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August 06, 2012

Touch Invest: Wine

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History has proven that there are profits to be made in fine wine investment. The extent of the profitability appears to be largely contingent on the ability to consistently invest in the best performing vintages for the optimum holding period. Like art, the wine market is  buoyant,  overall, the demand for fine wine exceeds supply, which is constantly diminishing as the wine is consumed, and demand from new global participants continue to grow, with data showing annual returns of about 14 % over 23 years from 1998-2011 (Liv-Ex investables index). For many individual investors, it is not a means to make vast profits, but a valuable asset that holds rewards beyond cash.

Touch Wine will provide a potted version of the fundamentals, covering  key issues driving investment returns, intrigue and commentary through community and news, and objective insights for investment decision making. Before diving into the fun part of scenting the market and doing your detailed research, we trust this brief orientation inspires and directs you to good resources to get you started on your journey to building expertise, understanding and knowledge of investing in fine wines.

History and Characteristics
Understanding the deep connection that wine enthusiasts enjoy requires a tour, virtual or otherwise, of the history of the rural areas of Europe where centuries have been devoted to achieving mastery of wine production. Wine investing is like being part of the agricultural, social and frankly the feudal heritage of medieval cities like St Emillion in France where Romans planted vineyards as early as the 2nd century and monks started commercial wine production in the area in the 8th century — living in a hermitage carved into the rock. World famous for its wines, St Emilion has 25 miles of underground galleries within its surrounding areas allowing for perfect wine aging by maintaining a temperature of about 56 degrees (F) all year long.  This early indication of the importance of storage to the optimum wine ageing is a theme which is central to the investment discussion surrounding wine and is a serious consideration for those of us without such advantageous natural surrounds.

From these ancient beginnings, the landscape for the global wine industry is now one of diversity and depth. On the production side, the wine industry spans the globe with production coming from sixty different countries with the top ten producers of wine in rank order being;  France, Italy, Spain, USA, Argentina, Australia, Germany, South Africa, Chile and Portugal. The top five producers of this list account for 60% of global production. Interestingly, the list of top ten countries producing wine according to the vineyard acreage is differs significantly to the previous list of producers and includes Turkey, China and Iran. On the consumption side, the US, France and Italy are the top three consumers while consumption per capita is dominated by Vatican City State, Norfolk Island and Luxembourg.

While the ability to delve into history and agriculture is a major draw for some to the wine industry, the reality is that for the purposes of the Touch Invest coverage, because a vast majority of the world’s wine production is not suitable for investment, we are only interested in a tiny percentage of the total worldwide wine market — some would argue it is only the 1% that represents the size of the investment grade wine market — and of this small sliver, about 80% comes from the classified chateaux of Bordeaux. For this very reason, the focus will be similarly representative peppered with pieces of more general interest for those interested in new vintage wines and the more sensory appeal of investing in wine.

The market for wine from the trade perspective is made up of producers, dealers, chateaux, negociants, retailers, auction houses and online market makers.  The most unique participant of this list is the negociant who are simply merchants that purchase grapes, juice or bulk wine from small farmers, which they then produce, bottle and market on a larger scale under their own label.

Investment Features
Academic writing on the topic of wine as an investment is plentiful and contentious. Relative to the other asset classes Touch Invest covers, the debate over whether or not it is a good investment is heated, and sometimes labeled as a “passion play”. Regardless, the topics most hotly debated for those inclined to become wine investors, are the appropriate storage costs to apply and the before-tax vs. after-tax results of analyses which vastly change the outcomes. Tax policy in the wine industry is an important driver of return discussions with countries like Australia and the UK being favorable and changes to tax policy highly impactful on markets as we saw in 2008 when Hong Kong made a change to remove their wine taxes, which is discussed as a key driver of subsequent market demand from this geography.

The first published study of the returns from wine was written by Krasker in 1979. Krasker was testing returns from wine relative to Treasury bills and considered 137 observations of post 1950 vintages of California Cabernet Sauvignon and Red Bordeaux sold at auction over the period 1973 to 1977.  In short, the conclusion from this paper was that wine is not an especially good investment but he noted that the effect of taxes on investment income makes storing wine a viable proposition for consumers faced with a high marginal tax rate and purchasing only wine they intend to drink. This type of commentary is at the very essence of tangible investing, i.e.,  returns can be more than financial and as such, academic writings which ignore the intrinsic value of the assets are less referenced here for the  Touch Invest audience.

The definition of investment grade wine is unstructured but are generally wines “showing a strong price track record in the established secondary markets of the world vis-à-vis other wines” according to Vinum Assets (vinumassets.com). Investment grade wines also tend to be an improving asset, as these fine wines mature they often become more desirable and more valuable

Characteristics that determine the future value of wine, according to Trellis Fine Wines (www.trelliswineinvestments.com) include:

(i) Pedigree – produced by a chateaux, domaine or producer whose name is synonymous with quality and prestige;

(ii)  Longevity – ability to age for at least 25 years with maturity occurring after the 10th year;

(ii) Price Appreciation – consistent and documented history of substantial price appreciation over a decade or more;

(iv)  Liquidity – made in sufficient quantities to be bought and sold on the secondary market; and

(v)  High Critical Acclaim – a score of at least 95 points by one or more of the principal worldwide wine critics.

Worldwide turnover of wine at auction was a record $478 million in 2011 which is a dramatic rise of turnover from some 90 million USD in 2003 providing proof for the growing popularity of this market (www.winespectator.com). Fine wines from France dominate the investment grade wine market by far and account for 70% of trades and 80% of total turnover at fine wine auctions. (Philippe Masset, Jean-Philippe Weisskopf, November 2010).

In recent years, an increasing number of speculators have been a large factor in driving wine prices up. This can be seen with wine futures where investors purchase the wine while it is still in the barrel, 2-3 years prior to release (en primeur). Futures have improved the liquidity of this investment as has the internet. For example, The Vintage Wine Fund quote updating “buy and sell” prices for each particular vintage. To generate cash flow and improve the quality of their investments they trade regularly with retail customers and collectors with individual requirements.

Properties, regions and vintages
Those considering fine wine investments will no doubt be reading up on the considerable literature and resources available on assessing fine wines. Here we will all but scratch the surface with the help of a summary from Decanter.com, providing some well-known characteristics of the most popular properties and regions:

– Bordeaux

Bordeaux represents 80-90% of the wine investment market and will likely take the lion’s share in any portfolio. The top Left Bank Classified Growths represent some of the bluest of blue chip wines – First Growth clarets like Latour, Lafite, Margaux and Haut Brion; the Super Seconds (a select number of Second Growths) are also a good source of investment potential. On the Right Bank, the most sought after names include Cheval Blanc, Petrus, Le Pin and Ausone. Chateau d’Yquem can also provide solid returns from certain vintages.

– Burgundy

Beyond Bordeaux, a select number of Burgundies qualify as investments. Here, the names to look out for include – Domaine de la Romanee-Conti, Coche-Dury, Comtes Lafon and De Vogue. However, the secondary market for Burgundy is much less developed and therefore much smaller.

– Rhone

The same is true of the Rhone Valley, where wines like Guigal’s single vineyard Cote Roties can sometimes provide handsome returns. Generally though, the Rhone remains undervalued as a region and has yet to really establish its investment credentials.

– Champagne

A number of prestige cuvee Champagnes are also worth considering for investment purposes including Krug, Crystal and Dom Perignon. In recent years, Champagne has proved a very profitable investment even compared to red Bordeaux. At auction, great prestige cuvees continue to command very high prices.

– Italy, Port, the New World – and the Bordeaux cults

Outside of France, investors need to be much more wary. Port is no longer regarded as a good investment bet. Some Super Tuscan wines like Sassicaia can on occasion perform well, as can a handful of Spanish wines. Some Californian and Australian wines have also appeared on investors’ radars, particularly in local markets. However, these generally more modern and less well established wines are more prone to the vagaries of fashion. New and Old World ‘Cult’ wines from California, Australia and Bordeaux ‘garagistes’ are best avoided by those newer and less savvy with the broader array of wine investing.

The Wine Spectator Auction Index (http://www.winespectator.com/) is also a good reference list; the index is a composite of average prices for selected benchmark wines sold at commercial auctions

Risk Return Analysis
The most often quoted source of consistent market data is the Liv-Ex Investables index. This is based on select red Bordeaux wines from the leading 24 chateaux (Rated 95+ points) and calculated back to January 1988. According to Investment Grade Wines (www.igwines.com), during the period January 1998 until February 2011 the index has grown 2074%, representing a CAGR of about 14% over 23 years. The index showed strong resilience to the 2008 market crisis, returning 96% since December 2008 at about 36% CAGR and regaining the 20% drop it saw from August 2008 to December 2008 in 13 months.

Analysis conducted by Touch Invest Founder and colleagues at SAID Business School (Oxford University) shows wine to have an average return of about 9.5% over the twenty years from 1984 to 2004 with standard deviation of 14%, reflecting volatility of approximately 3 percentage points above the US stock market. Through this same analysis, very little correlation was found with macro factors with only US interest rates showing any influence of note on fine wine prices.  Additionally, we found correlation with other tangible asset classes and the US stock market to be negligible with the exception of silver. As such, wine appears to be a decent diversification tool within a portfolio. That said, fine and rare wines are just as prone to falling in-and-out of vogue, and while wine prices seems to be uncorrelated with the financial markets, they are influenced by the overall state of the economy.Between 2005 and 2008, which some called the “golden age for wine”, the price of wine essentially doubled. According to Philippe Masset, Jean-Philippe Weisskopf in a report for the American Association of Wine Economists, (Raise Your Glass, November 2010) the result of the global financial crisis was a drop in wine prices of around 17% which was a far more moderate drop than their comparison point of the Russell 3000 which lost 47% in the same period. The data for their study came from The Chicago Wine Company (TCWC) and included all auction hammer prices between January 1996 and March 2009. Their methodology was to construct wine indices for various wine regions and prices and their findings included “that wine yields higher returns and has a lower volatility compared to stocks especially in times of economic crises.”  They also found the risk to holding wine, measured as the annualized standard deviation of returns, to be lower (8 percent) than the risk associated with holding equities (15 percent). In a nutshell, their findings show that the inclusion of wine in a portfolio and, especially more prestigious wines, increases the portfolio’s returns while reducing its risk, particularly during the financial crisis.

As the wine investment market is largely unregulated, it is important to research and find the reputable, well-established fine wine merchants and proven investment funds, or wine investment companies before you begin.

Buying and Selling
As you begin to build and create your portfolio, many find it helpful to look at wine indexes and cross-reference against wine auction catalogs, such as Acker Merrall & Condit, Christie’s, Sotheby’s and Zachys. If analyzing ratings and reviews, thinking about formats and quality, is a bit daunting at first, newer investors can also leave the bottle selection to the experts. Some wine merchants can tailor a portfolio depending on how much you want to invest, your preferred risk profile and how long you want to invest. The International Fine Wine Investment Community maintains a listing of wine merchants to help you find your wine-trading partner in your country (http://www.ifwic.org/directory)

–Time Horizon

“It takes 15 years to make a vineyard, harvest the grape, make the wine and bring it to the table at three or four year old.” (Great Bordeaux Wines, Enjalbert, 1983). This long production cycle is reflective of the patience required and importance of provenance within the wine industry when seeking the best returns. Investors should mimic the masters of production and are advised by industry experts to take a long term view of 7-10 years.

Those who do not require liquidity for the next 2-3 years, can buy wine en primeur, which tends to help maximize the investment. Alternatively, another good opportunity to buy wine is when the en primeur bottles are physically released onto the market – e.g., in September 2011 this is wine from 2008. Analysis seem also to suggest not buying in May, but wait until September as over the summer months the prices of most of newly released Bordeaux wines tend to drop a little.

Those choosing to buy already-bottled wine, should focus on buying full, undamaged wooden cases of excellent quality wines only. Standard bottle formats are the easiest to sell, so the best choices are cases of 6 x 0.75l or 12 x 0.75l, but 0.375l bottles in cases of 6 or 12 are highly desirable too.

–Liquidity

Wine is relatively liquid with many options for purchase and sale and an innovative and vibrant trading environment. It is estimated that there are about 300 wine auctions in total worldwide and the important auction seasons are in spring and fall. While the market is considered by some to be relatively thin, with only 30 to 40 consignors selling wine to between 100 and 150 buyers at auctions, there are a vast number of venues for entry and exit into the market online. This makes it a good market for newcomers from a purely logistical and accessibility standpoint, but it doesn’t make for an easier investment decision.

Wine funds (e.g. Elite Advisers Wine Fund, Wine Asset Managers) and indices (e.g. Liv-Ex in the U.K. or iDealwine in France) have emerged over the past decade to cater for new demand from investors. The resulting improvement in transparency and liquidity has rendered this market even more attractive for investors.

–Associated Costs

The practicalities of investing in wine include auction and/or agents’ commissions that are approximately 10-15% of the buying and selling prices. Those selling at auctions may also have consignor fees to consider. Most serious collectors now outsource their storage to ensure wine is stored in the best possible and appropriate conditions. It is important to note that many external storage providers also have the capability to handle any bonding (excise and customs) requirements while insurance costs and any required transportation and delivery can generally be included in the overall fee charged (e.g. typical storage fee $12-16  per case per annum).

In some countries like the UK, wine is regarded as a wasting asset so doesn’t attract Capital Gains Tax. (However, as this area of tax law is complex it is best to take advice from a tax lawyer or tax accountant.)  It is possible to avoid extra costs such as duty and taxes by buying wine “in bond” and storing in a bonded warehouse. By buying wine “in bond” you will be buying it at the lowest possible price at that moment in time. Wine stored in bond tends to be most desired by wine merchants, and the easiest to sell. History has proven that there are profits to be made in fine wine investment. The extent of the profitability appears to be largely contingent on the ability to consistently invest in the best performing vintages for the optimum holding period.  Like art, the wine market is currently buoyant, following strong demand from new global participants, with data showing annual returns of 14.26 % over 23 years from 1998 -2011 (Liv-Ex investables index).

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