The Problem With Masterworks

old ways of investing aren't working that's why over 500 000 people just like you and me have found a new way it's called Masterworks Masterworks the investment platform that lets you buy fractional shares of art no not that art fine art physical pieces from the likes of Banksy Andy Warhol Claude Monet an intriguing offering and one that's had a massive sponsorship campaign here on YouTube with many large creators pushing the idea that everyone should want to invest in art after all look at these crazy returns who wouldn't want to earn 39 a year but it does sound a little too good to be true the whole idea of investing in art seems a little dubious to begin with and ever since a collapse of FTX and the rise and fall of nfts it's become a sort of rule of thumb that if an influencer is promoting an attractive Financial opportunity it's probably a scam which is why I want to look further into it myself exploring the company's website reading through the SEC filings and speaking to representatives to see if this was the real deal or the next established titles and I did find a few red flags huge liquidity risks extra fees cherry-picked return figures it didn't paint a pretty picture so to speak now to be upfront I don't think any of this constitutes a scam I didn't find any evidence of wrongdoing and all these details are technically disclosed in the company's filings so while this video is a bit more of an investigative piece it's probably not all that deserving of the suspenders it's really hoping to make these work even still I see a lot of problems with how the service is promoted and the information that Masterworks chooses and doesn't choose to share with retail investors interested in their platform so if you've ever thought of using Masterworks you'll probably want to watch this first so let's dive into it together on today's playing bagel art investing is nothing new it's always existed as a sort of alternative investment category because even though artworks don't generate any inherent cash flows like a typical business prices for artworks have historically risen faster than inflation thanks to its collectible attributes some pieces have even seen strong returns over time thanks to the evolving reputation of its artist but art investing has typically been reserved for the alternate High net worth of society because it's crazy expensive pieces from notable artists even the alive ones frequently go for millions of dollars and buying and selling a piece of art can come with commissions upwards of 20 percent they're also costs for storing maintaining ensuring the artwork and when it comes time to sell it can be really difficult to find a buyer for your specific piece with many artworks only ever being sold once but that's where Masterworks comes in Masterworks claims to be the first platform to offer fractional investments in fine art with shares According to some promotions costing as little as twenty dollars they do this by buying artworks that they need to be valuable setting up a limited liability Corporation or LLC to hold the artwork and then filing an offering with the Securities Exchange Commission to sell shares of that LLC to its members so really when you're buying artworks from this platform you're actually buying shares of a company whose sole purpose is to hold and maintain the artwork in question and in three to ten years time Masterworks will look to sell the artwork splitting the proceeds amongst those holding shares best of all one of mass Works key offerings is a secondary Market an exchange of sorts where you can sell your shares to other Mass Works members before that future sale in case you need your funds sooner and it seems like a pretty smart solution but as you would expect Masterworks doesn't do this all for free the platform charges an annual management fee of 1.5 percent and takes a 20 profit cut when a painting is sold a pretty steep price but similar to what a hedge fund might charge for management of an alternative asset and these fees do cover everything that makes artwork such a hassle to deal with storage appraisals Insurance the whole nine yards you won't get to look at the artwork but such as the cost of success I suppose so what's the problem advertisements for Masterworks really pushed the idea that art is a desirable investment category Twitter ads tell people to keep scrolling if they like losing money to inflation and YouTube sponsorships highlight art as a low volatility diversifying asset class that has beaten seemingly every other investment category into its credit some research reports have highlighted art as a good inflation hedge and while artworks did see a decline in 2008 they do appear mostly on correlated to stocks but while there are some merits to these positives all of which you can be sure will be crammed into every one of these advertisements what's not seemingly ever mentioned is how incredibly risky art is as an investment category for one much like cryptocurrencies art is not a regulated investment in Masterworks despite offering an investment platform is not registered as a broker dealer or any other investment firm with the SEC or finra and right away that removes a lot of your protections as an investor Masterworks does partner with SEC and finra registered companies to specifically run their secondary market and to offer advising services but they themselves simply aren't held to the same scrutiny reporting requirements and importantly return presentation standards as you would see with a traditional Finance Company even the LLC shares which are filed with the SEC are only filed under what's called regulation a an exemption to registration that foregoes most of the auditing and Reporting requirements of a standard share offering now none of this implies that mass works is actively defrauding investors but clearly retail investors need to use a bit more caution using this sort of service there's not nearly as much oversight as you would have with a traditional broker and none of the safety nets or insurance that would help cover your assets if Masterworks were to run into Hard Times secondly as you can probably guess buying art as an investment is incredibly speculative as a collectible Arts value solely relies on the tastes and preferences of collectors something that we know tends to change from generation to generation in fact one report from 2018 by Dimson Marsh and Staunton found that over 118 years Fine Art not only underperformed Global equities but also the majority of other Collectibles analyzed thirdly as Masterworks puts in their own SEC filings art is a highly liquid asset and a significant percentage of objects go unsold when sent to auction this really does mean that art investors face the risk of not being able to find a buyer for the art that they own and while the secondary Market on Masterworks probably helps to address this to an extent it doesn't sound like it's actually all that useful one representative I spoke to about Masterworks said that they don't even mention the market to new members because of how difficult it is to offload your shares on it once again as massworks puts it themselves investors should be prepared to hold their class A shares for an indefinite period of time as there can be no assurance that the class A shares can ever be tradable or sold so right away you can see that you're taking on a lot more risk to chase those lucrative returns highlighted in YouTube ads then you might have otherwise expected but to be fair Masterworks does offer some solutions to these points Masterworks has been able to bypass the significant commissions that you typically run into when trying to buy and sell artworks and with a lot of their compensation being in the form of artwork shares and the profit cut on that final sale they do obviously have an incentive to make sure their artworks are eventually sold and sure while the risks might be high the reward does seem enticing indices for contemporary artwork the area that Masterworks focuses on do show the asset class L performing most other categories so surely investors could expect similar outperformance right as good as index returns might seem for contemporary artworks there's good reason to take these figures with a grain of salt while indices from Masterworks artnet and Sotheby's all show impressive performance over the past 20 years or so they all suffer from some key setbacks the Art Market is incredibly opaque with no essential database for tracking performance or prices so indices often have to rely on data for repeat sales of artworks that auction houses are willing to disclose in order to track their performance this only represents a small fraction of the Art Market one research report by quarterwig at L found that of 2.7 million Auction Sales from 1960 to 2013 only 2.5 percent were an identifiable repeat sale there's also good reason to believe that artworks that fall in value simply don't show up in these numbers in other words indices are victim to a type of survivorship bias after all it might be hard to remember but Art's primary function isn't as an investment category but as an emotional asset for emotional fulfillment if you will according to a report by Knight Frank the number one reason collectors own Investments of passion which includes artwork is for the joy of ownership with this ranking above Financial considerations and everywhere but Asia if the collector's artwork were therefore to fall in value there's a very good chance that they simply wouldn't sell it because they have other reasons for keeping it whether that be as a status symbol for decoration to gaze deeply into it every evening and contemplate the significance of man in the universe you know rich people stuff in fact a survey by Deloitte and Arctic found that only two percent of our collectors purchase art solely for investment purposes a larger 17 purchase for collecting purposes while the majority 81 consider returns but purchased primarily for collecting purposes and while you might view our collecting as a lucrative investment gate kept by the rich Collectibles only represent two percent of the assets owned globally by ultra high net worth individuals clearly it's not prioritized as an investment category by the ultra wealthy and even if indices did reflect the True Performance of all artworks at that aggregate level the very nature of Fine Art as a unique collectible doesn't make the sale data of other unique Collectibles all that relevant in determining the returns that you will likely experience especially given that with Masterworks you're the one at the end of the day selecting the individual pieces that you want to own past performance does not guarantee future results especially when you're talking about about someone else's artwork but Richard you might say even if that's the case what about Masterworks impressive track record they've seen an average realized annualized return of around 25 percent surely that's representative of their ability in curating art right well in spite of all the points I've covered so far Masterworks does host a very attractive track record with the range of returns being roughly 9 to nearly 40 percent annualized which is really good but you might notice that the track record only includes 11 paintings despite the site claiming that they've acquired over 200 assets this makes a little sense since the company only launched their platform in 2019 and they hold their paintings for three to ten years at a time but it's clearly not a very representative sample of the batch and here's the thing well Masterworks is always flaunting these 11 figures they do have a return figure for how their entire art portfolio has performed thanks to their internal appraisals and that annualized return is 9.9 percent now that's not bad it actually beats the S P 500 over that same time period but it's a far cry from the average annualized return of 25 that they show on their track record that's all without getting into the potential bias of this track record every single painting in this list was sold before the company stated 3 to 10 year holding period and while that could simply be because the company had an earlier opportunity to take advantage of a solid return it does raise the question of whether Masterworks has manufactured this track record by simply selling outperformers so as to bolster their realized return while leaving the losers in their held portfolio and look I don't like speculating about that sort of stuff but it's a real risk that you need to consider as an investor with this platform there's a big difference between 30 plus percent and 9.9 percent and this really touches on a problem that I've seen with some YouTube mentions here as well while traditional funds are required to follow pretty strict advertising rules when it comes to presenting their returns Masterworks ads will touch on the crazy returns earned by other paintings that they then themselves have never owned or offered on their platform and how art indices have outperformed every time inflation was above three percent which in case you were wondering has been about a quarter of the time since 1990 it's incredibly selective and it doesn't make it any easier to assess how artwork has actually performed as an investment even those index returns shown in ads that measure performance from 1995 onwards aren't as impressive when you look over a longer time Horizon and all this is compounded by what might be the most concerning thing in all of this which is the extra cost that the vast majority of people don't seem to be aware of the true up on Masterworks website where the company highlights its 1.5 management fee and the 20 profit share you might notice this little blurb underneath that reads additional expenses associated with acquiring sourcing securitizing and selling the painting are paid by the issuer that lingo might confuse some but the issue we're here refers to the LLC that's holding the artwork in other words it's the investors that will end up putting those extra bills it might seem like a negligible amount with the website not highlighting a specific dollar or percentage certainly it must be immaterial but that's not really the case within the SEC filings Masterworks discloses that offering prices to its members include an 11 true up a markup or fee paid to Masterworks for sourcing and financing the art deal that means when you buy a 20 share right away you've incurred an 11 cost something you don't see anywhere in the company's main website and the sided blurb seems to leave you open to other possible fees as well quote your distribution of cash proceeds will be reduced by commissions fees and expenses incurred as a result of administering marketing and selling the artwork while Masterworks has highlighted that in the past they've been able to avoid these high costs with their 11 painting track record in tougher times that might not be the case and in the world of art investing this might be a reasonable expense but it still seems incredibly misleading to highlight the firm's expense ratio in profit share in a way that makes them look like the only material expenses when there's basically an 11 upfront Trading fee for buying into an offering regardless of how good of a deal this could be argued to be that's not the issue the problem is that in speaking with several onboarding Representatives this true-up fee was never mentioned to me once until I brought it up and started asking questions and it raises my biggest issue with Masterworks as a whole at a high level Mass Works doesn't seem to be doing anything illegal they do offer a platform for buying fractional shares in artworks and I didn't see anything that would imply otherwise and for someone who is fully informed on the risks the costs and the potential return with this sort of investing there are arguments that could be made regarding Arts diversification and inflation benefits and to be fair I will highlight that when you call this company the representative suggests that you keep your allocations to Art under 15 of your total asset balance which is still quite a bit of your money to allocate towards a collectible but I will give credit where credit is due this doesn't seem as unhinged of a platform like FTX I'm sure they aren't running their accounting through QuickBooks and their transactions through slack but how the platform promotes its performance and cost structure while leaving out important details is really misleading in my opinion even if they do technically check all the legal boxes and that's all without covering some of the other problems I came across when exploring this platform the fact that despite shares being advertised is only costing twenty dollars they come with a minimum 500 investment I figure that's even higher for new members the fact that email soliciting new offerings look more like a Nike shoe drop than a serious investment offering with confetti and a percentage sold out bar to manufacture urgency the fact that these are actual price trajectory models shown to users for new offerings and finally yes I know it's a long list the fact that Masterworks charges hedge fund level fees while members still need to act manage their own art portfolios and again all these costs and risks might be an attractive offering within the realm of art investing Masterworks clearly isn't targeting sophisticated or accredited investors with experience in the fine art game advertisements largely focus on retail investors people who probably don't know how to navigate an SEC filing to find out all the important details that were left out of these advertisements in all amounts of something the Masterworks includes in their communication disclosure but that you can bet they'll never mention to a retail investor that they're trying to onboard the investment is suitable only for persons who can afford to lose their entire investment so maybe Masterworks does offer illegitimate investment opportunity maybe they are in the right Niche with the right strategy to take advantage of a liquidity premiums and opaque Market data my goal here isn't even to discredit their claim that they have a good system for identifying good artworks but people should consider if the returns of the platform are truly representative and if the costs and risks justify them after all maybe the reason fine art has been reserved for the ultra high net worth of society is because they're some of the only ones who can tolerate the massive risk and if you don't have any art expertise and are just looking to chase those juicy returns you see online you might want to ask yourself if a speculative investment is all that appropriate for your situation because if you aren't careful you might notice a decade down the road that you've bitten off more than you can chew so that's a video and because I really do want to be fair here if anything comes up that significantly changes my point of view on any of this I will release an update I really don't like targeting platforms like this but Masterworks is a massive sponsor here on YouTube and a lot of people are promoting this to their followers without touching on the necessary risks and costs that need to be discussed here so my hope is that people will now be more informed if they want to use the platform and if they decide to promote it so thanks for joining me today and as always be safe out there

Channel: The Plain Bagel

Views: 834,583

Keywords: Scam

Id: 6ojOkPmm8lw

Length: 18min 55sec (1135 seconds)

Published: Fri Feb 10 2023