83: Is Art Investing Legit?

0:00In America, half of every dollar spent on brand medicines goes to entities who don't make them. While middlemen like PBMs and 340B hospitals drive up costs, Biopharma is investing$500 billion in new infrastructure and manufacturing here at home and helping patients buy medicines directly at lower prices. Tell Washington to end middlemen markups and put American patients first. Visit phrma.org slash middlemen. Rinse takes your laundry and hand delivers it to your door. Expertly cleaned and folded. So you could take the time once spent folding and sorting and waiting to finally pursue a whole new version of you.

0:40Like tea time you. Or this tea time you. Or even this tea time you. So did you hear about Dave? Or even tea time, tea time, tea time you. So update on Dave. It's up to you. We'll take the laundry. Rinse. It's time to be great. Hey everyone, and welcome back to the Rich Habits Podcast, a top 10 business podcast on Spotify. My name is Austin Hankwitz, and I'm joined by my co-host, Robert Croak. Robert is a seasoned entrepreneur in his 50s with lifetime revenues of over$300 million, and I'm an entrepreneur in my late 20s with a background in finance and economics. Since quitting my full-time job in corporate finance a few years ago, I've built a seven-figure media business and actively advise some of the most well-known fintech companies around the world.

1:28As the show name might suggest, every episode. We talk about rich habits as they relate to business, finance, and mindset. However, we try and bring you two unique perspectives. One from an industry veteran, which is Robert, and the other myself, someone who's still in the process of building wealth and figuring it all out. So Robert, what are we going to be talking about in today's episode? Given the recent market volatility we've seen in September, we've had dozens of podcast listeners ask us about diversification, Not just buy gold, but truly uncorrelated returns to the stock market, so we're doing just that.

2:01We've invited Scott Lynn, the founder and CEO of Masterworks, on to explain to all of our listeners how artwork investing actually goes down. The true behind-the-scenes look into how everyday investors like Austin and myself are able to gain exposure into artwork that has historically seen strong, uncorrelated returns when compared to the stock market. As you all know, I began investing with Masterworks in 2018 after I saw an advertisement for their offerings on Morning Brew. I set up a call with one of their investment professionals to learn more about my options as a retail investor looking for some diversification, and they made the art buying process incredibly simple.

2:37So we want today's episode of the show to act sort of as an opportunity to pull back the curtain on what's actually going on at Masterworks, just like we've done with Jay Jacobs from BlackRock and their Bitcoin ETF in the past. We're going to discuss how they source new pieces, how they securitize them, right? Allow everyday people to invest in them, where the artwork gets physically stored, what the insurance process is like, and many more in-depth topics about art investing. So Scott, thanks for joining us on this week's episode of the Rich Habits Podcast. So give yourself a quick introduction, talk about Masterworks a little bit, and then we'll dig into the questions.

3:13Yeah, thanks for having me. So as you guys mentioned, my name is Scott Lynn. I'm the founder of Masterworks. Unlike your guys' introductions, I'm not going to say my age, but I appreciate you having me on. So let's dive in. Okay, Scott. So now speaking to tens of thousands of retail investors, entrepreneurs, and forever learners, a lot of them have heard about index funds, ETF, and other longstanding investment vehicles, and have done a great job building those well-diversified portfolios around those things. So explain to us, Austin and I, all of our listeners, what is investment grade artwork number one, And why would someone want to add that to their already well-diversified portfolios?

3:51It's a great question. So to answer the question, maybe it's helpful to just take a step back and understand the macro dynamics of the R market, right? When you think about the R market today, it's a roughly$1.7 trillion asset class. That's a number that Deloitte publishes. I like to compare and contrast that to venture and private equity, which is roughly a$3 trillion asset class. So it's roughly half the size of venture and private equity. Each year, about$60 billion in R changes hands. Now, the interesting thing about those stats, and it gets to your question around what is investable art, is out of that$60 billion that changes hands, approximately 64 % is from the top 100 artists.

4:28And most of these top 100 artists are no longer living. So these are artists like Pablo Picasso, Basquiat, Banksy, Andy Warhol, household names that many of your listeners have probably heard of. Those artists have enough data to really conclude that over time, their prices are appreciating at predictable rates, right? They have a low degree of volatility. So these are definitely not artists where, you know, you walk down the street in your hometown and you go into a gallery and you buy a painting for$10 ,000. We liken, you know, that sort of artwork sort of as to like buying a lottery ticket.

5:00You should buy it because you love it. You shouldn't buy it for investment purposes. So when we talk about investment-grade artwork, it's really these artists that have existed for decades or in some cases centuries, and there's very long track records around their prices that they've achieved over time. Got it. And so then I guess back to that second question, why would someone want to add that to their already well-diversified portfolio? I always think of this conversation I had with one of the heads of research at a major private bank, and he said there's two very simple criteria for including an investment in your portfolio.

5:30One is that the investment must outperform inflation. And two is it must lack correlation to everything else you're investing in. By lack correlation, I just simply mean if the stock market goes up, that new investment doesn't also go up and vice versa. So the interesting thing about art is when you look at contemporary art, which is really art created after World War II, that segment of the art market almost has zero correlation to every other asset class. I think the highest correlation is actually gold, which is roughly 0.2, which isn't that correlated. So independent of the appreciation rate of R, it acts as a really good diversifier as part of a portfolio.

6:05I love that. And it's probably one of the things Austin and I speak about the most is diversification. Because, you know, you and I, Scott, are both old enough to have been through a few ups and downs in the market. And, you know, a lot of people out there just have never seen the 2009, 2010s and some of the 1990s of what happened when people get wrecked in the markets. And so that's why I'm a big fan of diversification and always been a huge fan of art, just because I think the lack of correlation to the stock market and the crypto markets and all the other markets makes it such a great investment strategy to get that diversification you want.

6:41So let's talk now a little bit about the sourcing process. According to your website, your team at Masterworks have purchased over 450 pieces of investment grade artwork. So what goes into identifying those 450 pieces and why do you choose those specific pieces over others? Because you made a great point is you see all of these galleries with unknown artists with 10 and$20 ,000 price points. And I always say the same thing, too. That's like buying a lottery ticket because you don't know if any of those artists are ever going to reach that level of the Basquiat's or the Banksy's to where the real value is there and is going to be determined over time.

7:20And I really like that part of what you said. So dig into the sourcing process and where do the metrics come from for this? Yeah, so maybe let's just start with like, how is there data on the art market? So the interesting thing about the art market is that art has been traded publicly at auction for literally centuries. Sotheby's was a publicly traded company up until I think four or five years ago in the New York Stock Exchange. It was actually the oldest publicly traded company on the stock exchange. I think it's now 270 something years old. So art literally has been traded between collectors before modern-day financial markets existed.

7:55So when we talk about analyzing data, we really talk about analyzing that auction data over many decades within the art market. So our research team goes out and we look at literally millions of data points on paintings that have been bought and sold over time to try to understand which artist markets are appreciating at the best risk-adjusted returns. That's really critical, right? Because you can see artist markets that skyrocket right away, but they don't necessarily have predictable returns in the future. So we're always trying to focus on which artist markets produce the best risk-adjusted returns.

8:27Once we have that list of artist markets, we basically hand off the list to our acquisitions team, which in today's world is the biggest buyer of the art market, and they go out and they source paintings within those given artist markets. So to give you an example, in the Basquiat market, which is one of the artist markets that we buy, there's roughly 1 ,100 paintings that Basquiat painted during his lifetime. There's 600 or 700 paintings that are kind of available in private collections. And we've been offered over the course of the last five years about 300 of those paintings. Out of those 300 paintings that we've been offered, we've purchased, I'll get the exact number wrong, but somewhere around 15.

9:01So we're incredibly selective, not only in the artist markets that we select, but also in the paintings that we buy after we look at those artist markets. That makes a ton of sense. So what you're saying is that just like the stock market, there are thousands and thousands and thousands of things to invest into, right? With the stock market, it's companies. With the art market, it is actual pieces, right? There's so many different pieces out there. But you're saying instead of investing kind of the stock market, instead of investing into some random penny stock or some random company, let's figure out sort of these secular growth trends that are happening that some of these more successful companies are operating inside of.

9:34And we've seen some really cool data points to prove that. Let's go identify what those data points are now in the art market. And those trends could be specific people. Maybe there are other specific data points that you said that you had mentioned that you guys are following closely. And then from those, you guys are really digging deep and figuring out, okay, of the 300 that we can sensibly invest into, these 15, those seem the best to us. So I'm curious. I mean, that is a 5 % conversion. Is there any specifics that you can share with us as to what that 5 % really turns into? It's very small.

10:04It's far less than 1 % because if you think about the artist markets that we're buying today, we're active in about 70 artist markets. There's more than 1 ,000. So that alone is less than 1%. And then when we source works in each of those markets, we buy, you know, depending on the market, anywhere between 2 % and 5 % of what we see. So we're really buying a very, very, very small portion of the R market overall. Makes a lot of sense. Well, now let's talk about your track record, right? Your website says that you've distributed$60 million plus back to your investors as cash profit proceeds. So walk our listeners through the entire timeline now of investing into artwork, from sourcing it to holding it and then distributing those proceeds.

10:42maybe talk about the insurance process. I mean, I'm an investor on the platform. I see my unrealized returns of 34 % on a specific investment. So like use me as an example, maybe. So the process is relatively straightforward for people that understand how companies go public. We go out, we go through the process that we just talked about. We find a painting that we want to buy. We purchase the painting with our own capital and we file it as a public offering with the SEC. So the exact same process, more or less, that a company goes public, we go through. You know, want to see what one of these looks like, you can go to sec.gov, search for Masterworks, and you'll see literally thousands of public filings on all of these different paintings.

11:19So once we file it as a public offering, we then start selling shares in the painting. The offering closes. We distribute shares to all of the investors, which you can see the number of shares that you own in your account. We appraise those shares on a quarterly basis. And then we tell people to think of these as three to 10-year illiquid investments, right? So when you're thinking about what percentage of your portfolio should you allocate to art, you should always be thinking about that is a very long-term investment. This really shouldn't be capital that you need access to tomorrow because they are long-term investments.

11:48And then we have a separate team, a private sales team that operates out of a gallery in uptown New York that is responsible for selling that painting at the right time back into the art market. And we then distribute proceeds to people then. In definitively, we have secondary markets where people can trade shares on the secondary markets. But I always at least personally tell investors to assume that these are long-term investments and you shouldn't have to use the secondary market. You can opportunistically, but it's really a fallback position to a longer term hold. I think it makes a ton of sense.

12:15And so kind of going back though, to like the sourcing and the holding process, where do you guys store the pieces? Well, I mean, don't give me specific coordinates. I don't want anyone to let go, like get too excited and try and break in somewhere, but how do you guys store them? And then like, what's the insurance process like? I mean, I'm sure these are all insured pieces as well. Yeah, so we have, I think one of the largest insurance policies, if not the largest with Boyd's of London, a policy that's well over a billion dollars. So every vehicle is fully insured. The paintings are stored in the state of Delaware, actually, because we avoid sales and use tax when we acquire and subsequently sell paintings.

12:48And that doesn't sound like a huge deal, but when you actually factor that into the total returns, you know, it's quite significant for investors, you know, depending on what that actual tax rate is. So that's just a strategy to maximize returns ultimately. But, yeah, they're all kept in Delaware. I love it. Yeah. I talk about it's not what you make, it's what you keep all the time. So I'm sure our listeners love the fact that you guys are looking out for every single dollar because, you know, a lot of times you can have all this money changing hands. But if the profits aren't there for investors, it's going to hurt you a long time.

13:17So let's get into that part of this. Your website claims investment-grade artwork outperforms the S &P 500, and you have a chart that we'll show on the screen that shows from January of 2000 how the S &P 500 has only returned 250%, while investment-grade artwork has returned over 700%. So let's walk the listeners through, why is that? Artwork doesn't have a dividend. It doesn't have profits. It doesn't have customers. It doesn't sell anything. Why does artwork go up so much in value? you? It's a great question. And I think it's probably very similar to any other asset class. Like the chart that you're referring to is called the ArtPrice 100.

13:55You can access that index at artprice.com. You know, I think when we think about supply and demand in the art market, there's something that's very unique about artisan asset class that's different than almost every other asset class. When you think about the demand side, I think it's relatively straightforward. Demand is driven by ultra high net worth people living around the globe, you know, that are interested in buying these paintings. And the more high net worth people there are, arguably the more demand there is within the asset class. The thing that's very different, however, is actually the supply side of the art market.

14:25And most people don't totally appreciate the value of this dynamic. So when collectors buy paintings, when an artist is living and the artist paints paintings, then they sell paintings in a gallery, collectors start collecting the paintings. Those paintings are circulating privately within the market. Most collectors over time, particularly after one or two generations pass, wind up donating those paintings to museums. That's how museums acquire most of their collection. So, you know, an example of this is an artist named Jackson Pollock, who I know well. You know, in today's world, there's less than 20 Jackson Pollock drip paintings in private collections.

14:59He's the artist that, you know, dripped all over the canvas, his paintings. His best paintings are worth over$200 million. You know, he painted hundreds of paintings during his lifetime, but now there's only roughly 20 left that you can buy. And honestly, the 20 that are left that you can buy, there's a couple of A examples, but they're mostly B and C examples. And the B or C examples sell for$30 million because that's all that's left. So that dynamic of continuously decreasing supply when artists become more and more well-known and effectively canonized in a lot of our history books and culture generally is what probably causes prices to rise.

15:32And I want to jump in with one quick question, Austin, and I know you've got a good point to talk about. But one quick question that you alluded to is Walk me through and the listeners, because I'm really intrigued. It doesn't seem like there's a lot of these new Banksy's and Jackson Pollock's and all of these names that are building up in the art mark, which then I believe would add to more and more scarcity in the market itself. So how often do you see a new artist that really just rises to the top, becomes famous, and then their pieces then follow along in price, you know, appreciation? That's a great question.

16:08You know, I guess it depends what the definition or what the threshold of, you know, quote unquote famous is, but it's very rare. I mean, in terms of artists that we add to our list that are what we would consider mid-career living artists, you know, we might add a couple a year, a couple every other year. You know, it's definitely infrequent. infrequent. So what it sounds like then is kind of back to your answer to the previous question was that demand stays steady if not rises over time as people want exposure to these artwork pieces while the supply continually goes down because more and more people are just gobbling them up and they just don't sell them.

16:42And so Masterworks now is a part of that demand and you guys are purchasing artwork on behalf of people like me who don't have$200 million to go buy a drip painting, but so allowing us normal retail investors the opportunity to have some exposure to that in our portfolios so that as the demand increases and supply decreases, therefore economics 101 tells us prices go up, we can then realize that in our own portfolios. That's exactly the thesis. So in general, we encourage from an investing perspective, our listeners to sort of build their base of$100 ,000 invested into longstanding index funds that we all know and love like the S &P 500 or the NASDAQ, things like that, before investing into alternative asset classes, including artwork, also cryptocurrency, things like that.

17:27Then once they're ready to start investing, maybe allocate 15 to 20 % of their net worth to these alternative asset classes, including crypto and gold and collectibles, things like that. So personally, I'm like a 2 % of my net worth invested into artwork, but I'm curious, what sort of trends are you seeing as it relates to artwork allocation in a net worth or a portfolio. Are you seeing people allocate that single digits? Are we in the double digits? Are we above 15, 20 percent? What are the trends that you're seeing, Scott? Yeah, I mean, I think the trends that we're seeing tend to be lower single digit percentages, not dissimilar to yourself, but we see people growing those pretty rapidly over the course of a number of years, right?

18:08So if someone starts out at 2 percent, A year later, that might be 4%. A year later, they might be 6%. But we did, for those listeners that are familiar with Mercer, we did work with a firm called Mercer. It's a large consultant that advises a lot of asset managers. I think they advise more than like a$10 trillion,$40 trillion, some huge number in assets. And we spent over a year working with them to try to think through what is the right asset allocation model for ARD. And very broadly, I would say, if you're a conservative investor, it's somewhere between 5 % and 10%. Again, over a long period of time where you get comfortable with the asset class and you're confident that you can hold an investment for three to 10 years, and then five or 10 % more, depending on how aggressive you get on that scale.

18:51And a lot of that is just driven by the fact that when you look at contemporary art historically, it's outperformed public equities and it has low correlation. So it acts as this very interesting diversifier while still producing good returns. But again, you know, the caveat is being able to hold that long term over a three to 10 year horizon. Last question, Scott, is do you see a world or is it already in the works where we're going to see liquidity platforms based on blockchain and NFTs to where people would have liquidity auction opportunities in this type of investing if they needed to get out of it and didn't have a way to put liquidity into their investment?

19:31If they got in a pickle and needed to get some money out, do you see a world where blockchain and NFTs are going to kind of resolve that liquidity issue? I guess there's a couple of questions there. So we do operate a secondary market, so people can trade shares in our secondary market and sell shares in their secondary market. The other thing that we're working on, which is, you know, there's no certainty around this and it's a year plus project, but it's allowing investors the ability to open margin accounts using their securities as collateral to also more quickly access capital if they need to.

20:01I think in general, one of the challenges of the asset class, which you can probably hear me repeating this, is just it's a long-term investment. And I think the more we can do to make that easier for people to tolerate, the more adoption there will be to the asset class overall. To your other question around NFTs, I've always been, and depending on the point in time, I've been proven wrong, but I've always been the anti-NFT person. And it's not that we have anything against NFTs as the masterworks high level. I think the thing that we struggle with is when we look at data around NFTs, we can't really conclude that they're predictably appreciating.

20:36So if you go back to my definition of what should be included in a portfolio, it's something that beats inflation and lacks correlation. And I just don't know if you can conclude that in NFTs. They're sort of the prices are kind of all over the place. They seem highly volatile. I can't tell if they're correlated or not correlated. The data is fuzzy because of, you know, all these different trades on the blockchain. We've just never gotten comfortable having a typical investor who's investing in an IRA account allocate to NFTs. But, you know, maybe that changes in the coming years. Got it, Scott.

21:06Thank you so much for joining us on this week's episode of the Rich Habits podcast. If you're someone looking to learn more about adding artwork to your investment portfolio, be sure to check out masterworks.art front slash rich habits. Scott, thank you so much for joining. You just opened my eyes up even more. I've loved art for decades and I just love learning from people like you because with Austin and I always talking about diversification, you know, we're talking about artwork and cryptocurrency and wine and whiskey and all of these things. It's just great to dig in, get behind the curtains and really understand these markets, not only for ourselves, but for all of our listeners.

21:42Awesome. Thanks for having me. Thanks, Scott. Dang, dude. What an awesome interview with Scott Flynn. I mean, I understood how artwork investing happened, right? Generally speaking, just like I understand how Bitcoin ETFs work with Jay Jacobs, but really getting to sit down with the person who's pulling the strings behind the scenes and doing the things that they say they're doing is just so much more enlightening, if that makes sense. Yeah, I love it because we get the opportunity all the time to interview these crazy smart people that are behind the scenes, like you said, and we get to pull back the curtain and help all of our listeners understand more about what they're getting themselves into.

22:21What are these investment sectors? What are the best companies? How does it work? What are the returns like? Because, you know, there's a lot of different ways through diversity to really win in the game of investing, especially during tumultuous times. So today's episode was fantastic. Well, that reminds me, Robert, that we are gonna be hosting the president of Shopify on our podcast here in the next couple of weeks as well. A lot of people say, hey, try and do this e-commerce side hustle. I'm trying to sell on TikTok. I'm trying to sell little things. And so we're like, all right, people trying to do these side hustles.

22:51Let's reach out to Shopify, the side hustle online e-commerce king, and see if they want to talk to us. And they do. So stay tuned for that. And if you have any other ideas of people you want us to bring on the show to help explain things to you, if they're an expert, if they own a company, you know, whatever. Just let us know because that's the whole point of this podcast, to bring to you guys the opportunities to learn from the experts themselves. as well as share our own rich habits on a twice weekly basis. Now, before we move on, we want to give a quick shout out to one of today's episode sponsors, Mobi.