I was asked to give a talk at yesterday’s forum on wine investment at the Hong Kong International Wine & Spirits Fair. I felt a reality check might be in order given that the other 5 speakers were likely to be setting out their stalls, namely Simon Staples of Berry Bros., Robert Sleigh of Sotheby’s, James Miles of Live-ex, Peter Lunzer of the Peter Lunzer Wine Fund and Ella Lister, representing Octavian. Hence a focus on the pitfalls rather than the benefits of wine investment.

Introduction

Good afternoon. I have the privilege of sharing a platform with some of the wine trade’s most distinguished representatives from a broad spectrum of fine wine investment: a lively wine exchange, a prudent fine wine fund, a modern fine wine merchant, an auction house with impeccable provenance, and after me, Ella Lister, representing the UK’s best-known wine storage company, and wine investment journalist in her own right.

As a journalist and consumer, my starting point is that I have no vested interest in wine investment, just the consumer’s interests at heart. And I can’t think of a better phrase or soundbite when it comes to wine investment than caveat emptor, buyer beware.

Wine investment is nothing new. When I started writing about wine back in the mid-1980s, Simon Loftus of Adnams had just written a book called Anatomy of the Wine Trade, sub-titled Abe’s Sardines and Other Stories. Why the sub-title. As Loftus explained: ‘Abe bought a shipment of sardines that had already been traded many times and each time profitably. Unlike previous buyers, Abe took the trouble of procuring a box of his purchase. The sardines were terrible. He telephoned Joe from whom he bought them only to be told: “But Abe, those sardines are for trading, not eating”.

Are yesterday’s sardines today’s Chateau Lafite? While the Lafite may be a lot more palatable than a can of rotten sardines, at £2,000 a pop, or more, it might be equally indigestible if it ends up being drunk when it was bought for investment.

A History Lesson

It’s no coincidence that Simon Loftus had been involved in buying the Bordeaux 1972 vintage en primeur, and, just like the rest of the wine trade, fingers were severely burnt when it turned out to be an awful vintage sold at inflated prices. That was BP, Before Parker, however.

The great Bordeaux crash of 1973 ensued and en primeur only really got going again with the so-called banker’s vintage of 1982. In a way you can pinpoint 1982, a generation ago, as the point at which UK consumers caught the en primeur bug, and when the wine investment phenomenon, as fuelled by the consumer, started to take off. It’s no coincidence that it’s also the vintage with which Robert Parker made his reputation.

At the time wine investment started to take off, most of it was done by wine lovers on the very practical basis of buy two cases, sell one and drink one for free. Even at that time however, it was also being taken to a different, more hard-nosed commercial level.

The Business Expansion Schemes that followed in the late 1980s envisaged wine investment as a tax shelter for the well-heeled. Numerous wine merchants piled into wine investment as if there was no tomorrow, or rather, as if tomorrow was not so much the future as the futures. Most of these Business Expansion schemes ended messily with few returns going to the investor consumer.

Nonetheless, the success of the Bordeaux en primeur campaigns since the defining vintage of 1982 created a new wine investment mentality fuelled by growing wine investment opportunities .

The rise of Robert Parker with his 100-point scoring system cemented the notion of wine not just as lifestyle and status enhancer but as investment opportunity too as people perceived a more objective and independent basis for assessing wine that what had gone before, in particular the self-perpetuating 1855 classification.

Articles started to appear extolling the virtues of wine investment. And of course all such articles would, and some still do, end with the punchline: ‘if it all goes wrong, you can always drown your sorrows by drinking it’. Which is a bit like saying: ‘if your shares go down in price, you can always sell them and spend the money’.

A Case Against

While investing in wine can be an attractive proposition, it can be risky. Depending on the timing, it can take years for certain wines to produce decent returns. Most people don’t have the time or inclination to do what really needs to be done by the serious wine investor, i.e. know you subject by boning up on the wine market. Those who do are the brokers, the merchants, the auction houses, the fund managers, and - they seem to do alright out of it.

Let’s look at some of the risk factors

The Global Economy

Let’s look at the global economy. In the face of the most recent global debt crisis, Gary Boom of Bordeaux Index warned on 14 October: ‘The rising popularity of investing in wine has seen the commodity become increasingly tied to volatility in the wider financial markets’.

This is nothing new. The Asian market crash of 1997 / 8 saw prices drop by 20% and depressed prices of the 1996 First Growths e.g. for another 7 years. My own Château Latour 1996 bought for £450 in 1997 bumped along the bottom and only started to rise seven years later after I’d sold it for less than £2000 to buy some furniture for the new house I was moving into. If you were Roman Abramovich, the second richest man in Britain, you’d have bought Sibneft, the Russian oil firm, in 1996 for $100m. And sold it in 2005 for $13 bn. That’s what you might call a nice little earner.

September 11 2001 saw another 25% drop in prices.

In the wake of the 2008 credit crunch and Lehmann Bros collapse, some 2005s fell by 50% with a knock-on effect on older vintages. Between July 2008 and July 2009, The Wine Investment Fund and The Fine Wine Fund lost about 18 percent and 20 percent of their net asset value respectively.

Then along came the global debt crisis of 2011. The effect is that fine wine prices retreated 7.5% in the third quarter of this year with first growths from blue chip vintages shedding up to a third of their prices. Bordeaux prices at yesterdays’ Acker Merrall auction reflected that with quite a few selling below their low estimates.

Enter the IMF

In a recent IMF report, 2 economists, found that global financial turmoil and the ensuing recession in economic activity had had an adverse impact on global wine demand, prompting a 42% drop in fine wine prices in the second half of 2008. They cast doubt on fine wine investment after discovering, while investigating the broader commodities market, that the behaviour of oil and fine wine prices "has shown remarkable similarity".

They said: "Our results suggest that although fine wine can be considered as an investable asset, its behaviour is not significantly different than other commodities and therefore may fail to enhance portfolio diversification," they wrote in an IMF research paper. "Fine wine prices are sensitive to macroeconomic shocks, just like crude oil and other commodity prices".

According to the economists' estimates, a 4 percentage point decline in industrial production growth in emerging market economies, which is driving commodities prices, would induce a 22 per cent decline in real crude oil prices and a 15 per cent fall in real wine prices.

Yet volatility in the market is a factor that hasn’t been fully explored. An estimated two-thirds of the fine wine market is streamlining to the Far East. Some are saying China is not a bubble, but others that it’s too early to say whether China is a bubble or will sustain its growth, and with it, its demand for fine wine.

One of the potential problems as I see it is that an emerging economy has no loyalty towards wine. It’s fickle. What’s to stop the more hard-nosed individuals and institutional investors from switching in the blinking of an eye to antique silver, modern art or jade.

En primeur

Let’s also remember that the en primeur market, once the best source of wine investment for consumers, now appears to have run its course over a generation, and no longer provides the same sort of exciting returns promised between the 1982 vintage up to 2000. According to Max Lalondrelle of Berry Bros. & Rudd, : ‘We could be coming to a time when the en primeur game will come to an end’.

The beginning of a possible end to en primeur is linked to the increase in vintage consistency , e.g. in the 2000s, the vintages 2000, 2003, 2005, 2009 and 2010, alongside the good vintages 2001, 2004, 2006 and 2008. The upshot is that cellars are overflowing. Despite the fact that 2010 is widely perceived as a great vintage, its high pricing by some of the leading châteaux has had a disastrous knock-on effect on en primeur sales.

Is Parker the Saviour?

Following Parker too may give a guarantee of sorts but it may not be quite what it used to be. Why not?

(a) The very success of Parker is in itself an inflationary feature of prices; as we well know, the chateaux wait for Parker’s score before setting their opening prices;

(b) Insofar as he is reliable Parker effectively only covers Bordeaux; where do you go if you want to invest in Burgundy, Rhone, Champagne, New World?

(c) Parker points don’t always work, viz Carruades de Lafite, big Australian reds.

Investment Vehicles

As demand has increased in the past three decades with rising incomes, and prices have risen to encourage investors beyond the traditional wine lover, the amount of wine held for investment purposes has increased significantly.

There are now a growing number of investment vehicles for wine, from traditional wine merchants and individuals, to brokers, auction houses now expanding on the internet and vintage wine investment funds, of which there are at least a dozen and perhaps as many as 20 or so worldwide.

The Wine Funds

Many are Uk based but a new one, the DeRouge Fund is a wine fund approved in August by Chinese regulators—has announced plans to raise RMB 1 billion ($156 million) looking for minimum investments of RMB 1 million ($156,000) from private individuals, and RMB 10 million ($1.56 million) from institutions.

Wine investment funds alone may hold in the region of £300 million ( $US480m) and are growing rapidly. There’s even a new independent and dedicated magazine for wine investors launched online in September called Wineyields.com.

According to Chris Smith of the Wine Investment Fund: “We think total holdings in formal funds are around £300 million (US$480), and we are the largest. Then there are a lot of quasi-managed funds like Berry Bros, which would probably be as much again and possibly more, so you probably get to £750 million (US$1200 million) invested in wine investment. We’ve done some careful work on this and for the wines we look at the total stock of wine left is around £5 – 6 billion (nearly $US10 billion). It’s been externally verified so it’s a pretty good estimate”.

The Risks

Wine investment funds can be a risky proposition when things go down. I’ve already mentioned the 1996 vintage and the Asian crash and the knock-on effects. In September 2008, for instance, the Vintage Wine Fund found its major investors desperate to sell their holding just when selling fine wine had become all but impossible. Wine funds may also tie up your money for a minimum period, like the 5 years required by the Wine Investment Fund. If they don’t , you may be in for a hefty redemption fee.

According to Ella Lister, writing in the World of Fine Wine, ‘for the wine funds that have met with success, there are almost as many again that have met with obstacles leading to their demise or even preventing them from launching’. Ascot, the first fund, made what Peter Lunzer called “the not-unusual mistake of assuming that if you have funds to invest, you should invest them immediately, leading to poor portfolio selection.

Others have suffered from lax pricing practices—for example, Vinum, whose portfolio was mispriced for around two years, probably more likely due to incompetence rather than malpractice. Some incidents are fraud-related, such as Templar Vintners use of Vinum material, with their own name superimposed, to front an empty shell. Arch, was closed down by the Channel Islands Stock Exchange due to an issue with general reporting standards. A fund called Red2Gold, announced in early 2009, aimed to raise £100 million (US$160 million) to invest mainly in Bordeaux blue-chip wines but hasn’t yet materialized.

All the more important then to examine the small print of the wine investment fund and look for strategies adopted by the more prudent wine investment funds such as Peter Lunzer and The Wine Investment Fund.

In the case of wine investments funds, you should also look at the fee structure. Typically a wine fund will take a 20% performance fees plus 2% management fee, but it may be more. One new fund, called Ingenious, aiming to raise $5m, may have had problems raising cash because of a fee structure calling for an 8.75% investment fee, a 0.5 monitoring fee and up to 0.33 per cent in custodian fees on top of the standard 20% performance fee. Another, the Fine Wine Geared Growth Fund (FWGGF) has run into problems after introducing particularly high fees.

There is a general lack of regulation of wine investment companies, and with it, subjective methods of valuing stock. In the UK, the FSA doesn’t regulate wine investment funds but just the marketing by those funds. Many fund managers , but by no means all, now use Liv-ex mid-prices to value their net asset value (NA V) in a self-regulating bid to optimize the transparency of their activities. According to Ella Lister, “This is a response to less rigorous outfits that have been suspected of setting a net asset value at year-end that best impacts upon their annual performance fee”.

Other Factors

There are other factors that make wine investment either risky, undesirable or impossible.

Condition and Provenance

There is a need when you’re buying a physical wasting asset such as wine for good condition and provenance. I’ll say no more about that because that’s Ella Lister’s area. Linked to that, you need to consider the hidden costs of wine investment: storage of £10 - £15 per case per year, insurance and on-selling costs.

While the glass-half-full set will say that there’ll always be one bad apple, we can’t afford to overlook the instances of fraud and sharp practice:

The Hungerford Wine Company
Greens
Uvine the wine exchange company, advertised as the wine equivalent of the stockmarket, that went bust because of poor management.
Mayfair Cellars collapse in June 2006 following a £1.5m fraud perpetrated by its finance director Dominic Smith.
Most recently Vintage Wines of St Albans Ltd., with Stephanie Callebaut and Shameen Suleman receiving prison sentences for fraud in 2008.
Vinum, the wine investment fund that went broke because of overvaluation of stock.

Recent scams

More recently Hong Kong’s booming wine sector has had problems of its own, not least an investment fraud by a wine broker company called Premium Liquid Assets, which swindled over 400 people out of HKD$50 million by advertising a 10-30% investment return on en primeur wine.

Only this week in the UK came the announcement of a new scheme called Loan Against, An arm of Prestige Asset Management, it’s offering ‘loans of up to 70% of the value of blue-chip wines, with no other collateral required’. According to the company this is ‘the world’s first non-recourse, non-status wine investment loan, enabling private investors to buy premier crus…and other wines of distinction…’

Spokesmen said the system is unique for wine because it requires no credit check, and money is advanced using the wine as sole collateral. Loan Against will provide tax-deductible loans of between £100,000 and £10m for purchases of wines. Rates start at 2.49% per month, payable at the end of seven months.

What’s this? No credit checks? Loans for something that can at the very least be a 5-year investment repayable after 7 months? Rates start at 2.49% per month? i.e. 30% a year.

The background of short-term fix to long-term debt is against this week’s warning by the OECD that parts of Europe will sink into recession next year. The OECD has slashed its forecast for growth in the Eurozone to just 0.3% next year, down from 2%, in the US to 1.8% down from the 3.1% forecast, and recovery in 2013 will only be 1.5%, in the US 2.5%. Despite the grim forecast, the OECD forecasts growth of 6.7% in emerging economies and 8.5% for China.

To sum up then, There are no short cuts to wine investment.

In the long run, the best safeguards for the consumer are:

Education and information.

Not knowing anything about wine or not being interested in it leaves you more vulnerable to potentially sharp or fraudulent practices than the knowledgable consumer.

Know your wines

Only deal with a reputable merchant / broker / fund

Consider tried-and-tested strategies for buying .e.g the Wine Investment fund buys only 10 vintages of 35 wines between 1990 and 2006 and not en primeur.

If buying at auction, check on pristine condition and impeccable provenance

Pay for wine only against invoice

Obtain written confirmation of independent storage in good conditions

Obtain evidence of your title to the goods

Obtain advice on the optimum length of holding time

Look at how you can dispose of your liquid assets other than pouring them down your throat

I would like to finish by looking at which areas you might consider investment in but since it’s been more than ably covered by everyone else, I will simply say that the benefit of hindsight is a wonderful thing. The wisdom of foresight is a much more valuable commodity. And foresight when it comes to wine is the skilful interpretation of the past in the light of an accumulation of experience. If you have the skill, the knowledge and the time yourself fine. If you don’t, because you lack the skill, the knowledge or the time, make sure that you know someone who has.