Fine Wine Investing: Better with Age?

Investing

Is investing in fine wines a smart idea?

Investing in collectibles has certainly become trendy. Purchasing high value physical assets is now regularly spoken of as though it is prudent.  These high-value physical assets have their own acronym, SWAG: silver, wine, art, and gold. In particular, wine has become a much discussed investment topic.

Chatter aside, investors should exercise discretion when investing in wine or other SWAG assets. They should be concerned that the intrinsic value of SWAG cannot be calculated and that they are bidding against investors driven by non-financial motivations.

Valuation of Wine Is Impossible

Investors should be afraid to chase SWAG investments which lack any income or cash flow based valuation. In contrast, a firm like Microsoft (MSFT) generates sales, earnings, and cash inflows to its owners. As a dividend paying firm, Microsoft also pays its shareholders directly. As is the case for many stocks, the operations of Microsoft literally grow your investment.

If an investment does not have some kind of mechanism for generating value, then it resembles a pyramid scheme. Investors in these assets can only realize returns by flipping them at a higher price. Unfortunately, returns can only be realized by selling SWAG assets to another buyer or “greater fool” at higher prices.

In the long run, the only driver of returns for SWAG or commodity investments is inflation. However, there are investments such as dividend-paying stocks and Treasury Inflation-Protected Securities (TIPS) which also benefit from inflation. These beat a bottle of wine because they benefit from inflation and also generate income returns on top of investment principal.

The Wine Rush

As an asset class, wine has done very well in the past decade:

  • The Liv-ex 100 Fine Wine Index has outperformed most major asset indices between 2001 and 2011.
  • At a cumulative average annual growth rate of 11.3%, only gold (18.3%) and commodities (12.9%) have outperformed fine wine.

However, this price appreciation is actually bad for investors who are looking to buy now since these price movements only reflect investor enthusiasm – it’s not like every bottle of wine grew 11.3% per year during this period. Only the prices have changed, not the assets.

There are many ways to access the wine markets. Do-it-yourself wine investors who wouldn’t mind a roughly $1000 annual membership charge and trading fees between 2.5% and 1% could trade directly at www.liv-ex.com. Storage and handling of wine assets is handled by the firm and annual fees start at about $9,000 per year.

Investors can also invest in this asset class through a number of funds which specialize in wine investing. For example, the aptly-named Wine Investment Fund charges a one-time 5% subscription fee and a 1.5% yearly fee for private investors.

These fees are too high for most retail investors. They are by no means cheap from any perspective.

Investing for the Wrong Reasons

Wine investors can be bad company. Do not assume that the “social proof” of other investors purchasing wine somehow validates current asset prices. Instead, investors should be weary of the psychological or “psychic rewards” that some investors get from investing in wine.

To flush out this concept we should define the goals of investing. An investor should seek investments which (1) increase the expected value of her portfolio and (2) decrease uncertainty in the future value of her portfolio. These dual goals drive the search for assets that are trading below their intrinsic values and are boring.

Wine investing, on the contrary, is sexy. Some investors who are not focused on increasing expected returns and decreasing volatility in their portfolios will sometimes make investments for nonfinancial reasons. Non-monetary rewards have been dubbed “psychic rewards” by economists. Those who buy wine as an investment may be paying a psychic premium over its financial value. Though it should go without saying, paying too much is bad because reduces expected future returns.  Wine investment vehicles may also leak capital through high fees, but this is not unlike many other financial instruments out there today.