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February 4, 2011updated 10 Jan 2016 3:33pm

Put Your Money Where Your Mouth Is

By Spear's

Looking to diversify your investments? It could be time to hit the bottle, says Chris Smith
THE TRADITIONAL NOTION that wine investment is about buying two cases of young wine so that, after a period of maturation, you drink one case and sell the other to finance both, may have a certain romantic appeal. But serious investors understand that investment is all about risk and good decisions are made when the exposure to risk is clearly understood. In the fine-wine market, such understanding is becoming more commonplace as both institutional and private investors, after properly researching the market, conclude that a holding in fine wine is an important diversifier.

As an asset, fine wine has shown three consistent features. The first is double-digit annualised returns: the annualised growth rate of the benchmark index, the Liv-ex 100, has been around 14.6 per cent since its inception in 2001. In 2010, the index rose by 40.5 per cent. Secondly, low volatility: the wine market has shown lower volatility (equalling lower risk) than equities and other commodities such as gold and oil. The final feature is low correlation to equities: using the longest reliable monthly data series, the correlation between the wine market and the FTSE 100 is +0.02. In other words, the returns to fine wine are generally unaffected by movements in equity markets.

In fact, in the post-financial crisis era, there is some evidence that wine is becoming more negatively correlated with equities — and, commensurately, more positively correlated with other physical assets, notably gold. This is perhaps not surprising, as many of the characteristics that make gold attractive to investors also apply to fine wine: supply is limited, it cannot be debased and it has inherent value. In other words, it is being seen as a hedge against uncertainty and against inflation expectations.

It is worth exploring the supply side further. At The Wine Investment Fund, we define fine wine as being only from the top 35 wine producers (châteaux) of the Bordeaux region. Bordeaux is a finite geographical area of approximately 120,000 hectares of vineyards, home to approximately 8,650 wine producers. There are a number of classifications that cover most (but not all) of the properties, of which the most famous was the Médoc classification prepared in 1855, at the request of Emperor Napoleon III for the Paris Great Exhibition of that year. This list has remained almost unchanged to this day, except for some minor alterations and the elevation of Château Mouton Rothschild to a premier cru in 1973.

The 35 châteaux that we define as producing ‘investment grade’ wine amount to only around 1 per cent of the total production of Bordeaux — some 6 million bottles per year. Critically, no matter how good the vintage, the number of bottles can only reduce over time as the wine is consumed, creating an inverse supply curve. Moreover, while supply is decreasing, demand is actually increasing because, as the wine matures, it improves. These forces act together to push up prices.

Moreover, global demand for fine wine continues to rise — steadily in the case of the traditional markets of Europe and North America, and more rapidly in newer markets such as Russia and most recently China, which has seen phenomenal growth. In fact, sales of Bordeaux to China have doubled every year since 2005, overtaking the UK and Germany to become the number one destination for exports of Bordeaux by volume.
WHAT LIES BEHIND this growth in the Asian market? Initially, it was probably fair to say that it was not the taste but the social cachet, or giving it as gifts. Stories abounded of mixing £500 bottles of Lafite with Coca-Cola or 7-Up. As time has gone on the wine ‘scene’ has matured, although brand is king — and Lafite is the most important brand. Prices have rocketed: a case of Lafite 2004, which cost £2,200 in December 2008, is £8,000 two years later.

The future path of the market now turns most importantly on this question: of the wines that are currently being exported to China, are large amounts of it being drunk, or are they being held for future resale?

Unfortunately, there is no clear answer, and authoritative sources differ. To the extent that there is a consensus, it is that drinking constitutes the rationale for a large majority — perhaps 80 per cent — of purchases, which is high enough to keep prices rising for some time yet. In the meantime, an intimate knowledge of the market enables us to identify the wines that have changed their risk/return profile in recent months. We then use sound risk management techniques to manage our portfolios.

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As the market evolves, so we will continue to monitor and rebalance portfolios to maintain an appropriate overall risk/return profile. With these professional management techniques, we look forward to the prospect of more tasty returns.

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