Fancy investing in a wine fund?

A new wine fund is being launched to take advantage of wine as an asset class.

I do not believe it handicaps FranceÆs image that some of its most famous grand crus are priced as if they were objects of art... Each year more informed and wealthy individuals with sufficient discretionary income enter the world marketplace and desire to have the very best. It is a question of supply and demandà. prices for the top wines will continue to skyrocket.ö These are the words of Robert Parker in 2005, currently the worldÆs most influential wine critic, and concisely summarises the attractiveness of the fine wine market from an investment perspective.

The fine wine market used to be almost entirely the preserve of the French, but now encompasses wines from Spain, Italy, the USA, Australia and others. However, for the sake of investment the French still dominate, most notably through the red wines of Bordeaux. This is due to the large scale of production and longevity of the wines of the top chateaux, characteristics which lend themselves to a buoyant secondary market and capital appreciation. Bordeaux boasts a host of the most famous fine wine brands in the world, including Lafite Rothschild, Mouton Rothschild, Latour, Margaux, Petrus, Cheval Blanc and others.

An investor who knew which fine wines to buy from which vintages and what price to pay would have made excellent returns over the years. This is borne out by the performance of fine wine compared with returns from more conventional securities (see chart).

Since the early 1990s investment across a selection of grand vins and vintages will have yielded attractive double digit returns. It is also noticeable that the performance of fine wine is usually less volatile than investing in equities and has low correlation to the performance of other asset classes, providing genuine diversification. There has been a gradual increase in alternative investment funds as investors look to diversify away some of their risk. Fine wine is a luxury good, and the market offers greater protection against economic downturn whilst the upside potential is very strong.

However, those looking to tap into this performance may not know how to go about it. The wine market is fragmented, and picking which wines to invest in and knowing who to trust can be a daunting task to the uninitiated. Wine Asset Managers LLP (WAM), based in the UK, has created the Fine Wine Fund, a scheme established as an association of members that will invest purely in fine wine, to allow prospective members to benefit from expected returns without having to do their own research and deal with the administrative headache of wine investment.

WAM has been set up by Miles Davis and myself, both of us having spent several years in Hong Kong in the 1990s. We both have a background in the financial services industry, specialising in investment funds and analysis respectively. We have both been investing in wine over the last 10 years, with sufficient success to convince us that there was a large gap in the market for a professional wine investment vehicle.

We are joined by Steven Spurrier, the highly acclaimed consultant editor of Decanter magazine, who has agreed to act as a consultant. WAM believes the combination of capital market discipline, in-depth wine knowledge and strong industry contacts will provide a powerful vehicle through which to invest in fine wine, whilst authorisation by the Financial Services Authority (FSA) in the UK provides the required assurance to investors in an otherwise unregulated industry that has had its fair share of scams (recently Mayfair Cellars).

The strong performance of the fine wine market, which for our purposes here refers almost exclusively to the top chateaux of Bordeaux û with peripheral interests in the trophy estates of Burgundy, the Rhone Valley and Champagne û is expected to continue in the long-term.

The fundamentals are straightforward. Demand from the established Western world is ever-increasing, whilst there is strong new demand from the emerging business elite of countries such as China, Russia, Korea and India. This is set against an environment of strictly finite supply of grand crus wine, as the old vineyards are fully planted, whilst their production areas are legally restricted by the cru classe classification in the Medoc and St Emilion. Production is also naturally limited as only the very best grapes of each harvest are used in the grand vins so as not to compromise quality. As supply is fixed, only the price can absorb the heightened global demand. There is sufficient competition amongst the elite brands to ensure the highest quality is maintained, and a consistent drop in standard would have disastrous consequences for the offending chateau.

It is just as important to stock-pick in the fine wine market as it is when investing in conventional asset classes such as equities. Blanket investment in a particular producer or vintage will not provide the optimum returns. The brand and the vintage are vital, providing the required liquidity in the secondary market, but it is also essential to analyse the price and the rating of a wine in assessing its potential as an investment. WAM has an extensive databank and an expertise in financial analysis that allows it to identify the best investments in the market.

Timing is equally important. It has become normal for fine wine enthusiasts to buy an increasing amount of their wine in the en primeur market. This takes place about nine months after harvest when the wine is still in barrel, and some eighteen months before the wine is bottled, and allows producers to benefit from improved cashflow by selling wines early. (The greatly hyped 2005 en primeur campaign in Bordeaux probably has not escaped the attention of most readers). There is therefore a ôfuturesö element to the purchase, as the wines are young and there is a little uncertainty as to the eventual quality of the wine. In the 1980s, en primeur buying will have provided a strong return on the good vintages. However, the 1990s were characterised by a growing tendency for the Bordelais to try to exploit the increased interest from speculators by substantially increasing the price at first release. Analysis shows how investing in en primeur over the last decade will have yielded low or negative returns, depending on the vintage, especially after taking into account the opportunity cost, which in this case is the cost of cash.

WAM believes that purchasing in the secondary market now provides a less risky and more sensible approach to investment in fine wine. The drinking life of a wine will vary between producers and vintages. One of the main investment strategies for the Fine Wine Fund will be to buy wines that are about to or have recently entered their drinking lives. As supply starts to diminish rarity value increases, and this continues throughout the drinking life of the wine. Like other asset managers, WAM will also look for anomalies, which are commonplace in the fine wine market due to the lower liquidity and the less disciplined approach to wine purchasing. Relative valuation analysis on a vertical (single chateau over all the vintages) and horizontal (all the chateaux across a single vintage) basis allows WAM to consistently identify and exploit the valuation gaps, which tend to reduce or disappear over time, only to be replaced by others. This provides a constant cycle of investment opportunities.

Most people who invest in wine tend to go through their wine merchant, where at times bid/offer spreads can be discouragingly large ie, the different price at which the merchant will buy or sell the wine. When selling a wine on someoneÆs behalf the merchant will often charge his private client a 10% selling commission. As a market counterparty, WAM will be able to substantially reduce these costs, which will more than justify the management fees. As a non-merchant, WAM also provides independence. Given that merchants take on their own stock, there could be a conflict of interest where wines are intended for investment, although far less so where wines are intended for drinking. WAM believes that its status as an independent and financially regulated entity gives would-be investors peace of mind in this area that might not otherwise be there. The fund will be operated by a professional fund administrator and the stock will be completely ring-fenced for the members, providing security in the unlikely event that anything should happen to the asset management business.

The scheme will be set up in such a way as to effectively give each member co-ownership of a fine wine cellar.

When wines are fully mature and ready to be sold from the fund, the manager intends to offer the wine to its members first before offering them to the public.

This could be a nice way to access wine that might otherwise elude them, financed through profits made by their investment. The Fine Wine Fund wants its members to enjoy the fruits of fine wine both financially and literally.

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The above article is reproduced from the Summer issue of Asian Private Capital, a supplement to FinanceAsia magazine.
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