Preston Pysh  1:30  

So Scott, we’ve covered many types of investments here on The Investor’s Podcast, but art is clearly a new frontier for all of our listeners. I personally know so little about this topic, and I find it quite fascinating. Talk to us about how you got started in this sector of investing. I am super pumped to hear how you respond to this.

Scott Lynn  1:51  

I think like many collectors, I first started collecting art really out of passion. But like many collectors, I have made a lot of mistakes along the way and then eventually learn that art could all be an investment. From our perspective, we see this asset class, which is really enormous. If you listened or read any of the statistics on art as an asset class, the lawyer estimates that there’s $1.7 trillion in fine art in between ultra high net worth collector’s homes. 

There’s $50 billion to $60 billion a year they sell in terms of volume. There’s 2% to 3% turnover. It is a very interesting investment. But the problem with it, and we hear this all the time is that the only way to participate is if you have a couple of million dollars by payment. So it’s this really unique outperforming asset class that really nobody can afford. Unless you have a lot of money to acquire the art. We think it’s a natural asset class to be securitized.

Stig Brodersen  2:38  

You made such an interesting leap. You collected art. *inaudible* to [those] very interested in art. You could say that about a lot of people. I would say you took that one step further. I guess you took it like a mile more than anyone else. Could you talk to us some about that thought process? How did it become an idea and how did it turn into what it is today? 

Scott Lynn  2:59  

My background [has] really been in certain tech companies and at the same time, collecting art. My approach was really how to productize this from a tech perspective to make it accessible to all types of people. I think that’s probably the unique perspective. Most people in the art community are not tech people. Most tech guys I know are not our people. So that’s maybe the unique perspective that we bring. 

At a very high level, some of the correlation studies have been done. One that we like to cite a lot is a Citibank study from 2015. For the CIO at Citibank, private bank concluded that individuals should allocate between 1.4% and 4% to art, depending on what percentage of their portfolio they hold into liquid. I think a lot of that conclusion is really just based on two factors. 

One is that the asset class overall, just the fine art market overall, independent of the blue chip segment has outperformed the S&P for the past 20 years by 180%. The second thing that I think is important is that it’s really an uncorrelated asset class. So if you look at the .com bubble bursting in 2000, the art market actually increased over that period. The highest correlation to a financial crisis at the art market was actually in 2008 to 2009. 

When the market fell or the S&P fell 58%, the art market declined 26%. That had roughly a correlation factor of .5. But in general, the asset class is uncorrelated to almost all other asset classes, which we find very interesting when taken in context of its outperformance as well.

Stig Brodersen  4:24  

Why do you think that is the case? Typically, whenever we’re talking about cycles and economic markets, you would say that there are some goods that you would need regardless of the economy. Fine art seems to be an asset class you definitely don’t need. It’s something you don’t need when you need money and the economy is bad.

Scott Lynn  4:45  

Yeah, I think there’s lots of art history majors running around that might disagree with you on that. But in general, I would agree with you. We don’t actually know what drives our prices. There’s lots of academic or theoretical conversations we could get into on this. But the one hypothesis that we have is that our prices are correlated to “ultra ultra wealth creation” around the globe. 

Whether you talk about that in terms of growing inequality or however you want to characterize that, it does seem like that’s what it’s probably most closely correlated to. We have an ongoing research project right now. We’re trying to prove that but we haven’t yet concluded it. It is a global market. So I think the latest stats on the industry show that 40% of the art market is in the US, 20% is  in the UK, and 20% is in China. The rest is primarily Western Europe. So at this global market of people with multimillion dollar art collection that are effectively trading, $1 million, $10 million to $50 million paintings between each other that really drives the market. 

The easy way to think about the art market is probably to think about it in two different components. One is the primary market. I would think of just the primary market as being paintings that have never been sold before. These are usually living artists represented by galleries. That’s really a different segment of the market. The one Masterworks focuses on is the secondary market. These are paintings that have been sold multiple times that are usually by artists that are no longer living. 

We tend to think about the market in those two ways. Within the secondary market, that’s what we refer to as this blue chip segment, which is roughly 60% in terms of dollar value of the art market overall. This blue chip segment tends to be from household brand name artists, sort of like, Picasso, Monet, Warhol, Basquiat, and etc. These are usually the names that you’ve heard of. That primarily is Masterworks’ focus, but that’s a very high level way to think about the market.

Preston Pysh  6:24  

Scott, talk to us more about this blue chip art that you speak of.

Scott Lynn  6:28  

When we refer to the term, “blue chip”. This is a term that a company called, ArtPrize has created. The works referring to the top 100 artists by sales or the top selling artists tend to be from our perspective, the most interesting risk-adjusted returns in the art market. It means that the volatility if you invest in a blue chip painting is relatively low or very unlikely that your investment would ever go to zero. They provide relatively steady returns. These are paintings that can return 8% to 15% a year, somewhat predictably without taking a lot of risk. So to us, that’s the segment of the market that can be most institutionalized and is the most interesting. 

So, very high level, we talked about “ultra wealth creation” on a global basis that’s happening in countries outside of the US, as well as in the US. Independent of that, there’s this very interesting dynamic in the art market that’s almost unlike any other asset class where you have a continual decline in terms of supply on an artist by artist basis.

One of the things that you see in the art market is if you take well-known artists like Jackson Pollock, for example. Pollock in his lifetime created hundreds of drip paintings that he’s well known for. But there’s only 20 something of those drip paintings that are left in private collections today. The reason that supplies declined is because after collectors have died, or after they’ve decided to pass on their collection to museums, the number of artwork available in private collections just continues to decrease. 

So although Jackson Pollock is a well known brand, and a well known artist, the number of paintings that are available for purchase continues to decline every year. So in part, I think that [the] continuously declining amount of supplies is what drives prices up as well. I would think about taking into the art market as being broken into Old Masters, Modern Impressionism, Post-war, Contemporary was kind of the primary segment. 

We did this research piece in our research center at Masterworks where we looked at returns by segment of the market and we looked at volatility to effectively create a Sharpe ratio. It’s interesting what you find when you look at those different segments. One of the things that surprises people most often is that if you just very generally speaking were to purchase a Rembrandt today, a very well known Dutch artist, it would be unlikely that you would actually make money on that painting if you held it 10 or 20 years. 

Part of that is because in the art market, we see and taste change over time. Right now, most of the people that are net new buyers are interested in buying Contemporary Post-war painting, while some Modern Impressions and paintings. But they’re not really interested in buying Old Masters. We’re just not really seeing any appreciation in that segment of the market.

Stig Brodersen  8:57  

You mentioned that your preferences change. How do you predict that? I guess as an art buyer, you need to know what the change in preferences are before people know it.

Scott Lynn  9:07  

I think that’s right. As a buyer, or I guess as an asset manager, look at those trends. We look at the trends and appreciation rates. Artists that are sort of moving into this blue chip segment. We look at trends and depreciation rates, or artists that are moving out of this blue chip segment. We try to predict that. 

The good and the bad news about the art market is that nothing ever happens fast. Unlike the technology industry that I’m used to, you can see changes overnight or changes within a number of months. We don’t really see that in the art market. All these trends occur on a compounding basis over a number of years. 

Those are the trends that we watch to try to figure out how different artists and markets are changing, or how the market overall is changing. Primarily, liquidity comes from selling the painting to another private collector. That’s the number one thing that drives liquidity. We work with investors to help them sell their shares at times, if we need to get out of the investments. But people generally should think of this as a seven-year investment. It’s an illiquid investment, but they allocate [a] single digit percentage of their portfolio, too. They don’t really expect to have access to that until the end of the life of the investment.

Maybe let’s walk through the flow of lines of how we think about acquiring a painting and then ultimately liquidity. We’ll go out and we’ll acquire a painting with $10 million of our own balance sheet capital. We will then file that painting with the SEC to go public. And going public process is very similar to how you would think about taking a company public effectively, and that’s one equivalent. 

Once the painting is public, we then sell shares in the painting. At anytime after that, the collector can come and make an offer to buy a painting. And if the painting sells, the proceeds are distributed to those shareholders or investors. A lot of people don’t realize this, but the art market is very similar to the real estate market. A huge portion of art sells through public auction. 

There’s millions, most likely public comps that have been tracked over the years within the art market. I think in fact, one of the things that we tend to focus on are paintings that have sold two or more times the public auctions, so we can understand the appreciation rate or depreciation rate for particular objects. There’s been 60,000 times that the paintings have sold two or more times at auction. 

So there’s this really huge deep data set in the art market that helps us understand trends and value for a particular artist for a particular period. So when we’re looking at acquiring a painting, we’re looking at historical comparable paintings that have been sold by the same artist of the same style that are roughly the same example to try to understand how [have] paintings similar to ours appreciated collectively. How do we think our painting is appreciating historically to try to predict future appreciation rates.

Preston Pysh  11:28  

Scott, talk to us about risk. Here on the show, we always talk about protecting your downside risk first. And then if you purchase an undervalued asset, the upside will just take care of itself. So, as we consider the downside, what causes an art market to crash?

Scott Lynn  11:45  

People have been collecting art for thousands of years. The biggest crash in most recent history was the early 1990s with the Japanese sell-off. That was the most significant crash. But recently, other than the financial crisis, we haven’t really seen any significant downward movement in our prices. What we do see, and I think it’s one of those much more common, is we see specific artist’s markets decline rapidly. 

For example, one artist that we’ve really seen decline just from a market perspective is Damien Hirst. Damien’s paintings or sculpture [have] really declined in value over the past 10 plus years. I think we do see it on a particular artist’s basis. But other artists, conversely, like, based on all the data we have now, Monet, in particular, we see a very low likelihood that his painting declined in value. When we look at all of the paintings that we have by Monet that have sold two or more times, we only see a 3% chance that Monet has ever declined in value based on the second sale. That’s a very interesting data point. 

I think, within this blue chip segment, overall, we really view art as a very good source of value. So far, in declining in value, it’s declining 10%. Maybe it’s climbing 20%. But 50% declines or 100% declines are just very uncommon. 

We think [a] portfolio of art makes sense just like a portfolio in most asset classes makes sense. It is interesting. I mean, when we look at the blue chip segment, we don’t see a huge standard deviation in terms of returns by artists. We might see a range of return somewhere between 8% and 15%. That’s large, but it’s not like we’re seeing 1% to 40%. So there is a reasonably narrow band within this blue chip segment of returns. I guess we tend to focus on that.

Stig Brodersen  13:28  

Could you please tell us a personal story where you’ve been wrong and where you’ve been right about art valuation. What did you learn? I’m sure you have quite a few. 

Scott Lynn  13:38  

I have quite a few. I think one of the things that new collectors often get wrong and I’ve seen this many times over. It’s definitely *inaudible* itself. New collectors tend to focus on the artists themselves and not the examples by that artist. 

Let’s take an artist like Picasso who created over 50,000 objects in this lifetime as an example. When I was first collecting, one of the things I did is that I went out and bought this whole lot of Picasso’s ceramics from one of his neighbors in France. I can’t even remember the number I acquired. I think it’s something like 100 ceramics by Picasso. They’re in all these crates packed with straw. 

I remember receiving a letter about *inaudible*. I’m thinking that long term, this would be a great investment. The problem with that approach really is that if you look at the Picasso’s ceramics, they’re addition. They’re made in massive additions. He was maybe involved with it, but wasn’t intimately involved with the creation of those ceramics. So they have his name on them, but they’re not really that unique. It was not that special. Collectors of Picasso would certainly not aspire to one day own all of Picasso’s ceramics. 

I think that was a good lesson. Having all these objects by very random artists but not having any particular object be necessarily that good. Therefore, those objects are not really appreciating that much in the future. I think if you look at the value of Picasso ceramics today, they’re probably very similar to what they were 10 or 20 years ago. They haven’t really changed that much.

Preston Pysh  14:54  

Alright, so Scott, let’s also give you an opportunity to talk about one of your really good purchases.

Scott Lynn  15:00  

Yeah, for better for worse, I’ve had lots of stories. I had a ’76 to ’77 de Kooning, which in good news, one of the more important American artists. Woman I was arguably the most important painting in American history. I acquired this painting from *inaudible* a number of years ago. I’ll get these numbers specifically wrong so don’t quote me on this. But I think I acquired that painting for $7 or $8 million, and then came close to doubling the value on that in about two years. I sold it shortly thereafter. 

There were just a whole bunch of reasons. But that was the right time to acquire that painting and then the right time to sell it. There are opportunities like that that exists in the art market. I mean, we don’t certainly guide investors to think about those types of returns with our products. But they do exist from time to time.

Stig Brodersen  15:46  

What is a good return? I know you talked before about risk adjusted returns. We talked about [how] the asset class is different from what we usually talk about. Keeping in mind the types of risk we incur, what is [a] good return in the art market right now?

Scott Lynn  16:02  

I think it depends on the segment of the market you’re talking about. So for example, if we go back into my earlier comments about the primary market versus the secondary market, there’s a lot of people that just invest in the primary market for new artists, living artists that are looking for 30% to more than 100% returns. That’s a very speculative game. But a lot of those artists also have a high probability of going to zero as well. 

But to us, this is just a very interesting risk-adjusted asset class where you can theoretically outperform the market without taking much risk, or at least less risk than how we view developed equities. The art market is funny and a little bit hard to predict. It’s always collectors who are purchasing these painting. A collector usually has a very specific collection that they’re focused on building out. So for example, personally, I have this very specific collection of post-war artists from 1946 through the early 1960s. I’m always looking for one or two artists to kind of round out that collection or compliment it because my focus is really on building that collection.

Preston Pysh  17:01  

Scott, I’m assuming most people listening to this are like me, and have a very limited understanding of art investing. What would you recommend for them to become better informed about the methodology?

Scott Lynn  17:13  

It’s a good question. I mean, I will point you back to www.masterworks.io. to our resource center. We’ve assembled for investors, one of the most comprehensive resource centers of all third party resources as well as internal research that we published. It really helps. I think people think about the art market holistically and from a very high level before deciding to purchase a painting or to begin collecting. 

That’s where I would charge and then there’s a whole host of other websites like Artnet, or ArtPrize that allow you to research specific artists or comparables by different artists, or to look at historical auction records and really dive into the data. The advice that I would give myself and the advice that I give all new collectors is focus on the example, not the artist. Usually, if you look at the data that one particular object that’s an “A” object for that particular artists will always appreciate much faster than the third tier object by the brand name artist. That’s the one piece of advice that I would stick to.

Stig Brodersen  17:51  

It’s so overwhelming whenever you enter a new asset class. You don’t know where to start. You don’t know where to stop. You don’t know who to trust and who to not. How do you filter out all the noise? If you can outline perhaps some of the first few steps you would take as an investor.

Scott Lynn  18:10  

That’s a really great question. Let’s step back from that question a little bit and talk about kind of the evolution of how the art market has gotten to where it is today. If you go back to the art market in the US, in the ’50s, or in the ’60s, a lot of the decisions around what is great art were controlled by critics. People with the last names like Rosenberg, or Clement Greenberg, etc. They were really the tastemakers in the art world. 

Today, that critic culture has died out to a great extent. It’s really been replaced by galleries or dealers who decide what is good art. But they also have a financially vested interest in making that determination. So it definitely is a messy and difficult to understand industry for someone entering the art market today. 

My best advice on navigating that, unfortunately is probably to still work with people you know or to trust advisors. Rely on maybe the auction houses more so than the big dealers if you don’t have comfort with the dealer. Auction houses tend to be a bit more transparent in their approach. It is a difficult industry to navigate if you know nothing about it. 

There’s a concept in traditional industries where if you are giving advice to someone to purchase something, then you are effectively a fiduciary. You have an obligation to inform your client how much money you’re making, for example. That dynamic does not exist in practice in the art  industry, whether or not a lot of dealers do have a fiduciary obligation is somewhat debatable. But in practice, dealers don’t really subscribe to that concept. 

I do think it’s very important that people be very aware that those that are recommending purchases or those that may have a financial interest in transactions will probably not disclose that. It is sort of the buyer beware dynamic. I think anyone new approaching industry should be careful with that.

Preston Pysh  20:00  

One of the things I found really interesting is in the Citibank report, you reference. There’s a huge spike in the Chinese market when it comes to art. Why do you think that we’re seeing this now? How does that change anything?

Scott Lynn  20:13  

China has been a huge net contributor to the art market overall. We think it is a permanent change in the art market. You’ve seen most large galleries in New York open up in Hong Kong. There’s a huge Chinese collector base that’s just coming rapidly into the market. We don’t see that slowing down anytime soon. We have seen historically in the art market, other countries kind of come in and move out. 

Russia, for example, used to be a large overall percentage of the art market. Most of the money in Russia has been collecting sort of these very expensive paintings. [They] are no longer doing that. 

So we have seen that trend, but we definitely don’t expect to see the Chinese market decline anytime soon. I mean, there’s just so many new billionaires being created in China every day. A lot of those people are very interested in [the] contemporary art scene, in particular. We don’t really see that trend changing anytime soon.

Preston Pysh  21:01  

Thank you so much for accepting our offer to come on the show. This was such a fascinating topic. It is just completely out of anything that Stig and I have covered in the past. If anybody out there listening to this wants to learn more about you and your company, where can they look?

Scott Lynn  21:18  

The best place is our website, which is www.masterworks.io. As I mentioned before, there’s a great resources center on the website that has lots of third party content, as well as content that we created and researched on art as an asset class. You can also sign up and invest directly from the website as well.

Stig Brodersen  21:34  

Thank you, Scott. Thank you so much for your time to come here on The Investor’s Podcast and talk to our listeners about collecting art. 

Scott Lynn  21:41  

I really appreciate it. I hope to be back soon. 

Stig Brodersen  21:44  

All right, guys. That was all the Preston and I had for this week’s episode of The Investor’s Podcast. We’ll see each other again next week. 

Extro  21:51  

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