Investing in Wine: The Market for Illiquid Liquids

Valerie Wong Fountain, CFA ®, Managing Director, Head of Signature Access Platform

Megan Ruan, Rotational Analyst

The market for wine has long held a mystique that markets for other alternative investments lack. Apart from having names that are significantly harder to pronounce than “gold,” “silver” and “real estate,” fine wines can be inaccessible from a cultural and historical standpoint, as well as an investment one.

Buyers looking to enter the market must contemplate everything from which vineyards and vintages will

be most valuable, to how these assets must be delicately stored. However, although there are barriers to entry, the practice of investing in wine may offer opportunities for a better risk-adjusted return than investors might be able to find through other portfolio diversification strategies. To begin, it is important to understand what constitutes a “fine wine.” According to Brian Ward, director of Wine for the Winston Art Group, “Fine wines are distinguished from mass-market wines by their ability to age, value on the

secondary market, and producers’ long track records for excellence.”¹ In the world of wine, a reputation for quality is not something readily achievable and can take years, if not decades, to develop.

WHAT INFLUENCES THE PRICE OF WINE? For most investment-grade wines, the top drivers of value include vintage quality, provenance, rarity and ability to age.²  Importantly, the inherently finite

nature of the supply sets wine apart from most other commodities. Unlike gold or silver, wines are made unique by their location and year of production; once consumed, they cannot be replaced.

The effect of scarcity on price can be seen even with powerful brands. As an example, 2012 Domaine de la Romanée Conti (DRC) in Burgundy produced less than 4,500 bottles, which now sell for upwards of $13,000 per bottle. In comparison, first growth Lafite from Bordeaux produces 15,000 to 20,000 bottles per year, which sell for closer to $500 per bottle.³  For wines produced in limited capacities, the inverse relationship between price and quantity is accentuated as supply dwindles.

Demand for fine wine also follows an interesting pattern, driven in part by the emergence of new markets, such as China and Hong Kong, but also by its behavior as a Veblen good, with demand for certain wines increasing as prices increase.⁴ The prestige-seeking behavior of wine investors helps explain the outsized price tags on some Bordeaux and Burgundy wines, which are seen as the gold standard for investment-grade wine. Additionally, because the quality of wine cannot be ascertained before consumption, buyers often rely on expert opinion, such as that of famed wine critic Robert Parker, giving certain individuals vast influence over prices.⁵

Interestingly, factors key to wine’s appreciation tend to shift as the property ages. According to Charles Curtis, wine specialist at Gurr Johns, “Fine-quality young wines are as fungible a commodity as collectible watches, for example. However, as the wine ages, other factors such as condition and provenance become much more important, and each bottle that comes to market has its own history, much as a work of art does.”⁶

WHY CONSIDER INVESTING IN WINE?

The secondary market for fine wine currently sits at around $5 billion.⁷ Compared to other so-called silver, wine, art and gold (SWAG) alternatives, some argue that wine seems to achieve comparable results in terms of both volatility and return. Observations of the Liv-ex Fine Wine 100 Index, which tracks the price movement of 100 of the most actively traded wines in the world, showed returns over a 10-year period exceeding that for FTSE and S&P 500, with lower volatility than gold.⁸ Investors in wine would argue that it may be an asset worth considering for portfolio diversification, not to mention personal enjoyment.

WHAT KIND OF WINE DO INVESTORS COLLECT?

In the global hierarchy of fine wines, most collectors would agree that France leads the pack. Bordeaux, a name recognizable even to non-collectors, typically ranks first, followed by Burgundy. As one of the oldest and largest wine-producing regions, Bordeaux’s yearly wine output is around 900 million bottles, nearly 1.5 percent of the entire world’s supply.⁹ However, only a tiny percentage of this wine comes from one of the five First Growth chateaus deemed to be the crème de la crème of collectable wine. A remnant of Napoleon III’s era, the “First Growth” label is like an AAA S&P rating, the highest possible rating for creditworthiness. First Growth wines typically perform well in the secondary market, and of course, are renowned for stellar consumption quality.¹⁰ The five chateaus included in this prestigious circle are:

·         Chateau Lafite Rothschild

·         Chateau Latour

·         Chateau Margaux

·         Chateau Haut-Brion

·         Chateau Mouton Rothschild

However, although Bordeaux has historically been the top producer of fine wines, in recent years, Burgundy has surpassed Bordeaux in top lots as seen by names such as DRC, Leroy and Armand Rousseau at auction. “Top producers and vintages are seeing continued strength at auction, with wines from Burgundy, Bordeaux, Rhone and parts of Italy showing particularly well,” according to Ward. Burgundy, whose acreage is one-quarter the size of Bordeaux’s, produces an even more restricted supply of wine, contributing to the squeeze toward higher prices. Elsewhere in France, Second Growth Bordeaux11 is also beginning to show well in the market as a potential investment at a lower entry point.

Other traditionally reliable investments include vintage champagne (made with grapes from a single year’s harvest), which often appears in a well-diversified wine portfolio due to its ability to age and relative scarcity.¹² Outside of France, promising collectibles include Napa Valley Cabernet Sauvignon and more recently, Barolos and Super Tuscans from Italy.¹³

When buying wines from regions other than Bordeaux and Burgundy, it is important to choose flagship

wines, or wines whose producers have made a name for their respective regions. While these wines might not satisfy an investor’s sense of adventure, they are more likely to sell 10 years down the line.

COSTS AND CONCERNS

An important aspect to keep in mind is time horizon. Beginner collectors should be prepared to wait six to 10 years before selling, as most fine wines need time to mature before reaching peak drinkability and gaining traction in the secondary market.¹⁴ In addition, most wine auction sites prefer to sell wine in sets of three, 6 or 12, with certain exchanges requiring full cases. Therefore, purchasing at least three bottles of each wine is advisable if the end goal is to sell. Lastly, potential investors should consider the costs of building and maintaining a wine cellar. “The issue of storage is critical to success, as improper storage can destroy asset value,” says Curtis. Between the costs of a cooling unit, racking and installation, starting a wine cellar will typically set a collector back by about $10,000-$15,000 in initial outlay, with additional annual maintenance and insurance upkeep costs.¹⁵

ARE THERE OTHER WAYS OF ACCESSING THE WINE MARKET?

In recent decades, the wine market has become vastly more accessible. The establishment of the London Vintners Exchange (Liv-ex), a global platform for wine trading and indexing, has led to more transparent pricing and information. However, since direct trading on the Liv-ex is only available to professional wine merchants, most private investors purchase their wines directly through distributors, auction houses or the secondary market via fine wine retailers. Savvy investors may also be able to leverage arbitrage opportunities between the three largest markets, New York, Hong Kong and London, in order to lower prices and tax load.¹⁶

For experienced wine collectors, auctions can be more than just an opportunity to sell or acquire assets. Given the relatively small world of wine investing, auctions offer not only the chance to buy and taste wines, but also to enjoy the overall atmosphere of fine wine and dining. “Collectors are different at the highest level — they move in the same circles, tasting groups and events, and don’t buy wines like stocks and bonds. There is passion behind the act and a thrill associated with the chase,” says Clifford Korn, managing director of sales at Acker Merrall & Condit, America’s oldest fine wine merchant.

Aside from auctions, another method is to buy wines en primeur, or through wine futures. Wine futures grant an investor the opportunity to invest in wine while it is still in the barrel (i.e., before it is bottled). This can be done up to 18 months before the official release of a vintage. However, when engaging in en primeur investments, beware that the value of the wine is not guaranteed and may fall between the time of purchase and time of sale.¹⁷

For those wishing to bypass the need for storage facilities, one option is to invest in a wine funding vehicle, which operates similarly to a private equity fund. Investors are allowed to pool their money and buy shares in portfolios of investment-grade wine. Note that these funds typically have lockup periods of five years or more, and charge a similar fee structure to private equity and hedge funds, including management and performance fees.¹⁸

ANYTHING ELSE?

 The Latin phrase caveat emptor aptly describes participation in the wine market, given the potential for fraud. Regulation in the industry is sparse, leaving most of the responsibility for quality control to the asset owner. Therefore, wine investors cannot be too careful when verifying the pedigree of new purchases and safeguarding existing collections using proper storage techniques.¹⁹

Lastly, as a potential investor, it is important to remember that the value of a bottle of wine is ultimately derived from someone’s desire to drink it. As Korn advises all his clients, “If you like Pinot Noir, don’t invest solely in Cabernet because it’s popular. If the market shifts and you are stuck with a cellar full of wine you had planned to sell, you should ideally be able to enjoy drinking some of it.” And as most wine collectors would probably admit, there is more to investing in wine than pure monetary gain. After all, you can’t eat a bar of gold or a Picasso, but you can always drink a glass of Merlot.