Paintings For Profits: Should Investors Buy Shares of Art?

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Last year, I believe we had 6 paintings that sold for $100 million or more. The most expensive painting has sold for $420 million. You know, I do think it's likely that in our lifetimes we see a billion-dollar painting sell. It's a big asset class. It's $1.7 trillion in value with $60, $70 billion turning over every year. There's just a lot of expensive paintings out there today.

Welcome to the Barron Streetwise Podcast. I'm Jack Howe. The voice you just heard is Scott Lynn. He's the founder of a company called Masterworks. It lets investors buy part ownership in fine art—Picassos, Warhols, Monets. Much like how stock investors buy part ownership in companies. Is art a good deal for investors? Let's talk about it. Better grab a smock, it could get messy. Listening in is our audio producer Meta. Hi Meta.

Hey Jack.

Are you a fine art fan, Meta?

Um, not really, but I did used to go gallery hopping in New York where you like go to a bunch of different galleries and you look at the art. Nice. And you know, there's like free wine.

Oh boy, you say that like, was it more about the wine or the art?

It was definitely a combination.

Good, well they go well together.

Yeah, for the artist too. That sounds wrong. I meant that the more wine, the better you like their art, you know?

So if you're not sure about how good you are as a painter, bring gallon jugs is what you're saying.

I don't think it hurts.

I should know a thing or two about art. I've visited art museums in dozens of countries across 5 continents, and when I lived in New York City, I had a membership to the Metropolitan Museum of Art. I went at least 50 times. But if you ask me to compare, let's say, Monet with Manet, the only thing I'm pretty sure of is that you're not supposed to pronounce the T in either one. The truth is, I only went to the Met so many times because it was my go-to place when the weather was bad for pushing my daughter in a baby carriage to get her to take a nap. During all those Met visits, and all the museum stops during my world travels, surprisingly little seems to have sunk in. I know that Van Gogh is the guy whose fields look swirly, and that's about it. I saw an online guide to identifying painters that I think was meant as a joke, but it's actually pretty handy. For example, if it's a party scene and everyone seems happy, it might be a Renoir. But if everyone at the party seems unhappy, that might be a Manet. If there are ballerinas in the painting, guess Degas, although I'm not 100% sure how to pronounce that one. If you see a painting and everyone's naked and physically fit, it could be a Michelangelo. But if everyone's naked with big rear ends, That's probably a Rubens. If there are body parts in weird places, it could be a Picasso, but this one's tricky. I've seen Picassos where the body parts are in the right places. As far as I know, with Picasso, the body parts migrated to stranger places as he got older. Finally, if it looks like you're on a hallucinogen, it's a Dalí. Unless you're actually on a hallucinogen. In that case, it could be anything. Now, Metta, I understand we have a listener question about fine art. We do.

It's from Reed in Brunswick, Maine.

Hey, Jack and Metta. I'm a senior at Bowdoin College, huge fan of the podcast, been listening for a while now, and just had a quick question about investing in art. So that art is an asset class that's been kind of reserved for the ultra-wealthy, but recently there have been some platforms that have come out in efforts to democratize access to that asset class. I guess I won't name any specifically, but given the opportunity, would you recommend investing in art as a small, you know, retail investor as a means to diversify one's portfolio, or would you avoid doing so? Thank you.

Thank you, Reed, and congratulations on Maine having the third lowest per capita COVID case rate over the past week according to the Centers for Disease Control. You're almost tied with Vermont for second lowest, really. Hawaii is the clear leader. I'm only counting the 50 American states. If we're including American territories and associated states, no one beats American Samoa, the Federated States of Micronesia, and Palau when it comes to social distancing. Now then, art. Reid, you'd like to know whether to invest in pricey paintings using a platform that, as you say, Democratizes access. It sounds like you mean shared ownership. Buying a little stake in a painting instead of the whole thing in hopes of selling your stake down the road for a profit because the art becomes more valuable. The biggest platform I know of for that is called Masterworks. It was founded 3 years ago by a guy named Scott Lynn, and just for you, Reed, I put in a call. Hello?

Hi, Scott.

This is Jack Howe from Barron's. Hi, Jack. How are you? Doing well, thanks. Thanks for making a few minutes to talk with us.

Yeah, no problem.

Happy to help. Masterworks turns individual paintings into investments that lots of people can buy into at the same time. None of those people get to hang the painting on their walls, but all of them participate in the profits if the price of the painting goes up. Turning art or anything into a security that can be bought bought and sold like a stock, that's called securitization. Technically, Masterworks doesn't sell shares of paintings. For each painting, it creates a special holding company that buys, cares for, promotes, and eventually sells the painting. Masterworks sells shares of these holding companies, and just like with any initial public offering, it files forms with the Securities and Exchange Commission that fill the public in on the details. Take the example of Maxine, a 1974 painting by Alex Katz that sold at a Christie's auction late last year for just over $1 million to a Delaware limited liability company. The company was set up just to buy the painting. Then Masterworks offered shares of the company to the public. The SEC filing for that offering describes the painting the artist, and the company that bought the painting. It says the company's only purpose is to own, maintain, promote, and eventually sell this painting, and that it will seek to enhance its value by displaying it to the art viewing public. It also describes the management fee: 1.5% a year paid in shares of the company that owns the painting. That covers things like storage, insurance, and overhead. So if you've ever wanted to own Maxine but you don't have over a million bucks to spend, you can buy shares. And if you missed out on that deal, you might get another chance. That's because Masterworks investors can put up their shares for sale whenever they want. There are risks which are clearly stated in the Maxine filing. One of them says the value of the painting is highly subjective. Yes, it is. Another one says, "We may have overpaid for the painting." Yes, it's possible. But how can you know whether you've overpaid? The truth is, I have no idea what gives fine art its value. Supply and demand, of course, but there are no cash flows or underlying asset values to tell whether the market price has gotten out of whack. There's a painter named Mark Rothko who died 50 years ago. He painted giant hazy boxes. That's pretty much it. No trees, no ducks, not even big rear ends. Just hazy boxes. And the paintings sell for millions. There doesn't even seem to be any relationship between how many boxes you get and the price you pay. There's a 2-box Rothko that sold for $56 million and a 3-box one that went for only $1 million. Many years ago, I bought a coffee table book of Rothko paintings and stared at each page to try to see where the sky-high prices were coming from. It didn't work. In my case, not even wine helped. The truth is, when I hear that a painting went for $50 million, a small part of me suspects it's really a piece of performance art, a practical joke, and that the whole world is in on it and I'm the target of the joke. At any moment, someone's going to say, "Just kidding, we bought that for $3,250 at Bed Bath Beyond. We just wanted to see if you'd go for it." So my first question for Scott at Masterworks was, how do you know what to buy?

The thing that's most closely correlated with appreciation rate is actually artist. So if you choose the wrong artist, it doesn't matter how great the painting is, you're probably still not going to make money. So choosing the right artists are most critical. And this year we've identified roughly 45 artists that we think are most investible or that will appreciate most quickly. And then after our research team selects the artists, we essentially hand that off to an acquisitions team that goes out and tries to find all of the available examples by those artists.

Scott says Masterworks is currently tracking around 1,100 paintings and that it only buys 1 to 2% of what it sees. I asked how to avoid overpaying, and Scott says one way is to track sales prices of comparable paintings. I asked how important price momentum is when deciding whether to buy a painting. Scott says it's very important and that surprisingly, buyers don't seem to track it in a methodical way.

The reality is the art market's not that sophisticated, right? I mean, it is a big asset class that the ultra-wealthy are trading, and there's lots of smart people in it, but You know, for example, we're the only research team in the art market that analyzes returns. I mean, that in itself is shocking. So momentum is definitely what we look at, but there's really not a lot of people that are looking at momentum.

Masterworks says it aims to hold its paintings for 3 to 7 years, although it doesn't always hold them for that long. In October, it reached a deal to sell Mona Lisa, not that Mona Lisa, there's an anonymous graffiti artist based in England called Banksy. He spray-painted a replica of the Mona Lisa—yes, that Mona Lisa—only with a Red Bull's eye on her forehead, holding what looks like a Kalashnikov rifle. I'm not super duper good at spotting political subtext in art, but I think there might be some at work here. Anyhow, Masterworks offered the Banksy Mona Lisa to investors at a price that valued it at just over $1 million. That was barely a year ago, and it recently agreed to a sale at $1.5 million. Investors don't necessarily have to wait until paintings sell to cash in their stakes. Masterworks has a small secondary market in painting shares. A recent list had stakes roughly worth between $300 and $5,000. If you see something you like, you can buy it. Or make a counteroffer. If you have a stake to sell, all you need is someone willing to buy. Many people say stocks, bonds, and other financial assets look expensive now. I asked Scott whether he thinks fine art has gotten too pricey. He says no. He says one way to think of art is as a call option on the ultra-wealthy. That's another way of saying it's a bet that the rich will become even richer and be willing to pay even more for paintings. That bet has arguably paid off nicely over the past couple of decades. Scott also says that because artists die and because some of their paintings are donated to museums, that there's continuously declining supply for particular artists, which can boost prices. And that brings us to the heart of your question, Reed. Should you buy a share of art? If we were talking about a whole painting, I could take the easy way out and just say buy it if it makes you happy.. But since you won't have something to hang on your wall, your happiness doesn't really factor in. We can point to measures that show that art and stocks move differently, that they're not perfectly correlated. And there's an academic argument to be made that combining uncorrelated assets can reduce overall risk in a portfolio. But regular listeners know I don't love that argument once we get beyond stocks, bonds, and cash. For one thing, lowering statistical risk on paper isn't the goal of long-term savings. Maximizing wealth is. Also, correlations have a way of rising at just the wrong time. Paintings might follow their own path separate from the stock market for now, but I promise you, if stocks suffer a long, severe downturn, they'll eventually weigh on prices for lots of things rich people like. Luxury houses, Bordeaux, Bugattis, country club memberships, whatever. What we really want to know about art is how quickly it tends to rise in price on average over time. That sounds like a simple thing to measure, but it can be devilishly difficult. Anytime you create a price index of something, the first question you have to answer is which of that something will you include in the index. You want to create a house price index? Okay, which houses? You want to create a used sneaker index? Fine, which used sneakers? Also, you need for the thing you're measuring to change owners, because that's when you get a clear read on the price. Stocks change owners all the time, but paintings, not so much. Masterworks tracks its own art index. Here's Scott on how it works.

Half of the art market trades publicly at auction, so each year there's roughly $60 to $70 billion in art that turns over at public public auction. So we've taken the purchase price and the sale price on over 100,000 paintings now and how much those have returned over time, and then use that to construct indexes, perform correlation analysis, etc.

Scott says the pandemic has made it difficult to get a read on prices, but that broadly speaking, art has underperformed stocks for the past 3 or 4 years, but outperformed stocks over the past 2 decades. By a lot. Earlier this year, Masterworks published a paper that compared art returns with other assets. Over the 20-year period that ran through last year, paintings by a basket of artists called Masterworks Target Artists returned 10.7% a year. That compares with 5% for global stocks and just under 4% for U.S. housing. Now, Masterworks didn't show returns for U.S. stocks, which have done better than global stocks over that period.. But even so, its numbers make the case for shared art ownership seem simple. Here's Scott.

So we think it has a role in any investment portfolio. All of our investors today, the 100,000 people that are on the platform, are really just doing it to generate additional returns, just like they would with, with any other investment.

By the way, the record sale price for a painting is about $450 million. Paid 3 years ago for a Da Vinci painting of Jesus called Salvador Mundi. Masterworks wasn't involved. The buyer was Prince Badr bin Abdullah bin Mohammed bin Farhan Al Saud. Yes, that Prince Badr bin Abdullah bin Mohammed bin Farhan Al Saud, Saudi Arabia's Minister of Culture. Scott says he thinks we'll see the first billion-dollar painting sale within the next decade. Now, I hate to be a party pooper or a painting pooper.

That's its own class of art.

Thank you, Meta. All right, I don't want to be a party pooper, but the idea of beating the stock market with art over the long term leaves me skeptical. For one thing, I have a philosophical belief that nothing beats stocks. Stocks represent businesses. Businesses are machines that turn their inputs into profits. The inputs include stuff like raw materials and real estate, and labor, and financing. It's not a coincidence that stocks have outperformed bonds over the long term. Bonds are a type of financing, and if companies couldn't outperform financing, they wouldn't earn profits and they wouldn't exist. Gold is a type of stuff. If companies didn't have reason to believe they can outperform stuff They'd liquidate and use the proceeds to buy that stuff. Stuff increases at the rate of inflation over the longest time periods. If it increased faster than that, it would become infinitely unaffordable, and that doesn't happen. By the way, houses are stuff. We treat them like they're magical, mystical investments with their own special rate of return, when in reality they're just sticks and stones and earth and design and labor. The thing about stuff is it can veer sharply away from the rate of inflation over the short term. You can make money trading stuff, but I don't think of it as a long-term investment anywhere near as valuable as stocks. Now, fine art is stuff, but it's a special category of stuff called collectibles, and pricing there can be driven by scarcity and buzz. I'm not sure, frankly, how to sum up predicted returns for collectibles, and I know there are examples of them soaring in price over short bursts or even over decades, but I still don't think anything can predictably beat stocks over the very longest time periods.

And there's another reason for my skepticism. So we technically would call it a selection bias. So the problem is that these paintings that come to market a lot tend to be the ones that have appreciated quite a bit recently.

That's Arthur Kordeweg. He's an associate professor of finance and business economics at the University of Southern California Marshall School of Business. He mentioned selection bias. Hold that thought. Arthur studied art prices over a 52-year period that ran through 2013. His interest in the subject does not spring from artistic passion.

It's purely academic, so I'm not a collector or owner of art of any mention except the ones that I've I made myself, which I don't think should be qualified as art.

Now back to selection bias. Arthur says the problem with summing up art returns is that indexes tend to track paintings that sell a lot, and paintings that sell a lot are usually the ones that go up in price a lot. That's because of something called the disposition effect. That's a tendency of investors to be quick to sell assets like paintings that rise in value in order to lock in that good news, but they cling to paintings that go down in value, or stocks or houses that go down in value, in order to keep hope alive. If investors are mostly selling top-performing paintings and holding on to stinkers, and indexes are tracking just the sales, it introduces selection bias. That's when you're trying to measure a random sample of things to make generalizations about the larger group, but the sample you're using isn't random. Now, Arthur used a special data set to measure risk-adjusted returns for art both with and without selection bias.

So at the risk of oversimplifying, for the same level of risk, if you don't correct for this bias, it looks like you get a higher average return on paintings than you do on stocks. But once you correct for this selection issue, you only get about half of the expected return that you would get on stocks for the same amount of risk.

So there you have it, Reid. If you want to buy shares of art, think of them as something to trade out of personal interest or for excitement. Maybe a momentum-based approach like Masterworks uses can do better than the art market in general. I guess we'll see in the years ahead, but I personally wouldn't view paintings in whole or in part as a building block of a long-term investment portfolio. By the way, if you're an investor who's not interested in art, first of all, thank you for listening anyway. And second, just keep in mind that selection bias can affect other assets too, like houses and house price indexes.

Here's Arthur. There's a similar effect there that people tend to sell houses more that have gone up in value and tend to hold on to the ones that have come down in value for similar reasons. This issue would pop up in any market that's quite illiquid where you don't see sales very often. And where the reason why people might sell an asset or security is related to its appreciation. And that's a fairly broad idea. So this could pop up in many different other settings. You could think about corporate bonds or other assets of that nature.

Meta, I have a business proposition for you. All right. Banksy, right? He's a graffiti artist and his paintings sell for millions of dollars. And there was a guy called Basquiat who did graffiti. And 3 years ago, a painting of his sold for $110 million. It's called Untitled. You think that for $110 million you get a title? But anyhow, graffiti is clearly hot, and I'm looking for a new hobby. What if I go into graffiti, right? I'll start with the side of my house, I'll transition to paintings, and you can sell the paintings. You can generate buzz, get people to pay a lot of money for them. What do you think?

I think this is a clear case of assumption bias. You know, you assume that you can do art even though you're not an artist.

Is that— is assumption bias a thing or is that something you just made up?

I just made it up.

I think you might be guilty of assumption bias for thinking that you can just make up a new bias willy-nilly. Touche. Thank you, Reed, for sending in your question and everyone, please keep the questions coming. Just tape on your phone, use the voice memo app, and send an email to jack.hough, that's H-O-U-G-H, @barons.com. Thank you for listening. Meta Lutzov is our producer. Subscribe to the podcast on Apple Podcasts, Spotify, or wherever you listen to podcasts. And if you listen on Apple, please write us a review. If you wanna find out about new stories, new podcast episodes, You can follow me on Twitter. That's @JackHough, H-O-U-G-H.

See you next week. Model portfolios have evolved from a one-size-fits-all solution. In a recent roundtable conversation, Jeffrey Safe of BlackRock and Alessio DeLongis of Invesco break down what's driving the next model moment, discussing how a deeper level of customization is producing a better alignment with investor goals and creating a practice differentiator for financial advisors.