which artist markets have the most momentum and could be poised to have the best risk-adjusted returns. Once the research is complete, the company looks to purchase art at the best possible price that meets its criteria. Upon the purchase of a new piece of art, the company then files an offering circular with the U.S. Securities and Exchange Commission (SEC) that allows it to securitize the artwork.

The process of securitizing an artwork is what allows others to invest in shares of the artwork. Once an investor buys shares of an artwork, it is then held for approximately three to 10 years, which is the timeline that the company looks to hold before it sells the art. If held through to the sale of the artwork, a U.S.-based investor would pay tax on the gain the same as they do on regular income. If the investor turns to the secondary market to sell their interest, then any gain between the purchase price and sale would be taxed as capital gain.

Common in the world of alternative investment are fee structures that consist of a management fee combined with a performance fee. Masterworks charges its investors a management fee of 1.5%, paid in the form of equity at no out-of-pocket expenses to investors, which is used to compensate the company’s team for its time and expertise in selecting artworks, professional storage, insurance, annual appraisals, regulatory filings, etc.

1.5%

Masterworks charges its investors a management fee of 1.5%, paid in the form of equity at no out-of-pocket expenses to investors.

Like a hedge fund, Masterworks also charges a 20% performance fee based on profit. This fee aligns the company’s interests with its investors in its goal of selling paintings for the highest possible return. The combination of management and performance fees are the primary ways that Masterworks makes money.

20%

Masterworks also charges a 20% performance fee based on profit. This fee aligns the company’s interests with its investors in its goal of selling paintings for the highest possible return.

Recent Developments: Fundraising

On Oct. 5, 2021, Masterworks announced that it raised $110 million in Series A funding, led by Left Lane Capital. Participants in the funding round also included Galaxy Interactive and Tru Arrow Partners. As mentioned earlier, the valuation at the time of the funding puts the company at a valuation north of $1 billion. According to Axios, Masterworks says that it is profitable and that the funding will be used as primary capital.

Other Potential Sources of Revenue

Given the niche that Masterworks currently occupies, the company has a variety of other ways that could generate revenue. Currently, investors can buy into specific artworks, which is still quite targeted from a diversification perspective. The ability to offer other products such as diversified exposure to a basket of artworks could represent an additional avenue for the company to explore and open the platform to a wider audience.

According to Axios, Masterworks expects to spend nearly $400 million in 2021 and closer to $1 billion in 2022. The type of data and research coming out of the company that is based on this type of spending could be monetized in a multitude of ways.

The Bottom Line

The high-end art market has been the realm of the sophisticated and ultrarich. However, with the rise in popularity of the Masterworks platform, this type of innovation could level the playing field by giving all types of investors the opportunity to own fractional shares of a multimillion-dollar piece of art.

As mentioned, the alternative investment space is not for everyone, especially due to the relative levels of illiquidity, fee structures, and lower level of regulation. With that said, for those looking to diversify their portfolio, art could now be a possibility that has not been historically possible.

Article Sources

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  1. Masterworks. “Understanding Art as an Asset Class.” Accessed Oct. 19, 2021.

  2. Citibank. “The Global Art Market and COVID-19: Innovating and Adapting.” Accessed Oct. 19, 2021.

  3. Axios. “Art Investment Platform Masterworks Raises $110 Million.” Accessed Oct. 19, 2021.