Why wine investment (occasionally) works

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1 Written by Jancis Robinson 11 Jun 2005 Why wine investment (occasionally) works David Lester of Manchester University, whose frequent and valuable contributions can be read in 'your turn', has kindly contributed the following to today's Wine investment supplement in the Financial Times. This is an expanded version, written with the UK investor in mind but with lots of solid tips for those elsewhere too. We often hear stories about successfully finding desirable wines at remarkable prices, indeed, as one Victorian observed: `Every Englishman who is rich enough to pay income-tax has, at one time or other, effected a very remarkable transaction in wine'. We've all heard tales of people buying a case of Le Pin 1982 for 150, which would now be worth 18,500, if it hadn't already been consumed. It would be misleading to think that such deals are everyday occurrences in the wine world. Commodity trading theory As with all commodities, the rules of wine investment are simple: `price is determined by supply and demand', and `buy cheap, and sell dear'. Considering supply first: production quantities are determined by the weather, and as the producers generally seek a steady annual income, all things being equal, lower yields lead to higher prices. As a wine matures, bottles are consumed, the wine becomes rarer, and if it's desirable, its price rises further. In classical economic theory, a producer could scale up production to meet demand; for fine wine this isn't possible. In Europe the plots of land from which the greatest wines are produced are legally delimited. In theory those New World wines not tied to a particular place, such as Penfolds Grange and Screaming Eagle, could have their production increased; in practice fears of diluting quality prevent this happening. Be aware that some producers, most famously the previous owner of Château d'yquem, may reduce supply by holding back some of their

2 production for later sale. The factors affecting demand are more interesting. Rising global prosperity and economic liberalisation, especially in China and Russia, are leading to a worldwide increase in demand for fine wines. Obviously a worldwide economic slow-down or anxiety about the future will affect the market for fine wine, just as it will for other investments. Equally importantly, US wine critics such as Robert Parker and their 100 point scales have introduced a whole new cohort of the world's population to fine wine. Since production cannot be increased, prices inevitably rise. There is also an aspect of currency trading in some price movements: since international trading of wine is relatively straightforward, a currency movement can cause fine wine to flow between markets. To be honest, it is easier to exploit this effect by dealing directly in currency than it is at one remove through wine: the transaction costs are far lower. Wine trading in practice So much for theory, but how do you make money in practice? The classic wine investment advice is stark: `Only buy the best claret from great vintages. Buy it early, keep it in the original wooden cases and always choose magnums and never halves.' To which I would only add: `Store it professionally in a bonded warehouse'. Professional storage reassures potential purchasers that a wine has been stored properly; in addition, wines stored under bond can be bought and sold without incurring VAT. Be aware that if your primary motivation is purely investment, then the UK's Inland Revenue might view any profits from your wine trading as taxable income. For many of the world's most desirable wines, the real problem is getting hold of enough of it at the lowest price. Producers often seek to sell their wines around the world, building up a global customer base to insure against any weakness in individual markets. There are also a few producers who permit merchants to become exclusive agents for their wine in particular markets. In the UK, where demand for desirable wines usually exceeds supply, merchants divide up their allocations, selling to their favoured customers. Different merchants have different ways to determine who their preferred customers are. Mechanisms to determine preferred customers include: those who annually buy a particular wine, regardless of vintage; those buying lesser wines as well as the desirable ones (so-called `tied bottles' or `hostage bottles'); by lottery; first-come-first-served; overall annual spend; and - a new one to me this year - average three-year spend. There are two moments in a wine's life at which it is usually best to sell: immediately after a wine become physically available and once it has reached maturity. In the first case, those of us who've failed to get all of a wine we wanted on initial allocation are prepared to pay a broker over the odds to buy a few more bottles. There are two sources for these bottles: other wine enthusiasts who've received too many bottles, and the `grey market', ie bottles sold to foreign restaurants and wine merchants, and subsequently sold on through UK brokers. If it seems that fine wine buying is like fly fishing - with much patient waiting between landing a great catch, and no great quantities available - then that accurately reflects my experience. Which wines make the best investments? It is as well to keep in mind an anecdote from Simon Loftus' (of Adnams) book Anatomy of the Wine Trade which he attributes to the late Peter Sichel: `Abe bought a shipment of sardines that had already been traded many times and each time profitably. Unlike previous buyers, Abe

3 decided to try a can of his purchase. The sardines were terrible. He telephoned Joe from whom he'd bought them only to be told ``But Abe, those sardines are for trading, not eating!''' Naïvely, one might suppose that demand for a particular wine was determined by its quality. In fact it's a wine's desirability and not its quality per se that is important. Some of the factors affecting desirability are fashion, high price, perceived quality, and rarity. But we do not want wines that are too scarce, since if they are traded too infrequently, buyers are not expecting to find the wine, and it can be difficult to judge accurately the market price. According to Mark Bedini of Fine & Rare Wines, "For many rare wines, for example Roumier's Musigny, our system uses direct comparable wines to gauge the right price for a wine. For extremely rare and valuable wines - German Auction wines, for example - we would have to fall back on our experience." -Bordeaux reds The traditional favourites are Châteaux Latour, Lafite-Rothschild, Margaux, Haut-Brion, Mouton-Rothschild, to which Châteaux Pétrus, Cheval Blanc and Ausone can be added. The first five are available in sufficient quantity that you should be able to secure a case at close to initial pricing if you so desire. Pétrus and Ausone are much smaller and will be harder to find. Pricing of claret is closely correlated to Robert Parker's scores, so if you are seriously investing, you should subscribe to his newsletter The Wine Advocate; the rest of us don't have to bother. Bordeaux has a well-developed market for selling wine before it is finished: the en primeur market. In the internet age it is also worth checking prices in France as well as the UK for en primeur purchases; I secured some of the top clarets from 2000 at opening prices, direct from the negociants, whereas UK merchants and brokers had low availability and high prices. Negociants prepared to deal with the UK public include 1855.com and Millésima. Pick the right wines in the right vintages and making money by buying Bordeaux en primeur is easy; for other wines and vintages your investment usually grows very slowly at best. However, making a quality judgement about such young wines is very difficult, and Mr Parker often revises his scores when the wines are bottled, 18 months later. Inveterate gamblers who are tempted by the earlier example of Le Pin 1982, should have realised that it was an unknown in 1982, and be on the lookout for modern unknowns that will subsequently be recognized as classics. One tip when buying en primeur is to price up equivalent recent vintages using this should reduce the chance of overpaying for a wine. -Bordeaux whites With the irrational exception of the 2001 Sauternes, the market appears almost moribund. Given the almost immortal nature of these sweet wines, and the proven quality of the vintages The only reason I can see for the higher prices of some of the 2001s is fear in the US about provenance for the older vintages. -Red burgundy Most wines are produced in small quantities. One exception is Domaine de la Romanée-Conti, or DRC and its most famous wine: La Romanée-Conti. Production quantities are high for Burgundy, and there is a thriving secondary market. The difficulty, as Adam Brett-Smith of the UK agent Corney & Barrow acknowledges, is actually getting hold of case quantities of the wine at the initial price. To increase availability, the Domaine has pioneered the use of first sixand now three-bottle cases of these wines for the UK market. There are much rarer and equally sought after wines, such as Domaine Georges Roumier's Musigny of which there are typically just 300 bottles annually to satisfy world-wide demand; it's rarely seen on the secondary market. -Red Rhône The best wines are made in tiny quantities, meaning that case quantities are tricky to source at opening prices, and that there is a limited secondary market for mature bottles. You might consider Guigal's top Côte-Rôties and Chave's Hermitages.

4 -White burgundy Undeniably one of the world's great wines, but because there are many producers, each wine is made in such small quantities that there is almost no secondary market for mature bottles. Buy them to drink. -Vintage port These wines develop, and therefore appreciate, very slowly. As the UK Inland Revenue do not consider it a `wasting asset', expect to pay Capital Gains Tax. -Italy, Germany and Spain All make great wines in small quantities. As usual this makes subsequent trading problematic. Buy them to drink. -US The most prestigious wines, such as Screaming Eagle, are sold to mailing list subscribers. Apparently the 2001 was $300 per bottle on the mailing list, but on the open market expect to pay about $1000 in the US, and 1000 in the UK. If you're not already on the mailing list, forget it. -Australia Penfolds Grange is produced in reasonable quantity and has a well-developed secondary market; this contrasts with Henschke's Hill of Grace which is produced in small quantities. Fraud There are a number of relatively rare dubious practices to watch for. A wine investment company might offer wine at an inflated price, so use to check prices. Sometimes companies sell wines they don't own. Typically this is an en primeur sale, giving the perpetrator 18 months before the fraud is uncovered. One common clue is that although the price is correct, there is availability in quantity. Finally, there are fake bottles out there: the only real solution being frequent exposure to the real thing, and dealing with trustworthy merchants and brokers. To reduce the risk of fraud, I adopt the following precautions: - check that the company is not one of the suspect drinks investment companies listed on Jim Budd's website - check that the company is submitting its tax returns on time at - pay by credit card as you've a better chance of getting your money back in the event of things going wrong. Costs There are a number of incidental costs that we often forget to include. Moving a single case of wine typically costs 10 per case, though prices fall for multiple cases. You might be expected to pay this when the wine is delivered and when it is sold. Using Private Reserves Ltd as an example of a bonded warehouse for private investors, the costs are: 3.50 per case for receiving a case, and storage at 8.82 per case per year, including insurance [but their costs are particularly reasonable see this recent comparative survey of storage rates - JR]. As an example, I asked Mark Bedini to take me through the process of selling a case of Hermitage La Chapelle 1999 through his broking company [something I'd advise; see my forthcoming notes on 1999 North Rhônes JR]. The current market price is 321, so subtracting the broker's charge of 15 per cent, I could expect to receive , provided that the market price didn't change. I've paid four year's storage and would need to ship the wine

5 between bonded warehouses; together this will cost a further If the wine fails to sell immediately, I'll have to pay additional storage charges to Fine & Rare. As I paid another UK wine merchant 395 for this wine, I've made a loss of You don't often hear this sort of wine investment story.