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Investors in fine wine have seen their investments outperform traditional investments for years. In addition, they have been able to capitalize on the associated benefits that come with this kind of alternative asset class. However, there are some downsides to investing in wine that investors need to weigh before they decide to begin.
The past is not the future
As always, past portfolio performance can’t predict the future. Wine investing has too many variables to be considered low-risk, including annual changes in wine production, the quality of wine produced, wine drinking habits, and even the health of the global economy.
In addition, wine investing profits are based on scarcity. But as many regions in the world now produce better-quality wine, the overall quality of wine – even blue-chip wine is increasing. As investors rush to secure the best wines with hopes of selling them in the future, some may find that their bottles are fetching lower and lower profits, because more wine is being held and made available by wine investors for sale at auction.
Ultimately, wine is an illiquid investment. It is included in the “alternative” asset class because its value cannot be known until it is sold. Moreover, it can be more difficult to sell than stocks, bonds, and commodities, because it can only be sold through licensed brokers and companies. Strangely enough, wine is harder to sell than precious metals, gems, and traditional securities.
Cyclical profits and investment bubbles
All investments tend to follow some type of cyclical pattern, and fine wine investments are not an exception. During World War II, when France was occupied by Germany, prices increased by 600%, but then fell by 50% after France was liberated from German occupation. Industry observers have noted the same industry cyclicality in the 1970s, 1980s, 1990s, and in the 2000s (2009 – 2013).
In general, fine and premium wine (wine selling for more than US$10/bottle) sales have been increasing over the years. They netted US$17 billion by the end of 2017, after increasing 8% per year since 2012. Moreover, it is expected that the sales increases will continue until 2022 – when they’re predicted to peak at US$25 billion.
But have prices always just gone up? No. There have been wine bubbles in the past, and some industry observers think that at least some wine investors are in a bubble now.
By summer 2008, the Liv-ex Fine Wine 100 Index had risen to over US$300 from barely more than US$100 over a three-year period. After that stratospheric rise, it plummeted to US$170 by the following autumn. It then recovered to US$330 before falling to US$230, a price it floated around for years afterward.
What’s driving critics’ current concerns? The Liv-ex Fine Wine 100 Index rose to US$237.60 in November 2018. That’s 1.3% higher than the listed price in October 2018, and the highest price level for the index since September 2013, when it climbed to US$243.80.
You see, when the index rises too quickly for market observers’ comfort, they assume that eventually, it will drop just as quickly. The index has followed such patterns in the past (e.g., 2008). While the November 2018 price was not much higher than its longtime average, observers don’t understand what has pushed the price up. Thus, they suspect it owes to people overvaluing the market or aspects of it.
A highly speculative investment
In the past, wine investors purchased bottles of wine when they were en primeur– when the wine was still maturing in its casks. Normally, investors had to wait 1-2 years before the wine was available for sale. Thus, that was the cheapest time to purchase the wine. Unfortunately for investors, the cost of buying wine en primeur has increased significantly.
Purchasing wine en primeur was like investing in an IPO. The investor was betting that the wine would sell well and for far more than it cost to acquire and maintain it before the sale. That made those investors’ bets highly speculative.
Further adding to the cost of wine, it’s usually held for about 5 years for short-term investors, and 10 years or more for long-term investors. During the holding period, the investor must safeguard the investment at an increasing expense, in hopes of profiting from the wine when it is auctioned off.
Variable profits: Quality, costs, and dilution
The available stock of fine wine can be diluted by the production of more wine during that production year. But as more people drink the wine, less of it is available for sale at a later date.
Many variables affect the quality of the wine, including how it’s produced, transported, and stored. So, wine investors must have reliable and accurate knowledge about not only the corks used in the wine bottles, but the temperature at which it is stored, its environmental humidity, and how much light it is exposed to. Low quality equals lower prices at auction.
And the value of wine does not increase forever. Because wine changes as it ages, its value depends upon the opinions and taste buds of others who are potential purchasers and consumers of the wine. Also, at some point, a wine’s taste will begin to decline. Investors must estimate how long they can hold the wine before its desirability to wine drinkers lessens. Predicting the best time to sell a bottle or case of wine is as difficult as timing stock trades.
Until the wine is sold, it should be insured against natural (e.g., earthquakes, floods) and man-made (e.g., fires, theft) disasters. The insurance can be very expensive, and investors must consider its costs when estimating their gains and losses.
An unregulated market
Wine investing is unregulated, unlike traditional investments. No agencies, inspectors, or other industry watchdogs protect wine investors from unsavory characters and crooks.
Wine connoisseurs know that wine counterfeiting is a serious problem. To avoid purchasing overpriced vinegar, wine buyers require a lot of documentation when considering their wine purchases. Wine investors must be convinced that the wine is the “real deal.” Thus, wine investors must show proof of origin of the wine when it is sold.
Sometimes, wine investors must “sacrifice” a bottle of wine for tasting in order to show that their stock is authentic. Counterfeiters can also lower wine prices by slipping counterfeit bottles into the current stock up for auction.
Finally, there is the temptation of having fine wine available to drink and serve to guests, and not drinking it because you want to sell it for a profit in the future. The curse here is that wine investors may purchase wines that they want to drink, instead of purchasing wines that are likely to increase in value over time. Worse yet, that status and value may only increase buyers’ desire to consume the wine or give it away, rather than hanging on to let it appreciate.
In short . . .
Wine investments have outperformed equity and fixed-income investments on the FTSE 100 for 20 years. Over the past few years, wine has also outperformed other alternative asset classes like copper, oil, and gold, with less volatility than stocks and no correlation to traditional investments. Through recessions, market fluctuations, or changes in interest rates, it may remain a good investment over the long term, and may continue to produce a nice yearly ROI.
But it does have its downsides. Investors should weigh how much risk they can tolerate when investing in this speculative market. Yes, the potential gains are high, but just like an IPO, so are the potential losses. Investors are advised to only invest what they are willing to lose. Like all good things, bingeing on it may result in a nasty financial hangover.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Alisa Hopkins doesn't own any shares mentioned.