Unpacking the Risks Behind Fractional Art Investments with Masterworks

Art collecting has long seemed like a highly-exclusive hobby restricted only to the ultra-wealthy – something which everyday investors could admire from outside a climate-controlled gallery, but never actually participate in. Yet the rise of a new model called “fractional art investing” aims to tear down those velvet ropes guarding the art market.

Five years ago, a platform called Masterworks launched, offering digital fragments of real-world Warhols and Banksys to the masses with considerably lower buy-ins. By turning masterpieces into assets with tradable shares instead of whole canvases, fractional ownership promises to let regular investors clink champagne glasses with blue-chip price tags.

Of course, where money meets art, new risks also await. We’ll unpack those here – though they might not deter the new class of aspirants flocking to fracture fortunes from fine art.

What Is Fractional Art Investing?

So what exactly does it mean to “fractionalize” art ownership? Well, as we just touched upon, the concept lets investors collectively own a Picasso or Basqiat while slicing and dicing the price tag into bite-sized pieces. Instead of one deep-pocketed patron plunking down $20 million to nail a canvas to their penthouse wall, Masterworks parcels out shares in the painting to crowds of shareholders.

Their model lets everyday investors buy shares at $20 or more each, so they can get skin in the game, claiming their sliver of asset appreciation rather than sole custodianship of the physical art.

In other words, it brings a stocks-and-bonds approach to the historically opaque and insider-driven art market. Masterworks buys the whole painting, handles storage and maintenance, then sells shares online to a range of investors who otherwise couldn’t afford a spot in the winner’s circle when the auctioneer slams the gavel.

The Potential Upsides

What drives investors to scoop up slivers of Banksy’s Mona Lisa or bits and pieces of a Francis Bacon painting? Well, art is often promoted as an excellent hedge against inflation, with returns uncorrelated to stocks. That makes art a darling for diversifying your portfolio.

While entire artworks regularly sell for multiple seven-figures, Masterworks offers bite-sized shares starting at a much friendlier price point. Their art procurement team targets appreciating artists, strategically timing exit sales to private collectors to potentially score outsized returns.

Take a Cecily Brown painting that Masterworks sold for $1.8 million after a couple years – a $10,000 investment back then could have netted you $7,600. Or the George Condo sold for $2.9 million, delivering a 39% annualized return. Not too shabby next to stocks, bonds or even NFTs.

Additionally, contemporary art overall has dramatically outperformed stocks, gold, and housing over the last 25 years for top-tier dealers and collectors. While past performance doesn’t guarantee future results with individual works, the returns and democratized access entice a new generation to speculate on fine art fortunes.

Downside Risk #1 – Art May Lose Value

Of course with fortune also lurks folly. So what hazards hide behind the velvet rope? Firstly, the art market waxes and wanes cyclically. Individual painting prices ebb and flow even more unpredictably than stock index trackers, which is both a blessing and a curse depending on what end of the stick you wind up holding.

So while Masterworks touts appreciation potential by selecting rising stars, nothing guarantees a work increases in value – even branded blue chips can flop. If overall demand drops for an artist, so would the market price, along with your fractional value.

Yet savvy buying at opportune moments can mitigate timing risks. Masterworks vets artwork thoroughly and targets artists with upward momentum backed by data. Still, as with any growth investment, external macro swings or waning investor enthusiasm can dull returns regardless of initial trajectory.

Downside Risk #2 – Liquidity Issues

Another double-edged sword: liquidity, or lack thereof. Remember, an investment is only worthwhile if readily converted to cash.

The good news is that Masterworks offers a secondary market to trade shares, but potential buyers swim in a much smaller pool than public stocks. You must find an interested investor keen on your specific piece. So while Masterworks conducts periodic sales to optimize timing, this also means you can get stuck with illiquid holding shares if you need to cash out in a hurry.

With that said, the market is steadily growing more liquid as fractional ownership’s popularity expands the bidder ranks. And compared to locking up capital for private equity funds or real estate, art shares pose reasonable liquidity relative to many types of alternatives. But limitations exist, requiring patient capital willing to tailor exit timing to market demand swings.

Downside Risk #3 – No Say in Exits

As a minority shareholder, you can’t decide when a prized painting gets sold, relying on the Masterworks experts to time the temperamental art market and execute deals aimed at profitability.

This means placing great trust in the exit strategies, even if you personally become less confident in future price appreciation. While the company generally opts for targeted holding periods between 3 to 10 years, investors must remain patient if their own liquidity needs don’t align precisely with a planned sale.

Yet concentrating the sale authority with specialized art dealers also provides advantages. Their market focus may give them sharper instincts on ideal buy-low and sell-high timing compared to a fragmented ownership group. So while you must hand over some control, the experts may excel at riding the waves and getting you the biggest ROI.

The Verdict?

So does fractional art investing live up to its promises or leave cautious investors unsatisfied? Well, the early returns have certainly caught people’s attention, even considering the risks involved. With crowd-powered models like Masterworks removing traditional barriers, more individuals can now get in the game, securing slices of assets once reserved for an elite few.

While perfectly timing markets proves difficult as always, the seasoned specialists seem to know what they’re doing. Their artist selections and sales strategies appear strategically crafted to maximize returns.

Past performance certainly gives reason for excitement about future possibilities, though of course offers no outright guarantees for prospective buyers. Yet the concept remains undoubtedly an intriguing one – helping bring fine art down from its prized pedestal into practical investment portfolios.