Would you buy a share of a Picasso?

A no-nonsense introduction to fractionalized art investment

Welcome to the third edition of the Priceless newsletter and a big thank you to everyone who has subscribed since the second edition. It really means a lot!

I’m writing this when many art buyers have just returned from the first Art Basel Miami Beach in two years, after the fair was cancelled in 2020. I didn’t go to Miami this year, which is a shame, because being surrounded by art, having a few cocktails on the beach, and admiring Leonardo DiCaprio, who’s always there, would all have been preferable to freezing my tail off in Brooklyn.

It will not shock you to learn that NFTs were on sale all over Miami last week. From an art investing perspective, one of was the most interesting and confounding NFT offerings was from Particle, a company co-founded by former Christie’s executive Loic Gouzer, which claims to be “democratizing ownership of fine art masterpieces”.

Instead of offering NFT buyers the chance to buy a standalone digital artwork, Particle wants to sell 10,000 unique pieces of the title deed, or proof of ownership, of an existing painting as NFTs. The painting in question is Banksy’s Love Is in the Air, which Gouzer purchased for $12.9 million this May.

This is an interesting twist on fractional art investment, because startup companies have been attempting to sell shares of individual artworks to investors for over a decade. The idea behind fractional art investment is that, for a relatively small outlay, investors can own shares in a multi-million dollar artwork by an artist like Andy Warhol or Pablo Picasso, and also trade these shares without the underlying artwork being sold.

In recent years, some companies have started selling art shares that are tokens on a blockchain, and now Particle is selling art shares that are NFTs. Whatever the distribution mechanism, the objective is broadly the same: to democratize the art market and make it accessible to regular investors.

If you read my last newsletter about understanding the risks in art investment, this may sound like a promising concept. Anything that improves the art market’s illiquidity and allows people to invest in art masterpieces, the portion of the art market that is most likely to appreciate, sounds pretty sensible.

In truth, the world of fractional art investing is littered with failed companies and disappointed investors. Some investors have found that selling their art shares to other investors is extremely difficult or impossible, so their only exit strategy is to wait for the fractional art company to sell the underlying artwork and hope that it sells for a profit. Sometimes this happens, but often it doesn’t. I’ll come back to this later.

Instead of selling shares of an artwork that can be sold, the folks behind Particle have decided that investors will be better off owning shares in a painting that can never be sold. The Banksy has been donated to the Particle Foundation, a non-profit public trust and museum, so that its physical value is “legally destroyed” and transferred to the individual NFTs. Particle investors will not be buying part of a painting, but its replacement.

Whether Particle will succeed with this pitch is anyone’s guess. What is clear is that, despite its checkered history, fractional art ownership has become a lot more popular with investors during the pandemic, particularly among younger investors. Some 43% of collectors under the age of 35 who were surveyed in Deloitte’s 2021 Art and Finance report were interested in investing in fractional art investment products, compared to 17% of older collectors.

One of the main beneficiaries has been Masterworks. The company purchases what is calls blue chip artworks by artists with market momentum; files an offering circular for individual artworks with the SEC, allowing investors to buy shares; and then sells those artworks after three to seven years. Since 2019, it has securitized more than 80 artworks in this way, spent over $400 million on art in 2021, and wants to buy nearly $1 billion more in 2022. It’s one of the biggest buyers in the art market and over 250,000 users have signed up.

Given the amount of interest in fractional art investment and the challenges involved, it seems like a good time to outline some of the questions you should ask before you invest in Masterworks, purchase Particle NFTs, or buy into any of the other companies currently fractionalizing or tokenizing art.

What is the holding period for the underlying artworks?

After they complete an offering of shares in an artwork, most fractional art businesses have a holding period before they will sell that artwork and return any proceeds to investors. This can be a mandatory minimum holding period of several years. In the case of Sygnum Bank and Artemundi, which launched the tokenization of Picasso’s 1964 painting Fillette au béret in July, the investment period will be five to eight years, unless token holders vote to sell before this. At other businesses, including Masterworks, the holding period is at the discretion of the company.

Picasso’s Fillette au béret. Seraina Wirz / © Succession Picasso / 2021, ProLitteris, Zürich.

So if you invest in a fractional art business, you have to be prepared to invest long term. You also have to accept the risk that the artwork may not sell for a profit, if at all. Clearly, companies will try to sell artworks when the market is most favorable for that artist, but as Masterworks states in its offering circulars, “An investment in Class A shares is unsuitable for investors that are not 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 resold or that the Painting can be sold within any specific timeframe, or at all.”

How long has the company been in business and has it sold art before?

Given the long investment horizon and uncertain outcome, check whether the company has ever sold any of its art portfolio for a profit. This may sound obvious, but some fractional art companies go out of business long before they reach that stage.

My Art Invest, which also claimed that it was democratizing the art market, had a minimum five-year holding period for the art in its portfolio. But just three years after My Art Invest’s glitzy launch party at its London gallery, where guests were offered champagne and iPads to buy shares in the art on display, a court liquidated the indebted company’s art assets.

Is its marketplace for trading art shares viable and accessible?

The only way to exit a fractional art investment before the end of the holding period is for investors to sell their shares to other investors. This relies on the fractional art company’s trading platform generating enough interest from buyers, which can be a challenge. There have only been 37 trades in Picasso’s Fillette au béret, for example, since it was listed on SyngEx, Sygnum Bank’s digital asset trading platform.

Masterworks has generated more trades because of its large user base – over 15,000 people have purchased shares on its trading platform, as of October – but given the small number of participants in most fractionalized art offerings, investors might not find secondary market buyers at any price. Even if buyers are available, there can be other preconditions for trading, such as the requirement that all the initial shares in a painting have been sold first, or that the seller is a citizen of the country in which the issuing company is based.

What is the fee structure?

Fee structures differ, but much like a hedge fund, Masterworks charges a 1.5% annual management fee and a performance fee, which is 20% of any profits when an artwork is sold. It also takes an upfront fee of approximately 11% of the purchase price of each artwork when it is securitized.

That means an artwork has to appreciate 11% when it is sold just to cover just Masterworks’ upfront payment. As Felix Salmon writes in Axios, there’s a strong case that any business that immediately makes 11% on every artwork it buys, and retains 20% of any upside, plus its management fee, when it sells, “has created the most lucrative art-dealing business model of all time.”

That’s probably why Masterworks raised $110 million in Series A funding this October, giving it a valuation of more than $1 billion, and while that’s great for its venture capital funders, it’s not so great for its art investors, who are buying into an asset that “tends to appreciate slowly, if at all,” as Salmon puts it.

What returns does it offer and does this match its marketing material?

If a company has actually sold some of its art portfolio successfully, what returns has it made to investors? Masterworks has successfully sold at least one artwork in its portfolio. However, the company’s 15% historical performance, net of fees, from September 2019 to September 2021 that it mentions on its website is based on the appraised fair market value of the artworks it owns, not actual sales or realized gains.

Assessing a company’s track record is particularly important, because the marketing of fractional art businesses can tell a different story. For example, ArtSquare, the blockchain-based fractional art platform that calls itself “The fine art stock exchange’’, poses the following question on its website:  “Did you know that blue-chip artwork has outperformed the S&P 500 by more than 250% in the last 10 years?”  

I’ve no idea how ArtSquare is defining blue-chip artwork here, or how it came up with this number, because the source isn’t provided. As I discussed in the last newsletter, the art market’s performance in 2021 has been rather more shaky. However, since ArtSquare and other fractional art businesses are offering investors the chance to buy shares in one artwork by one artist, not a security linked to the performance of the broader art market, this sort of information is pretty useless anyway.

Are these investments regulated?

Sygnum Bank is a regulated bank with a Swiss banking license, but generally speaking, fractional art businesses are not regulated by any financial regulatory authority or licensed to provide financial advice or services. Masterworks lists the artworks it securitizes with the SEC, but the company itself is not registered, licensed, or supervised as a broker dealer or investment adviser by the SEC, the Financial Industry Regulatory Authority, or any other regulatory entity in the US.

I should point out here that fractionalized art investment companies are not the same as those offering general art investment funds, which do offer investors the chance to buy into a portfolio of art – I’ll be taking a close look at those in a future newsletter. But I hope the information above will provide some useful context the next time you read about a company on a mission to democratize the art market. If the current landscape is any indication, they’ll be plenty more.

I’d love to hear your thoughts on this topic, or on any other topic that you’d like this newsletter to cover in the future. I’d also love it if you could subscribe, if you haven’t already, and share this with others. It’s free and I’ll do my very best to keep it interesting. Finally, if you’d like to make a small donation to support my work, I’d be very grateful, and you can do so through buymeacoffee.com. Just click on the button below.

In the meantime, I’ll leave you with my top art investment news picks of the last quarter. Wishing you all a very happy holidays and I’ll see you again in 2022!

• Sales during New York’s marquee evening art auctions in November totaled $1.95 billion, according to ArtTactic. Although this included $676 million for the Macklowe Collection, rescheduled from 2020 because of the pandemic, it was a record for any major sale season in New York since May 2018. 

• Art dealer Inigo Philbrick pleaded guilty to defrauding art investors, collectors and lenders out of $86 million in November, including those who bought stakes in artworks for overinflated prices. In some cases, he sold more than 100% of an artwork to multiple investors.

• A new app, Artpass ID, promises anti-money laundering compliant art transactions for art buyers and sellers.

• As NFT trading volume hit $10.7 billion during the third quarter, Gary Vaynerchuk, founder of VaynerMedia, told attendees at NFT.NYC that he was worried about NFT investors suffering catastrophic losses if the market collapses.