Pouring Wine to Your Investment Portfolio - Returns on a High!

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Pouring Wine to Your Portfolio

January 15, 2015

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Wine – A long-term alternative investment that yields high returns and has low correlation with other assets

Investment-grade wine is an alternative asset class similar to gold, fine art, rare coins, and stamps. In the last decade, investment in

Fine Wine provided higher returns compared to the traditional asset classes such as equity, bond, real estate, or commodity due to its

limited production and increasing demand from the emerging markets, especially China. Also, Fine Wine investment had low

correlation with other asset classes (less than 0.4) during the same period. Higher returns and low correlation make Fine Wine an

interesting investment asset class. Moreover, after moving in the negative territory for almost four years on poor vintage quality, Fine

Wine prices rebounded in August 2014 due to positive investor sentiment, driven by rising demand from China. The investment-grade

wine index Liv-ex has generated positive month-on-month returns for four months in a row since August 2014. Amid such historically

low price levels, Fine Wine is emerging as an attractive investment alternative for long-term investors considering its high returns and

low correlation with other asset classes. Fine Wine is expected to have a bright future in 2015 due to growing demand from buyers in

Asia and the US; moreover, an improved vintage harvest in 2015 would support the price of Fine Wine.

Ankit Goel, Bhavik Mehta, and Garima Gupta – Investment Research Team, Aranca

Fine Wine investment offers portfolio diversification at higher returns and low correlation

Investment in wine generated consistent (~9.5%) annual return in the last decade

According to MarketLine, the global wine industry was expected to sell 22.1bn liters of wine and generate total revenues of around USD

292bn in 2014. Only ~1% of the total wine produced is used for investment purposes, while the rest is consumed. The wines used for

investment purposes are also called “blue chip” or “investment-grade wines”. As the value of wine increases over time, it offers high

returns if held until the maturity stage, which varies from a minimum of five years to 20 years or more. Over the last decade, the price of

wine had an average annual appreciation of approximately 9.5%. Gold is the only asset class under our study which generated slightly

higher returns (10%) than Fine Wine during the same period. Since investment in Fine Wine provides higher long-term returns and has

low correlation with other asset classes, it is considered as an attractive alternative asset class and acts as a portfolio diversifier for an

investor’s investments.

Fine Wine and gold yielded highest returns among different asset classes in the last decade

Source: Bloomberg

0

50

100

150

200

250

300

350

400

450

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

LIVX100 Index S&P 500 S&P Global REIT MSCI World Index CISDMEW Index (Hedge fund) Gold S&P World Commodity Index MorningStar EM Corporate Bond Index

Wine generated highest returns among all asset classes during 2004-11 due to higher demand from emerging markets and limited production of investable-grade Fine Wine.

Wine yielded lower results than gold since 2H 2010 due to poor harvest at one of the key producers (Bordeaux)

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In the last three years, the investment-grade wine index Liv-ex 100 declined 7.1% which can be mainly ascribed to a drop in the prices

of Bordeaux wine which constitutes the majority of the index. In June 2014, of a total of 100 wines contributing to the Liv-ex 100 Index,

about 84 wines were from Bordeaux. In the last four years, the Bordeaux region witnessed poor vintage quality, with the 2013 vintage

considered as the worst in 30 years owing to weak harvests. This deteriorated the quality of wines, leading to a decline in prices.

Reversing the downtrend, the Liv-ex 100 Index began generating positive month-on-month returns since August 2014. A current low

price level lured buyers back to the market, as investors believe the price of wine has bottomed out. The demand for Bordeaux wine

has improved since August 2014, led by increasing investor confidence, especially in Asia and the US. Among Asian countries, China is

a key growth driver, where wine consumption is expected to almost double to 400mn cases of wine by 2016 from 230mn cases in 2012,

according to Morgan Stanley’s estimates. With this, China could become the biggest wine consumer globally, outpacing the current

leading consumers France, the US, and Italy. In 2012, the estimated wine consumption in France and the US was close to 340mn

cases each, while that in Italy was 250mn cases. Overall, this rising demand for wine from the US and Asia (especially China) is

expected to outrun the supply as production levels have fallen in the last few years. This would also contribute to an increase in the

prices of Fine Wine. Moreover, a normal-to-good vintage harvest in early 2015 may be a key catalyst supporting the rising prices.

Key advantages of wine as an asset class:

High capital growth and low volatility: According to our analysis, the investment-grade wine market (represented by the Liv-

ex 100 Index) generated an annualized return of 9.5% during the last decade. This is the second highest return among all

major asset classes included in our study. Only gold outperformed the investment-grade wine on an absolute basis, generating

an annualized return of 10.0% during this period. The volatility of annualized monthly returns of the investment-grade wine

market was the second-lowest among all asset classes. Only a standard deviation of 6.8% for Hedge Funds (represented by

the CISDMEW Index) was lower than that of 10.9% for the Liv-ex 100 Index.

Fine Wine investment offered the lowest risk-reward than other asset classes in the last decade

Source: Bloomberg. We have used available indices with data history of 10 years or more to represent various asset classes. Period: November 2004-November 2014

Superior risk-adjusted returns: During the last decade, the investment-grade wine market generated the highest risk-

adjusted returns (as measured by both, the Sharpe ratio and Sortino ratio) among the asset classes included in our study. The

Sharpe ratio and Sortino ratio of the Liv-ex 100 Index came at 0.67 and 0.92, respectively, higher than all other asset class.

LIVX100 Index (Wine)

S&P 500

MSCI EM Index

S&P Global REIT

CISDMEW Index (Hedge fund)

Gold

S&P World Commodity Index

MorningStar EM Corporate Bond Index

MSCI World Index

0%

2%

4%

6%

8%

10%

12%

0% 5% 10% 15% 20% 25% 30%

Retu

rn

Risk

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Fine Wine investment yields the highest risk-adjusted returns than other asset classes

Source: Bloomberg. Risk free rate considered as US 10 year Treasury bond yield. Period: November 2004-November 2014. *MorningStar EM Corporate Bond Index.

Portfolio diversification: Historically, the investment-grade wine market has not shown high correlation with other major

equity-type asset classes, nor does it tend to strongly move in line with hedge funds, gold, bond, or other commodities. It had a

correlation of 0.24 with the S&P 500 Index, and correlations of 0.16 and 0.34 with the Gold Index and S&P World Commodity

Index, respectively. Thus, investments in investment-grade wine may help investors protect their portfolio against events that

have severe impact on the equity and commodity markets. Among other asset classes, only gold possesses similar portfolio

diversification characteristics. The Gold Index and Fine Wine Index had correlation of less than 0.4 with all other asset classes

under our analysis.

Fine Wine investment provides good portfolio diversification as it has low correlation with other asset classes

LIVX100

Index (Wine)

Gold S&P 500 S&P

Global REIT

MSCI EM Index

S&P World Commodity

Index

CISDMEW Index

(Hedge fund)

MorningStar EM

Corporate Bond

LIVX100 Index (Wine)

1.00 0.16 0.24 0.26 0.28 0.34 0.38 0.39

Gold 0.16 1.00 0.10 0.17 0.33 0.39 0.32 0.31

S&P 500 0.24 0.10 1.00 0.84 0.79 0.45 0.80 0.66

S&P Global REIT 0.26 0.17 0.84 1.00 0.71 0.36 0.68 0.73

MSCI EM Index 0.28 0.33 0.79 0.71 1.00 0.57 0.91 0.73

S&P World Commodity Index

0.34 0.39 0.45 0.36 0.57 1.00 0.64 0.51

CISDMEW Index (Hedge fund)

0.38 0.32 0.80 0.68 0.91 0.64 1.00 0.76

MorningStar EM Corporate Bond

0.39 0.31 0.66 0.73 0.73 0.51 0.76 1.00

Source: Bloomberg. Correlation of last 10 year M-o-M returns. Period: November 2004-November 2014

(0.5) - 0.5 1.0

S&P World Commodity

S&P Global REIT

MSCI World Index

MSCI EM Index

S&P 500

Gold

Bond Index*

CISDMEW (Hedge fund)

LIVX100 Index

Sharpe Ratio

(0.5) - 0.5 1.0

S&P World Commodity

S&P Global REIT

MSCI World Index

MSCI EM Index

S&P 500

Gold

Bond Index*

CISDMEW (Hedge fund)

LIVX100 Index

Sortino Ratio

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Consistent returns over time: Investment in Fine Wine should be considered for long term as the returns are more

consistent and less volatile for longer time horizon due to supply-demand imbalance in the long term. The figure below

illustrates that CAGR returns over a 10-year period are consistent and not so volatile, whereas CAGR returns over five- and

seven-year periods are relatively more volatile.

Liv-ex 100 Index’s 10-year CAGR has been consistent compared to 5- and 7-year CAGR

Source: Bloomberg and www.liv-ex.com

Tax-free investment for UK investors: The taxation authorities in the UK consider investment-grade wine, with life

expectancy of less than 50 years, as a wasting asset. Thus, any profit derived from the sale of such wines is not subject to

capital gains tax under the current UK taxation rules.

Key concerns of wine as an asset class:

Low liquidity: The investment-grade wine market is less liquid compared with the conventional equity and debt markets due

to small market size and high brokerage charges (15–20%).

Higher transaction, maintenance, and insurance costs: The transaction costs associated with the trading of investment-

grade wine is considerably higher than those of other asset classes such as stocks and bonds. Moreover, wines need to be

stored in a vibration-free environment and away from light (at a standard temperature). Investors of Fine Wine can rent a

specialized wine storage unit or allow the wine merchant to store these on their behalf. However, both methods incur heavy

storage costs. Additionally, investors have to spend large amounts of money on insurance costs against any damages. Thus,

considering the high costs of transaction, storage, and insurance, the wine investor expects a significant price appreciation

before reaping profits.

No provision for interim income: Unlike the dividend-paying equity stocks and interest-bearing bonds, investment-grade

wine does not generate any income for the investor until it is sold. Thus, the high expenses on the storage, transaction, and

insurance would only increase the costs for the investor while waiting for the price to appreciate.

Complexity in trading process: It is unlikely that a local liquor store would stock high-end wines from sought-after vintages.

In addition, buying investment-grade wines on their initial offering would be difficult because wines in short supply typically go

to long-term customers first. Thus, a wine investor would prefer to buy a Fine Wine at a specialty auction. Moreover, the

auction route is usually the only avenue available to wine collectors seeking to sell bottles. This, coupled with multiple state

laws, adds to the complexity in trading in investment-grade wines.

-5%

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25%

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Dec-1

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Oct-

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Au

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Ja

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Nov-1

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5 year (CAGR) 7 year (CAGR) 10 year (CAGR)

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

M-o-M YTD 1yr 5yr

Liv-ex Fine Wine 50 Liv-ex Fine Wine 100

Liv-ex Bordeaux 500 Liv-ex Fine Wine 1000

Liv-ex Fine Wine Investables

Fine Wine indices Performance as on 30 November 2014

Liv-ex 100 Index

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Spoilage, damage, or theft: Investment-grade wines, being a tangible and consumable asset, are subject to the risk of

spoilage, damage, and theft. However, an investor can minimize these risks by storing wines in a safe and temperature- &

humidity-controlled facility and by buying insurance for the wines’ replacement value.

Supply of counterfeit wine: Wine investors are always at the risk of being supplied a counterfeit wine. A recent news article

from the InsuranceNewsNet magazine estimates that 70.0% of all Chateau Lafite Rothschild in China are counterfeit.

How to invest in Fine Wine?

Investment in Fine Wine is not a new phenomenon. Investment in wines increased after the establishment of wine stock exchanges in

1999 which provided investors with easy access to market information, most important of which is the price of wine. In order to qualify

for the investment-grade wine, the wine should possess high quality, longevity, sufficient production levels, and ability to deliver

significant price appreciation. These wines have a strong demand and their value appreciates over time. Some common ways of

investing in wine are listed below:

Wine aging: This requires buying a high-quality vintage wine and selling it after some years. This is commonly known as

“aging of wine”. The process is cumbersome as it involves storage costs, temperature control for storage, and a seller who

would pay the right price for the wine.

Wine auctions: Investment-grade wines can be procured from auctions. These auctions are common in the US, particularly in

Chicago. The auctions in London are held mainly to decide on the retail price of other vintage wines.

Wine stock market: Wine is widely traded on three wine exchanges in the UK: London International Vintners Exchange (Liv-

ex), Cavex, and Berry Bros. & Rudd (BBX). These exchanges focus primarily on top wines having high saleable value. The

Liv-ex has multiple indices and sub-indices (Liv-ex Fine Wine 50, Liv-ex Fine Wine 100 and others) that are widely used to

track prices of tradable investment wines.

Wine funds: The function of these funds is identical to that of mutual funds. A group of investors form a pool of capital. The

fund manager, who is the caretaker of this pool of capital, invests the same to buy wine and waits for the right opportunity for a

resale. The profits gained by the fund manager are either re-invested or passed on to the shareholders. Since this form of

investment involves huge risks, most investors here are high-net-worth clients who have a large risk appetite. Some wine

funds include The Wine Investment Fund, Fine Wine Fund by The Wine Asset Managers LLP (WAM), and The Vintage Wine

Fund by OWC Asset Managers Ltd.

REITS: Investors have the option of investing their money in vineyard lands through REITS that deal in vineyard land as an

asset. For example, the Blue Chip Winery Fund of the Bahamas follows the strategy of buying stake in vineyards and wineries

based in Europe and Canada.

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Pouring Wine to Your Investment Portfolio - Returns on a High!

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