Matthew Small, Portfolio Manager

With ongoing financial uncertainty, the allure of the wine market’s growth and stability is leading more investors to increase their exposure to wine as an asset class.

In the recent Cult & Boutique podcast, we looked at how professional investors look at risk-adjusted returns when assessing and managing investments. We have seen that wine has lower price volatility than the mainstream asset classes but what are the inherent risks in investing in wine and can effective portfolio management help to mitigate these?

The largest crash of the modern wine investment era happened in May 2011. Leading up to the crash the Liv-Ex 100, the benchmark wine investment index, was up circa 70% in the previous 16 months. This strong performance was driven by Asian demand following a 4 trillion yuan stimulus package in China.

 

 

The trigger for the crash was two-fold. The market was running hot with the 2010 Bordeaux vintage being priced at a 13% premium to the previous year. American buyers with their cellars recently topped up with a strong 2009 vintage and recovering from the 08 financial crisis withdrew from the 2010 campaign.

Secondly, China announced a crackdown on gift-giving of luxury goods among government officials. This sudden halt in Chinese and American demand saw the Liv-Ex drop 33% over the coming months.

Thankfully the wine investment market has evolved since 2011. The primary fine wine market is now worth circa £4bn each year with a global reach of market participants ranging from wine enthusiasts to institutional investors.

The 2011 crash was symptomatic of an immature market which lacked diversification. The broadening we’ve witnessed has created a situation with Bordeaux comprising circa 35% of the total value traded compared to 95% in 2011. Regions like Burgundy, Champagne, Italy and California have added diversification to the market and reduced non-systematic risk, more than ever investors understand the importance of diversified portfolios.

 

– Warren Buffett

 

 

Over the last 5 years, we can see that all 3 wine indices have produced steady market returns as the wine market has evolved. It is no surprise that the top-performing Liv-Ex 1000 is also the most diversified of the three indices.

Interestingly it was the weakness in sterling due to a potential Brexit in 2015 which stimulated the next bull market. The current sterling weakness bodes well for the wine investment market given circa 65% of demand is in non-sterling-denominated currencies and the main wine exchange base currency is sterling.

 

 

Since the 2011 market correction both the benchmark index, the Liv-Ex 100 and the broader index, the Liv-Ex 1000 have enjoyed steady growth despite a few regional underperformers. One country that has struggled in recent times is Australia. In March 2021 the Chinese government formalised a 116%-218% tariff on all imported Australian wine. At the time China was the biggest importer of Australian wine.

This saw the Aussie wine export market to China shrink from A$1.1bn to A$25m in just over a year with the majority of the losses in sales coming from everyday drinking wines. We also saw a reduction in the fine wine market where Australian wine trading volumes fell less dramatically from 34.1% on the rest of the world index to 22.9% YTD.

As discussed in previous articles, identifying investment wines with a 95+ point critic score, low annual production, long drinking windows, an ability to age and a strong brand limit downside risk and tend to outperform despite regional challenges. Grange from Australia’s producer Penfold is a great example of a wine with international appeal that outperforms despite regional challenges.

Most recently we have seen the Sterling depreciate against both the Dollar and the Euro. With the majority of the on-exchange secondary market denominated in Sterling, this is clearly good for the non-sterling investor, but how do we mitigate FX risk for the UK investor? Firstly, with around 65% of the total value demand on Liv-Ex coming from non-sterling-denominated currencies, a weaker Sterling is good for those who already own investment wine. We saw back in 2016 when the Sterling value depreciated due to Brexit, this was the initial catalyst for a market bull run.

 

 

So, what about the UK investor looking to get into fine wine? With the strength of both the Dollar and the Euro, the US and European primary market may be a more expensive entry point. Instead, invest in high-quality wines already on the secondary market from classic vintage years, listed in Sterling. Thankfully this is easily achieved with both the two main wine exchanges based in Sterling.

The FX differential also provides profitable exit opportunities. At Cult & Boutique, we can list wine on American auctions due to our ongoing relationships with the two main US auction houses, Acker and Zachys. This provides our clients with the option to maximise the Dollar value of their wine and convert it back into Sterling. This can often be a more profitable option than selling in Sterling and is something we closely monitor for our clients.

Despite wine having the lowest price volatility of the main investment asset classes, like any investment, it’s not without risk. Working with an experienced portfolio manager can help mitigate a lot of these risks through diversification, asset selection and active management. At Cult and Boutique, we tailor each client’s portfolio to their unique time frame and return requirements.

 Matthew Small, Portfolio Manager

 

Talk about investing with anyone and nine times out of ten the name Warren Buffet comes up.  Warren and his mentor Benjamin Graham developed a style of investing that focused on the fundamentals of a company, creating an intrinsic value based on these fundamentals and comparing it to the market value.

We’ve taken a bit of time out to see if we can use this “Value Investing” strategy in the fine wine market?

Firstly, let’s look at what all top investable wines have in common.

• They have a great critic score like the 100-point 1989 Haut Brion
• Low annual production like the DRC Romanée-Conti at 500 cases per year.
• Come from a big-name vineyard with heritage and a story such as Chateau Lafite Rothschild

Based on the above fundamentals, is there a winery or region that meets all the criteria at a fraction of the price of its Franco friends?!

“Hell Yeah!!” Napa Valley Baby!!

Napa burst onto the scene at the infamous 1976 Judgement of Paris, where 11 unsuspecting wine judges, unanimously picked the Napa rouge in a blind taste test over the old-guard Bordeaux. Since then Napa has been racking up 100-point scores from all the major critics, smashing our first fundamental.

 

 

Next, let’s look at production. Scarcity is key to the value of a wine, like any luxury good the limited supply drives the price. A first growth Bordeaux such as Chateau Lafite Rothschild can produce circa 35,000 cases per year compared to the top-rated Napa, Screaming Eagle which limits production to circa 1000 cases. When these wines reach their peak drinking maturity with the majority of the vintage consumed, scarcity drives price.

Finally are there any Napa wineries with a story or heritage? Napa Valley is based on stories. Take Robert Mondavi whose feud with his brother led him to leave the family winery and relocate to California with the aim of creating Cabernet better than the French. Or what about Brett Lopez who bought JJ Cohen’s land and named his wine, Scarecrow after JJ’s most famous film, The Wizard of Oz.

So the big question… Why is Napa trading at such a discount?

It was America’s worst kept secret. The domestic demand for Napa wines was so strong that US suppliers were not incentivised to export to more complicated international markets. A point highlighted below by Lisa Perrotti-Brown (MW) in a recent Cult and Boutique podcast.

 

 

The data also backs up this increased adoption of Napa wines. Between January and June 2022, 154 different Californian wines have been traded on the Liv-Ex exchange vs 145 wines in the same period of 2021. The California 50 (the Napa index) performance also strengthens this argument up 26.1% over the last 12 months vs the benchmark Liv-Ex 100 up 22%.

Don’t be fooled into thinking nine extra wines traded is insignificant. A 6% growth rate is a characteristic of the early adoption phase in the growth cycle. The early adoption phase is a great entry point for investors before the growth curve accelerates into the early majority phase.

We can see that the Napa Revolution is on, and now the French are getting in on the action. LVMH just announced the acquisition of Napa Stalwart, Joseph Phelps Vineyards. This deal adds to the LVMH roster of international wine market titans including Dom Perignon, Moet and Cloudy Bay.

It’s clear LVMH believe Napa wines are going to be the next global trend with the CEO citing increased demand in Europe and Joseph Phelps’ iconic name and heritage driving the purchase!

Please note that LVMH is buying Joseph Phelps at the top of the Californian real estate market. Details of the deal have not been released however values of circa $725m have been rumoured which is more than double paid for any other Napa winery in recent years.

It should also be taken into consideration that interest rates are expected to rise considerably in the coming quarters making any debt used for the purchase much more expensive. Despite the high price tag and economic concerns, LVMH is confident in Napa’s global potential.

 

 

Leading the adoption of Napa Reds are the Millennial / Gen Z demographic. A study performed by market research agency 3Gem showed that 75% of the under 25s who invest in wine spend up to £20k a year on the liquid asset. This trend is expected to expediate as an estimated $68 trillion dollars will be inherited over the next 20 years.

Millennials are looking for quality wine investments which don’t necessarily adhere to the status quo. Winemakers who make exceptional quality wines, with interesting bottle designs and modern art labels are much more appealing than family crests and an antiquated En-Premier system.

Given the current economic climate of high inflation, rising interest rates and low economic growth many investors are looking at wine investment as a counter-cyclical hedge. Given the large growth opportunities in the Napa region, the Californian stalwart is my number one growth trade for any wine investor’s portfolio.

Very rarely do LVMH, Lisa Perotti Brown and Warren Buffet’s investment style align, but when they do, it’s time to Buy!

 Matthew Small, Portfolio Manager

The economy is on the cusp of recession, being battered by high inflation, rising interest rates, low economic growth, a cost-of-living crisis and geopolitical instability. The markets as a result have suffered with the S&P 500 realising the worst H1 in 40 years and flight to safety asset classes like treasury bonds and gold prices struggling to find momentum next to a strong dollar and higher interest rates.

With most traditional portfolios “diversified” between equities, bonds and real estate all struggling, cash is no longer king with 9% inflation and rising, investors are seeking alternative investments to weather the current financial storm.

 

What’s the alternative?

Analysts predict 46% growth in the Alternative Asset market over the next 12 months, driven by investors’ need for diversification and inflationary hedges. We expect wine to lead the way within the Alternative sector due to its stable returns and low price volatility. Wine is the only Alternative listed as both a financial and consumable asset, making it best seated to deal with inflationary spikes. The UK market currently lags behind its European neighbours with only 35% of UK asset owners invested in alternatives vs 90% in the EU.

To many investors, the term Alternative Investment strikes panic with thoughts of high risk and massive losses, but is this actually the case? Liv-ex, fine wine’s global online exchange, just released its June market report, highlighting four consecutive months of 0.7% growth despite COVID, wars and recessionary fears. Over the medium and long term, wine continues to perform with the Liv-ex’s benchmark index up +23% in 2021 and averaging 12% over the last 15 years.  Given these impressive short and long-term returns, what is the risk?

A great way to determine risk would be to compare its annual standard deviation of monthly returns to traditional asset classes such as Equities and Bonds. Standard Deviation is similar to volatility and measures how widely prices are dispersed from the average. Simply put the lower the standard deviation the less risky the asset class.

We can clearly see from a risk perspective; wine is the most stable asset class with equities the most volatile.

To further validate this point, we can analyse the correlation between the S&P 500 and compare it to the Liv-ex 100 and 10-year treasuries. When testing correlations 0 – 0.2 would mean weak correlation between markets (excellent for diversification), 0.2-0.4 would be moderate correlation between markets and >0.4 would mean strong correlation between markets. If wine shows a weak correlation to the equity market it would further strengthen the argument that wine is low risk and not linked to economic cycles.

If we first look at the correlation between 10-year treasuries and the S&P 500 we can see there is a moderate to strong relationship between the two markets, except it is inverted so when values of stocks go up, values of bonds go down. Now interestingly with wine, a correlation coefficient of 0.12 demonstrates a weak relationship between the S&P 500 and the Liv-ex 100. This means that if the S&P 500 goes either up or down, the Liv-ex 100 is not affected. This would indicate that the wine market does not carry the same risks as the equity market. As mentioned previously this is a great diversification tool for any portfolio.

We have seen that wine is both low risk and does not track the equity market, so can we then deduce that wine outperforms in recessionary environments? To test this idea let’s see how the Liv-ex 100 performed compared to the S&P 500 in the last 3 bear markets. A bear market is defined as a drop of 20% or more from the previous peak.

From the chart, we can see that the Liv-ex 100 outperformed the S&P 500 in each of the bear markets.

 

So why does wine perform so well in recessions?

The price of fine wine is determined by different fundamentals. Investment wine’s value is based on critic scores, scarcity and prestige of the winemaker as opposed to income statements and growth outlook.

The supply of fine wine is relatively static due to terroir and legal constraints. On the flip side, demand for fine wine is increasing as people drink more fine wine than ever before and the investment market has broadened.

Fine wine is a tangible asset whose utility improves over time with decreasing supply of each vintage. This makes it suitable for wealth creation over the medium to long-term. Fine wine has “real value” in that it is a physical asset, unlike stocks and shares.

Wine is an inflation hedge as it is both a financial asset like gold and real-estate but also a consumable. Given wine’s low correlation to the equity market and inflation tracking properties, wine is a great investment in stagflation environments.

Throughout 2021 the wine market shone, setting new records for trade and pushing the market’s leading indices to reach new heights with month after month of consecutive growth.  And 2022 began right where 2021 left off, given a helping hand from a solid 2020 Burgundy vintage.

The market did begin to show signs of a slow down as we edged through February with only small gains from both the Liv-ex 100 & Liv-ex 1000. But this started to pick up again from March onward and although the Liv-ex 100’s Q1 was slower than in 2021 the Liv-ex 1000 showed robust gains fueled by both Burgundy and Champagne.

The Russian invasion of Ukraine on 24th February added to widespread concerns of rising inflation, as the rising cost of oil, gas and metals started to impact negatively on already strained global supply chains.  So far, wine seems immune but we are remaining sensibly cautious.  However, this is the perfect environment for wine to shine as an alternative asset, as it has certain advantages over more mainstream financial options.

Vintage wine is a diminishing asset, you cannot produce more of any particular vintage than was originally made.  Plus, as an asset, it is necessary to invest time holding on to stock in order to see growth.  Both of these factors help to keep the wine market’s volatility extremely low.

As the chart below demonstrates, the Liv-ex 50 has remained very stable during Q1 while other markets and commodities displayed erratic price movements in response to current events.

 

 

Champagne & Burgundy lead the way in Q1

Burgundy and Champagne’s performance was very strong last year, and this continued into 2022.  So far this year Burgundy and Champagne have been the leading performers, growing by 14.6% and 9.6% respectively.  Although the Champagne 50 index has the best annual growth figure at the time of writing, the Burgundy 150 index has been the best performer over the past three months.

Its also worth noting that the growing interest in, and value of, US wines such as Screaming Eagle has helped to push the Rest of the World 60 index forward.

 

 

Burgundy’s Leflaive 2012 is the best performing wine in Q1

The following table of Q1’s top price performers clearly demonstrates Burgundy’s dominance with nine of the ten positions being taken by the region.  The best performing wine of the first quarter was Domaine Leflaive, Batard-Montrachet Grand Cru 2012 which grew in value by 76.3% since the start of the year.  This was followed by Domaine Bonneau du Martay, Corton-Charlemange Grand Cru 2014 which grew by 55.2% over the same period.

Regional Overview of Q1

As mentioned above, Burgundy and Champagne have really stolen the show so far this year and this was reflected in their overall share of trade.  Burgundy’s share was 25% and Champagne’s 11.5%, Bordeaux still took the lion’s share of trade at 32.8% but this is lingering around an all-time low for the region and is an ongoing sign that the wine market has matured and diversified beyond Bordeaux’s hay days of 90% trade share.

Champagne climbed the rankings significantly in 2021, making it the third most-traded region. Tuscany was nudged down the rankings in this process but the region sits on firm footings as proven by strong trade in Super Tuscan wine Sassicaia in Q1.

Q1 2022’s Most Desireable Labels

Although Burgundy completely dominated the top ten price performers, you’ll be glad to hear that the top wines traded by value were more varied.  Champagne’s Louis Roederer Cristal took three of the top spots for wines traded by value, alongside Dom Perignon, Screaming Eagle from the US and Pomerol’s Petrus.

 

 

California 50 Outperforms the Broader Market

Looking back at the past year, one region has presented itself as a very secure option for growth.  The California 50 index has grown by 34% over the last 12 months to reach its highest ever level.  We have been recommending premium Californian wines since as early as 2010 and clients with the foresight to have taken up our early offers have either sold their positions or are now in a very comfortable position.

Prices from the region’s best wines continue to soar, boosted by great ratings from the world’s most influential wine critics.  The UK market for top Californian wines has also developed and now sees an increased demand for premium labels such as Screaming Eagle, Dominus and Harlan Estate.

For example, Screaming Eagle’s flagship Cabernet Sauvignon is the best performing wine in the California 50 index and has risen by 42% over the last year, easily outperforming the index’s other contributors.  This growth has largely been the result of the stellar 2009 and 2010 vintages which have delivered 61% & 75% respectively over last year.

 

Where from here?

Even though global stock markets have experienced a rough ride of late they have managed to recover the majority of their losses, regardless of the volatility seen in commodity markets and gloomy global economic forecasts.

While the snowballing effects of COVID, Brexit and the European war are yet to knock the markets completely off course there remains a sense of financial insecurity that actually bodes well for the fine wine market.  Wine is increasingly being used as a financial safe haven, similar to the traditional use of gold in times of uncertainty.

Bordeaux’s En Primeur campaign is well underway and is a time when the market traditionally slows down as it awaits the first inkling of what quality the next vintage will be. A well-priced futures campaign can serve as a huge boost to the market heading into Summer but if the chateaux are too greedy price-wise then market progress could be dampened.

Overall the market is in a similar place to the close of 2019 where external events – global trade disputes and Brexit – lead many to defensive strategies to protect their capital and reduce the volatility of their overall investment portfolio.  The wine market’s track record of low volatility and steady returns is now common knowledge and the confidence it builds could help to shape the rest of the year for wine investors.