Hedge funds aren’t what they used to be. They used to be exclusive investment vehicles where wealthy investors could generate double digit alpha with very little correlation to the major market indices. Nowadays most hedge funds don’t deliver uncorrelated returns at all and they generate minuscule returns after fees and expenses.
I am not saying that all hedge funds are bad. Our flagship strategy focuses on the best stock picks of the top 100 hedge funds (out of nearly 1000 hedge funds tracked by Insider Monkey) and has been able to outperform the market by around 40 percentage points since its inception in May 2014. By tracking the best performing hedge funds we’re still able to identify extremely attractive priced stocks (see our latest idea, a growth stock trading at less than 3 times its core earnings), but our strategies are highly correlated with the market.
Long-term bonds are doing very well this year as long-term interest rates hovering around their all time lows. iShares 20+ Year Treasury Bond ETF (NASDAQ:TLT) returned 20% and iShares 7-10 Year Treasury Bond ETF (IEF) returned 11% this year. However, this means that going forward 10-year and 30-year treasury bonds will probably deliver negative real returns (i.e. the actual returns will be below the inflation rate). Rational investors are buying these bonds only because they expect/hope to sell it at a higher price to an irrational Fed at some point in the future. That’s not how we invest.
Gold investors also experienced very strong returns this year. SPDR Gold Shares (NYSE:GLD) returned close to 20%. This year gold prices were positively correlated with the market but over the long-term the correlation coefficient is not much different than zero. The problem with gold is that it isn’t a good long-term investment. Last year Warren Buffett compared $10000 invested in gold vs. an S&P 500 index fund in 1942. Buffett said that index fund investment would have become $51 million whereas gold investment would be worth only $400,000.
I don’t know why Buffett specifically picked 1942 as the starting point but gold investments have been underperforming the market since 1979, 1989, 1999, and 2009. Gold prices appreciated by 4.7% annually since 1979, 4.6% since 1989, 8.7% since 1999, and 3.3% since 2009. These figures are slightly above the inflation rate. Annual inflation rate averaged 3.2% since 1979, 2.4% since 1989, 2.2% since 1999, and 1.7% since 2009. So, over the last 40 years gold outperformed the inflation rate by 1.3 percentage points annually.
I came across a groundbreaking investment idea for hedge fund, fixed income, and gold investors: artwork by blue-chip artists. A New York-based startup called Masterworks now allows people to buy shares in artwork by blue-chip artists like Andy Warhol. Before getting into the details, let’s take a look at the returns generated by this type of artwork.
According to the art market information website Artprice.com, an index of 100 blue-chip artists returned around 9% annually since January 1, 2000. Artprice.com’s Artprice100 blue-chip artist index also gained 4.3% in 2018 and 16% during the first half of 2019 (see the graph below).
I interviewed Masterworks’ founder Scott Lynn and asked him about the blue-chip art market. “High-level, blue-chip is art created by the top 100 selling artists (in terms of transaction volume). This accounts for the majority of the art market, but excludes unimportant, emerging, or mid-career artists. Citibank did the first correlation study on the asset class in 2015. You can see their correlation factors in that report. We’ve also done an updated one with Art Market Consultancy (the same firm Citi used) to bring that data up to date. Essentially, art is uncorrelated with other asset classes,” he said.
According to Citigroup’s report, the correlation coefficient between the stock market and the art market is only 0.11. Given its high single digit annual return and low correlation with the stock market, it is no wonder that art market is an attractive investment vehicle for affluent investors.
We also asked Scott Lynn about gold. Here is how he explained why he prefers art over gold:
“We do not believe gold is a strategic asset class for various reasons. Our research team has not done an analysis to determine which is a better hedge against inflation. Similar to gold, art is a currency hedge since it can be moved across borders easily. Unlike gold which has an increasing supply (as more gold is mined), the supply of blue-chip artwork is constantly declining as paintings are donated to museums. We believe this decreasing supply is one of several factors that is causing art prices to increase.”
Ordinary investors can’t easily invest in blue-chip art. One way to get some exposure was to buy Sotheby’s (NYSE:BID) stock but French media tycoon Patrick Drahi is in the process of taking over the company for $3.7 billion and that’s understandable. The supply of blue-chip artwork is indeed constantly declining; at the same time the number of ultra rich people who invest in art seems to be increasing at a breathtaking rate.
One of the countries that produced several billionaires in recent years is China. When I look at the list of the top 100 blue-chip artists in Artprice’s index, I see Picasso, Warhol, and Monet among the top 3. However, Chinese painters QI Baishi is at #4, ZAO Wou-Ki is at #7, FU Baoshi is at #8, and WU Guanzhong is at 12th spot. I’d be lying to you if I told you that I heard off these Chinese artists before. I believe that as the number of billionaires in the world increase, we will see further price appreciation in the art market.
Now Masterworks is providing ordinary investors with the option to invest in this flourishing corner of the art market. All you need to do is to go to Masterworks.io and register. Masterworks already purchased Warhol’s “1 Colored Marilyn reversal series 1979” for $1.815 million in November 2017, filed it as a qualified security offering with the SEC, and now selling 99825 shares at a price of $20 per share. Ordinary investors will be paying a 10% premium to the 2017 auction price, but in my opinion this is a deal because the appreciation rate in Warhol’s artwork in the last 2 years is probably north of 25%. I say this because Artprice.com whose Artprice100 Index appreciated 4.3% in 2018 and 16% during the first half of 2019 (cumulative gains of 21%) said the following about the strong performance of its index:
“However, Andy Warhol, Fu Baoshi, Zao Wou-Ki and particularly Wu Guanzhong have all clearly enjoyed value accretion, providing the main thrust for the progression of our Artprice100© index in H1 2019. Without setting any new auction records, these artists have all enjoyed strong price inflation. The sale of major works by these artists will no doubt confirm the trend.”
This implies that the appreciation in Andy Warhol is even more than the average appreciation of 16% this year because the index includes other artists like Pablo Picasso whose paintings are estimated to lose 2% of their value this year. So the value investor in me is telling me that investors are paying Masterworks 85 cents for a dollar worth of Andy Warhol’s 1 Colored Marilyn reversal series.
Masterworks’ business model is similar to the private equity model. They are working hard to buy blue-chip artworks at attractive prices to earn their fees. “Our fees (1.5% per year plus 20% of future profits) are inclusive of insurance costs. So in the case of something being stolen or destroyed, investors are covered,” Scott Lynn said. Investors looking to buy shares of Warhol’s artwork should know that these are long-term investments. “Our intention is to own the Painting for a five- to ten-year period, although we may elect to hold the Painting for a longer period or sell the Painting at any time due to certain circumstances. … The Painting is effectively perpetually available for sale following the Offering. If any person makes a Bona Fide Offer (as defined in our operating agreement) to purchase the Painting at any point in time, the Administrator will submit such offer to a vote of the then holders of our Class A ordinary shares, excluding any shares beneficially owned by Masterworks (“voting shares”) and if holders of a majority voting shares vote in favor of accepting such Bona Fide Offer, we will accept the Bona Fide Offer and sell the Painting,” read Masterworks’ offering statement on the SEC’s site.
One cool benefit of owning fractional shares of Masterworks’ artwork holdings is that investors will be able to view these paintings at a gallery a in New York City at Broome and W Broadway (497 Broome).
I believe Masterworks’ offering is a groundbreaking investment idea for long-term investors who are looking for low correlated high single digit returns. Ten year treasury bonds currently yield 1.5%. This means if you invest $10000 in 10 year treasury bonds, you will get $11600 in 10 years. Incidentally this is the same appreciation rate as Artprice100 Index in just the first 6 months of this year. Currently, investors can take advantage of the large appreciation rate in Andy Warhol’s artwork by buying fractional shares through Masterworks at a 15% discount by our calculations.