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The rules of wine investment have changed

Take note: The rules of wine investment have changed...

The resounding message from both the wine trade and the financial press throughout the Noughties was unequivocal; when investing in a case or two of the red stuff for profit stick to the top blue-chip châteaux, only buy from the finest vintages and pay close attention to the judgements of über critic Robert Parker; if His Bobness bestowed a score of 95+/100 you could be pretty sure you were on to a good bet.  But how do these simple rules fare in today’s ever more sophisticated wine investment world?

A perfect candidate to put the old rules to the test is Château Latour 2003, a wine so desirable its very mention is enough to render your average oenophile weak at the knees.  Latour is Bacchanalian royalty; one of an elite of just five châteaux honoured with Premier Grand Cru (First Growth) status, and in this vintage it sports the hallowed 100/100 Parker score.  Awarded just 3 times to the estate in the last 100 years, Latour 2003 represents the very zenith of wine making. 

According to price-comparison website wine-searcher.com the average price for Latour 2003 in November 2009 was £8,172.¹ Jump 12 months and that average has risen to £9,984 - growth of some 22.2%.  Not bad.  So yes; the rules still work, to a greater or lesser degree.

Over the same period, however, any number of wines sporting far less prestigious labels and impressive grades enjoyed such ferocious price ascension as to cause the mighty Latour to blush.  Previously unheralded Duhart-Milon, for example, positively shot up across a number of recent vintages, the 2005 appreciating by some 90.8%.  Meanwhile Carruades de Lafite 2002, awarded a distinctly humble 87/100 by Parker, enjoyed a stellar 133.2% rise.

Even in the big-boy league things weren’t as they should be; Lafite 2007, critically considered the weakest vintage of the Noughties, left the estate’s offering from the magnificent 2005 vintage for dust; an eye popping 153.7% versus ‘just’ 60.7% respectively.

In fact, had you been one of the lucky few with the foresight to punt on Duhart-Milon 2007 last November, ergo breaking all three rules (it scored just 90/100), you would have enjoyed truly staggering growth of 166.6%!  So there’s the lesson: stick to the rules and turn £1 into £1.22 in a year; flagrantly disregard them and turn your pound into a whopping £2.66. 

At Albany Portfolio Management we began breaking the rules early last year to great effect.  Whilst the ‘market’ (as defined by the London International Vintners Exchange’s benchmark 100 Index²) has appreciated by an admirable 33.0% in the last 12 months, the wines contained within our customers’ portfolios have grown by 66.1%³ - a smidgen over double.

¹ the average prices quoted on www.wine-searcher.com are cited throughout this report - an explanation of the methodology behind the calculations may be viewed here | ² www.liv-ex.com | ³ the full Albany Portfolio Management performance data series may be viewed by clicking here

The answer lies east...

For those more long-in-the-tooth wine investors among you (who have no doubt been making tidy and consistent profits by sticking to the old rules for decades, thank you very much), these figures will come as a bit of a shock - and rationalising them will prove rather taxing we suspect.   In fact, for the answers you need look no further than to mighty China.

China has positively exploded into the wine market in recent years - emerging in the blink of an eyelid as the most significant and dominant force in the market - and in consequence the dynamics of the marketplace have changed beyond all recognition.  Of course, these days China can afford it: The figures relating to the country’s wealth creation are truly astonishing, documenting a meteoric rise in fortunes.

In terms of numbers of millionaires, China has charged from outside the top 10 to No.2 in just four years, and now sits only behind the US. It’s these young (your average Chinese millionaire comes in at a tender 38) cash-rich individuals who have fallen head-over-heels in love with fine wine.  Consumption of top claret in China is increasing at an inexorable rate and a case or two of the fine stuff is now the gift du jour to lubricate business deals and government dignitaries. 

With little more than 100,000 cases produced in each vintage for worldwide distribution by the Big 8 Bordeaux châteaux combined (the five First Growths + Petrus, Ausone and Cheval Blanc; accounting for as much as 90% of the wine investment market), throwing China’s 128 billionaires, 55,000 super-rich, 875,000+ millionaires and several million newly wealthy individuals into the pool was evidently going to cause waves.

The impact on the finely balanced supply / demand dynamic of the market was devastating to the old order.  Demand had never before increased on such a scale or so suddenly and something had to give;  with preciously finite supply, (or more accurately, diminishing supply - the perfectly inverted supply curve, as the wines are consumed, is a unique characteristic of fine wine as an asset class investment) prices went into orbit. 

This sudden influx of demand goes some way to explain the remarkable performance of the wine market overall in the last two years.  What’s less evident though is why the old rules have been rendered quite so redundant.  The answers lie in three notable shifts in market mechanics; let’s call them the China Effects 1 - 3:

The China effect No1:  The rise of the brand

In newly wealthy, image conscious China, significant chunks of disposable income are being spent on high profile luxury goods.  According to a recent Credit Suisse report, China - with approximately 25% of the world’s population - accounts for only 5% or so of the international market for every day brands like Coca-Cola, but as much as 30% of the likes of LVMH, owner of Louis Vuitton.  Indeed LVMH, Rolls Royce cars and Omega watches already cite China as their most important marketplace, and according to research by  Merrill Lynch and Cap Gemini it will be the biggest consumer of luxury goods overall by 2013.

It’s this love of conspicuous consumption that has lead to the emergence of a select band of wine producers as ‘brands’ in China.  Château Lafite-Rothschild is a case in point; as China’s thirst for fine wine grew, Lafite emerged as the firm favourite and a near fanatical love affair began.   Buying was frenzied and prices rallied accordingly, hastily repositioning Lafite into a price bracket of its own; the differential to the other First Growths quickly becoming so great that the uninitiated would be forgiven for thinking that Lafite is in a quality league of its own (it isn’t).

With soaring prices across all vintages good, bad or indifferent, Lafite rapidly became financially inaccessible to many.  In response, and in a notable departure from the traditional patterns of the market in the west, Chinese buyers sought to satisfy their Lafite addiction by snapping up anything that reflected the brand identity. 

The rule-book busting examples cited on the opening page of this report are, in fact, all members of the extended stable of Domaines Baron de Rothschild.  Carruades is in reality simply the second wine of Lafite - the effort the estate produces each year from the grapes that don’t make the cut for the grand vin - and Duhart-Milon is a little Fourth Growth estate bought by the Rothschild’s in the 60s.

Tellingly, these days both Carruades and Duhart are known affectionately in China as ‘little Lafite’, their credibility cemented by their branding which, at a glance, makes it virtually impossible to distinguish one bottle from the next (see image).   The spirit of the diffusion fashion brand - think Emporio vs Giorgio Armani - runs strong in the Chinese wine market.

Whilst in this example the integrity of the brand is held steadfast by the indisputable quality of Lafite as the underpinning wine, demand for the others appears to have little to do with vintage or quality, but all to do with the attaining the Lafite experience and the kudos that comes with it without the eye watering price tags.

The China Effect No.2: Market Polarisation:

In normal market conditions one would expect the prices of the top clarets to more or less echo the natural pyramid of the classed cru league table; First Growths at the top and therefore most expensive, dropping in visible steps down to the Fifth Growths (notwithstanding a slight readjustment here and there to reflect the rise or fall from grace of certain châteaux over the years). 

Within this natural order, one would expect to find near parity in the prices of the First Growths (including Lafite) from like vintages, and to find the best of the Second Growths at perhaps a third to half of these values - give or take.  Certainly the 2^nd wines of the estates - all produce a second, generally inferior offering in the same vein as Carruades from their crop each year - would normally be trading at a mere fraction of the prices of their grander brethren. 

Today, as a direct consequence of China’s buying patterns, this snapshot is unrecognisable: Lafite prices soar above anyone and everyone and even the very best offerings of the Second Growths languish at mere fractions of the Firsts. Most astonishing of all is that Carruades prices - which just a few years ago were £250-£300 per case - now dwarf the generally far superior Second Growths, and compete with the prices of even the First Growths.

Just how profound the impact of China has been on prices is evident in the graph below, and whilst most pronounced in Lafite and its siblings, the effect is nonetheless visible across the other First Growths.  In turn this has created a noticeable black hole - a price band void - in the marketplace: survey the stock list of any fine wine merchant today and you will be presented with an array of these £5,000+ First Growths, and a selection from the lower classed Crus priced from just a few hundred pounds to rarely more than £2,000.  Between £2,000 & £5,000, however, you’ll find the cupboards decidedly bare: Classic market polarisation.

Of course, the iron law of supply & demand simply won’t tolerate this position for much longer. Whilst the super-rich are evidently perfectly happy to pay thousands per bottle (indeed the more expensive the better if it’s an image driven purchase or a gift to impress), there is now a considerable, growing international demographic of wealthy individuals both within and outside of China, either unwilling or unable to meet the soaring cost of the First Growths, who are nonetheless demanding world-class, prestigious, fine Bordeaux.

These individuals are now forced to seek quality and value outside the traditional First Growth market, and so - with our investor’s hat on - we’re presented with some rare and compelling opportunities amongst the lower Crus; all the more so when considering that many are wonderful gems crafted in celebrated estates, dripping with pedigree and in terms of quality, every bit the equal of the First Growth elite. 

Consequently the best offerings from the lower Crus are now beginning to find themselves subject to the very same market forces - exponential increases in demand coupled with tumbling supply - that have had such a dramatic effect on the prices of Lafite and the other First Growths (not to mention Carruades) over recent years.  As the market naturally and inevitably broadens to accommodate this demand, it is here that some of the greatest gains are likely be found in the wine market over coming years. 

The China Effect No.3:  Push-ups and Pull-ups  

Whilst price appreciation across all the major châteaux from pretty much every recent vintage has been considerable, the individual ascensions have been far from smooth.  In the first two quarters of 2010, the recent non-prime vintages from Lafite (01, 02, 04, 06 & 07) positively blasted ahead - soaring from an average of £3,614 to £4,794 in Q1 (32.6%) and then on to £6,600 for Q2 (37.7%).  In the same periods the prime vintages of 00, 03 and 05 managed just 7.9% in Q1 and 8.7% in Q2, the ratio between prime and average vintages narrowing from 2.6:1 to just 1.9:1

The rally of the non-prime vintages in Q1 & Q2 is simply a reflection of the fact that they were cheaper and therefore more accessible.  Historically, buyers in the west had tended to shun the lesser vintages, preferring to sacrifice quantity for quality. In China, the opposite seems to be true - although only up to a point (see below) - unravelling the mystery of the far higher growth seen in Lafite 2007 than in the 2005.

Come Q3, however, and the tide turned: the non-prime dash slowed to a positively pedestrian 6.1%, hitting an average of £7,002 at the end of September (it is worth mentioning at this point that at the time of composition prices have once again begun to surge forward), whilst the prime vintages rallied from an average of £11,832 to £15,336 - an admirable 29.6% charge which expanded the ratio to 2.2:1.

In consideration of this reversal of fortunes, it becomes evident that once the gap narrows sufficiently, the additional cost for the added quality and/or kudos of the best offerings becomes rather more palatable to the Asian Lafite fancier.  This progress - which might be likened to a caterpillar contracting and expanding itself for forward propulsion - is a notable pattern across the all major châteaux.

In fact, the same syndrome can be seen not only between vintages of contrasting quality, but also between competing châteaux; where Lafite leads, it seems, Latour, Margaux & Mouton et al will eventually follow (just a few rungs down the price ladder).

The new rules of wine investment...

So, the million dollar question:  Is it possible to take lessons from the effects of the impact of China, and draw up the findings into a new rule book for today’s market?  The answer is both yes and no.  The old rules were simplistic in the extreme, and attempting to re-evaluate them into a wine-investment-by-numbers format is, of course, futile in such a rapidly changing, organic marketplace.  The market is in fact so unrecognisable on comparison to that of just two years ago that the crystal balls of commentators have become decidedly fuzzy when trying to predict the future.

Nonetheless, our report would be of little purpose without some effort toward pointing the modern wine investor in the right direction, and so we make the following offerings (and while we’re at it we’ll put our money where our mouth is with a few specific tips):

1. Second best is, er, best (for now)...

One would be forgiven for thinking that today’s wine investment market - rather like the property maxim location, location, location - is all about Lafite, Lafite and yet more Lafite.  This couldn’t be further than the truth, and in reality every one of the châteaux cited in this report can dazzle with their own tales of stellar price growth.

Even in this lofty company, however, Carruades has - to the disbelief of all in the trade - proved to be the greatest investment of recent years.  Demand for the brand experience at a bargain price is already filtering down to the 2^nd wines of the other First Growths - Forts de Latour, Petit Mouton, Pavillon Rouge (Margaux) and Clarence (née Bahans) Haut Brion are soaring.  Forget the grade and forget the vintage; neither, we suspect, will turn out to have much bearing on your fortunes.

In fact - and here we’re going to stick our neck out - at current prices forget Carruades too.  That’s not to say it won’t go up some more - it probably will - but the price / quality ratio is already frankly ludicrous, so if you want to cash in on the Lafite brand we reckon you’ll do far better with Duhart-Milon. Cheaper, better, and every bit as credible as a Lafite substitute.

Those really fancying an outside punt could even consider a case or two from the 2^nd wines of the Second Growths and / or the other rising stars.  A case should cost you less than taxing your car, and any one of these has the potential to be a future Carruades...

A word of warning here, though: the quality of these second wines is on the whole nowhere near sufficient to justify the price ascension.  At some point we believe that prices will plateau as the market in China and the rest of Asia becomes more sophisticated and affections switch to the likes of the châteaux below.  We reckon you’ve got just 18-24 months to play in this field.

2. Seek out the next big thing...

We would expect the polarisation of the market to rapidly narrow; simple economics dictates it.  If, like us, you’re feeling bullish about the future of wine, then the sizable void below the First Growths will surely be filled by the rise of “the next big thing”.

Whist the wines cited above are a lot of fun and have some serious short term potential, investors building sensible, well balanced medium or longer term portfolios should have these wines represented in their holdings.

Here’s a selection of our top tips:

3.  Spot the difference...

Where the price differential between the wines of a certain château from vintages of varying quality appears too great or too narrow, there is most likely an opportunity.  If the differential looks too narrow, bet on the best vintages to accelerate away. If it’s too great, bet on the lesser vintage to play catch-up.  Simple as that. 

The same goes if the gap is too great or narrow between the wines of competing estates in like-for-like vintages.  Armed with this information, our underperforming Latour 2003, with its lack lustre 22% compared to 89.9% for Lafite 2003 in the last 12 months, turns from lame duck into compelling opportunity; in fact, we would highly recommend it to anyone considering a £10,000 investment.

Indeed - notwithstanding our new rules no.1 and 2 - Latour and the other First Growth estates should still form the backbone of any portfolio.  Rule no.3, then, is simply designed to get the best from blue-chip planning; to increase the reward by a margin.  The greatest returns may well be found elsewhere in coming years, but the safest will be realised here; make sure you get these into your portfolio before you start playing with the upstarts.

Even here, though, we predict that the playing field will change and that within the next 12 months a challenger for the Lafite crown will emerge from other First Growths – the gap is simply too large to justify.  We fancy Latour, as we believe its blockbuster weight will suit the Asian palette, but others fancy Mouton for its Rothschild moniker, Margaux for its finesse, or even Haut Brion for its uniqueness.

The push-me, pull-you affect now makes even Petrus and Domaine de la Romanée Conti (DRC) - to many the absolute epitomes of fine Bordeaux and Burgundy respectively and the most expensive by a margin - look positively cheap.  We realise how obscene this must sound, but having been desperately overshadowed by the growth of the First Growths in recent years, the gap has narrowed too far.

Just 2 years ago, for example, Petrus 2000 was £31,680 compared to Lafite 2000 at 11,878; a ratio of 2.7:1.  Today the ratio has narrowed to just 1.7:1, £36,972 vs £22,008 respectively.  These estates are ripe to once again reposition themselves in price league of their own.  Recommended, but for deep pockets only!

Final thought:  The issue of sustainability...

The great debate in light of such stratospheric growth is no longer whether wine is a viable alternative investment, but - as the newly crowned class leader - whether the growth is sustainable.  Clearly, the extraordinary bursts of growth seen in certain wines have to cool off from time to time (laughably, were Lafite 2008 to continue to grow at the same rate of increase of the last 12 months for another decade, a case would set you back a rather stiff £137,000,000!), but overall we remain steadfast that the bull-run is here to stay.

Whilst in Europe we are only just beginning to emerge from the greatest financial crisis many of us has experienced, elsewhere the world is getting richer - and new wealth means boom-time for luxury products.  The figures relating to China may be almost unfathomable, but the behemoth hasn’t yet even broken into a jog; consumption sits at just .33 litres per head of capita each year - just 2 large glasses - compared to 27 litres (36 bottles) in UK.  Yet the future doesn’t belong only to China; sure, she’s an erupting volcano, but there are distinct rumblings coming from the likes of India and Brazil...

In fact, fine wine consumption in India - whilst still a tiny fraction of that in China - is actually increasing at a faster rate; it would seem that a second nation with over a billion citizens is preparing to launch itself en masse into our little market, and the mobilisation of this giant - with its far younger population (China is aging disproportionately due to the one child policy) and accommodating trade structure - holds the potential to usurp China from the number one spot.

It is these facts that in our opinion render the notion of a ‘bubble’ nonsense.  By its very definition, an economic bubble must carry the threat of either a sudden drop in demand or the expansion of supply outstripping demand (aptly demonstrated when droves of newly formed on-line businesses entered the market in the late 90s precipitating the dot-com bubble bursting) causing the bubble to ‘burst’.  Conversely, prices of wine are rising naturally and organically in response to increased demand and falling supply.  The new price levels are simply a consequent revaluation of the commodity.

Having said that, from time to time the ride could get bumpy. As native Chinese economist Andy Xie, former Morgan Stanley star chief Asia-Pacific economist, rightly points out this month on his blog, a new syndrome in the market is ‘hoarding’ - not just by speculators but also by those individuals who intended to consume their purchases but ended up hanging onto them in light of their soaring value. 

This admittedly makes it difficult to assess the true state of supply and at some point it’s safe to assume these individuals will put their assets up for sale, temporarily increasing supply and potentially causing a short-term price wobble here and there. This, of course, is perfectly normal in any market; it’s called profit taking.

Overall though, we consider wine investment to be in rude health.  For us mere mortals the prices of these super-wines may not compute, but in real terms - and as an ultimate luxury - they remain accessible and affordable with plenty of room for more growth.  Certainly those who fancy immersing themselves in the finer things of life will still find they can afford a bottle or two of First Growth claret long before they can travel the world in the first class cabin, drive an Italian Sports car or hide out in a villa on the Cote d’Azur.  Take it from us, fine wine prices overall are going in one direction; north.

Disclosure

We believe that investing in wine should be both enjoyable and profitable, but like any traded commodity there are risks and wine can go down in value as well as up. Neither Albany Portfolio Management or the wine market in general is regulated by the Financial Services Authority.

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