Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
For many investors, an ideal asset class would combine superior long-term absolute and risk-adjusted returns with a hedge against inflation and stock market volatility. There’s a way to get all of that, in an asset class you might never have thought of until now: fine wine. Investment-grade wine deserves careful consideration, particularly now that – unlike other collectibles, such as art and rare books – it can be traded on a regulated exchange.
People have been purchasing fine wine for investment for more than 150 years. The practice originated with the British, Dutch and the French. Only recently, however, has it become possible to do an in-depth comparative analysis of the investment-grade wine market versus other asset classes – sufficient market information only became available after the creation of the London International Vintner’s Exchange (“Liv-ex”) in 1999 and the subsequent publication of the Liv-ex Fine Wine Investables and Liv-ex 100 indices in 2001.
I’ll review what we’ve learned about the advantages and risks of fine-wine investing over the last two decades, but first it’s helpful to understand the basics of what is – and isn’t – a part of the investment-grade wine market.
The wine market: An overview
When examining fine wine as an investment, there are two threshold questions that an investor must answer: “What constitutes an investment-grade wine?” and “How do you define the investment-grade wine market?”
The vast majority of the world’s wine is not suitable for investment. Short longevity, poor quality, and large production volume makes meaningful price appreciation impossible. Investment-grade wines make up less than 1% of the global wine market, with approximately 80% coming from Bordeaux. The remaining 20% comes from the top producers in Burgundy, the Rhone Valley, Champagne, and from Tuscany and Piedmont in northern Italy.
The characteristics that define an investment-grade wine are:
Pedigree – The wine must be produced by a chateau, domaine or a producer whose name is synonymous with quality and prestige.
Longevity – The wine must be able to age for at least 25 years, with maturity (peak value) occurring no earlier than the 10th year.
Price appreciation – The wine must have a consistent and documented history of substantial price appreciation, spanning a decade or more. Liquidity– The wine must be made in sufficient quantities so that it can be bought and sold on the secondary market.
High critical acclaim – The wine typically must have been given an excellent review by one or more of the principal worldwide wine critics, such as Robert Parker, Wine Spectator, James Suckling or Jancis Robinson.
Drivers of investment-grade wine prices
The main driver of prices is a persistent imbalance between supply and demand within the investment-grade wine market. This imbalance makes investment-grade wine a good investment and it arises from the following factors:
The supply of investment-grade wine is severely constrained by limited production. This constraint is primarily a result of a restrictive classification system and zoning laws imposed on the top producers in Bordeaux and Burgundy.
Worldwide demand for the top investment-grade wines has significantly increased over the last decade, thanks to the emergence of the “new wealthy” who want to own theses wines in China, Russia and other emerging markets.
Fine wine improves with age, thereby becoming more attractive and valuable as it matures.
As fine wine ages, it begins to be consumed, which increases both its scarcity and demand.
The advantages of investing in investment-grade wine
The substantial price appreciation of the world’s finest investment-grade wines over the last decade has done a lot to call attention to the potential of this asset class. But the investment-grade wine market has far more to offer than its recent track record of impressive returns. Data from December 1993 through August 2012 (18.5 years), as presented in Table 1 and Table 2, below, illustrate those benefits.
Table 1: Comparative performance – Liv-ex Fine Wine Investables Index vs. all Major Non-Fixed Income Asset Classes
Period: 12/1993 - 8/2012
Liv-ex FW
Investables
Index
S&P 500
Index
MSCI-EAFE
Index
MSCI -
Emerging
Markets
Index
DJ-UBS
Commodities
Index
Gold (London
PM Fix)
NAREIT
Equity
REIT Index
DJ-CS
Hedge
Fund Index
Annualized
Return
13.62%
6.09%
2.22%
3.06%
8.93%
8.00%
4.44%
8.65%
Standard
Deviation
12.10%
15.51%
16.99%
24.34%
16.02%
16.02%
20.41%
7.50%
Sharpe Ratio
1.12
0.46
0.22
0.25
0.62
0.56
0.32
1.15
Downside Std.
Dev.
4.89%
9.58%
10.87%
15.50%
9.34%
8.33%
13.39%
4.01%
Sortino Ratio
2.77
0.75
0.34
0.39
1.06
1.08
0.49
2.15
Max. 12-Month
Return
64.17%
46.37%
53.70%
86.98%
51.67%
55.39%
79.98%
33.50%
Min. 12-Month
Return
-24.12%
-44.43%
-51.06%
-57.69%
-43.06%
-19.62%
-62.75%
-19.04%
Source: Trellis Fine Wine Investments, LLC.
Table 2: Cross-correlations of monthly returns - Liv-ex Fine Wine Investables Index vs. all Major Non-Fixed Income Asset Classes, Inflation and Market Volatility
Period: 12/1993 -
8/2012
Liv-ex FW
Investables Index
S&P 500
Foreign
Equities
Emerging
Market
Equities
Commodities
Gold
US Real
Estate
Hedge
Funds
US Inflation (US-CPI)
Volatility (VIX)
Liv-ex FW
Investables Index
1.00
0.08
0.09
0.07
0.13
0.02
0.11
0.15
0.23
0.01
Inflation (US-CPI)
0.23
0.02
0.03
0.04
0.20
0.07
0.07
0.12
1.00
0.05
Volatility (VIX)
0.01
-0.66
-0.60
-0.58
-0.28
-0.03
-0.39
-0.43
0.05
1.00
Source: Trellis Fine Wine Investments, LLC.
Let’s review some of the benefits of investing in fine wine that this data reflects.
Unless otherwise noted, all references to the investment-grade wine market below are based on the Liv-ex Fine Wine Investables Index.
Long-term capital growth: Over the last two decades, the investment-grade wine market produced an annualized return of 13.62%, higher than any of the major non-fixed-income asset classes over the same period. Low volatility: The investment-grade wine market produced the second-lowest volatility of annualized monthly returns among all major non-fixed-income asset classes. Only the 7.50% standard deviation of the Dow Jones-Credit Suisse Hedge Fund Index was lower than the 12.10% standard deviation of the Liv-ex Fine Wine Investables Index.
Superior risk-adjusted returns: The investment-grade wine market produced the second-best risk-adjusted return (as measured by the Sharpe Ratio) among all major non-fixed-income asset classes. Only the 1.15 Sharpe Ratio of the Dow Jones-Credit Suisse Hedge Fund Index surpassed the 1.12 Sharpe Ratio of the Liv-ex Fine Wine Investables Index.
When measured by the Sortino Ratio, moreover, the investment-grade wine market produced the best risk-adjusted return among all major non-fixed-income asset classes. None of the major non-fixed-income asset classes had a lower Sortino Ratio than the 2.77 ratio produced by the investment-grade wine market.
Portfolio diversifier: History has shown that equity markets tend to become more closely correlated when markets are turbulent. But the investment-grade wine market historically has not moved in lockstep with the other major equity-type asset classes, nor has it correlated strongly with hedge funds, gold or other commodities. The investment-grade wine market has had a correlation of 0.08 with the S&P 500 Index and correlations of 0.02 and 0.15 with gold and the Dow Jones-UBS Commodities Index, respectively. Thus, adding an allocation to investment-grade wine may help to insulate a portfolio against events that broadly affect the equity and commodities markets.
Inflation hedge: Investment-grade wine is a tangible and consumable asset, and such assets typically do well in times of rising inflation. The investment-grade wine market has had a positive correlation of 0.23 with the US Consumer Price Index. In other words, the price of the investment-grade wine market has tended to increase during higher inflation, suggesting that wine may provide an effective hedge against rising inflation.
Market Volatility Hedge: The investment-grade wine market has had virtually no correlation with US stock market volatility (a correlation of 0.01, as measured by the VIX Index). This suggests that, unlike the other major non-fixed-income asset classes (all of which have a negative correlation with the VIX Index), the returns associated with the investment-grade wine market are unlikely to be adversely affected by an increase in US stock market volatility.
Currency hedge: The purchase and sale of investment-grade wine in foreign countries, such as the United Kingdom, continental Europe and Asia, can provide US investors with a hedge against a decline in the value of the dollar.
Personal ownership of a tangible asset: Wine is a tangible, transportable and consumable asset. Thus, it is extremely versatile, in that it can be purchased purely for investment as well as for personal consumption and enjoyment.
You can see many of these benefits most clearly in the following graphical presentation:
Graph 1: Annualized returns – Liv-ex Fine Wine Investables Index vs. all Major Non-Fixed Income Asset Classes
Source: Trellis Fine Wine Investments, LLC.
Graph 2: Annualized monthly standard deviation – Liv-ex Fine Wine Investables Index vs. all Major Non-Fixed Income Asset Classes (lower is better)
Source: Trellis Fine Wine Investments, LLC.
Graph 3: Sharpe Ratio – Liv-ex Fine Wine Investables Index vs. all Major Non-Fixed Income Asset Classes (higher is better)
Source: Trellis Fine Wine Investments, LLC.
Graph 4: Sortino Ratio – Liv-ex Fine Wine Investables Index vs. all Major Non-Fixed Income Asset Classes (higher is better)
Source: Trellis Fine Wine Investments, LLC.
Graph 5: Historical Performance – Liv-ex Fine Wine Investables Index vs. US Stocks, Commodities, Gold, and Real Estate
Source: Trellis Fine Wine Investments, LLC.
Invest with caution
As with any investment, however, investing in fine wine has certain disadvantages. These include:
Risk of Loss:Like any other asset, the price of fine wine can go down as well as up, losses are always possible. But fine wine has historically produced returns that are much less volatile than the stock market.
Less-liquid market: With no pun intended, the fine wine market is less liquid than the stock and bond markets. Thus, it may be more difficult to quickly sell fine wine investments than conventional securities.
With the advent of the Liv-ex fine wine exchange in 1999, however, and the recent establishment of similar exchanges in Hong Kong and Shanghai, the fine wine market has become much more liquid. As with any other exchange, these provide daily market pricing for investment-grade wine and pair buyers and sellers through a bid-ask system. Although they are generally only open to professional investors, brokers and merchants, individual investors can obtain access to these exchanges by investing through a reputable wine fund or independent wine investment consultant who can trade on theses exchanges on their behalf. In addition to exchange access, investing through a fund or consultant can also increase an investor’s liquidity by allowing them to having access to privately brokered sales and better pricing if they prefer to sell their wine at auction.
Spoilage, damage or theft: As a tangible and consumable asset, fine wine is subject to spoilage, damage and theft. But by storing wine in a temperature- and humidity-controlled facility operated by a reputable wine storage company and by obtaining insurance for a wine’s replacement value, an investor can effectively eliminate this risk.
Higher transaction costs: The transaction costs associated with the purchase, storage and sale of fine wine tend to be higher than the transaction costs associated with stocks, bonds, and other investments. But investors can significantly reduce these costs by using a reputable wine fund or independent wine investment consultant who can negotiate better prices and volume discounts.
Lack of income: Unlike stocks and bonds, fine wine does not produce any cash flow that can be used to determine its intrinsic value. In that sense, fine wine is more like a commodity, since its value is primarily driven by supply and demand. But that doesn’t mean that fine wine cannot be valued. Rather, the persistent existence of price inefficiencies within the investment-grade wine market – combined with objective factors such as a wine’s critical score, historical price appreciation, pedigree and recent price momentum – suggests that fine wines can be valued on a relative basis. Therefore, if an investor has access to sufficient market information, he or she can look for undervalued wines that are likely to produce above-average long-term relative returns. Also, as with any alternative asset, the speculative nature of fine wine can be substantially mitigated if it is held as part of a broader asset allocation portfolio.
Conclusion
Including investment-grade wine in a diversified investment portfolio offers many potential benefits to investors, including: hedges against stock market volatility, inflation and a decline in the US dollar; low correlation with traditional and alternative asset classes such as real estate, gold, commodities and hedge funds; and the security associated with the personal ownership of a tangible asset. To protect against some of its disadvantages, investors should consider investing through a reputable wine fund or independent wine investment consultant.
Wine may not be the first investment that comes to most investors’ minds, but savvy advisors should be aware of its potential benefits. Certain clients may love the idea of diversifying into investment-grade wines – and they’ll love it even more once they see what it can do for their portfolio.
Mark Ricardo is the founder and president of Trellis Fine Wine Investments, LLC, a US-based fine wine investment company. He also is the president and chief investment officer of Tiber Creek Investment Management, LLC.
