Investing In Fine Wine: The Do’s And Don’ts—Part III
Avoiding the pitfalls. By Lewis Chester DipWSET
Château Margaux
Portfolio Construction
Portfolio construction is key to risk management for any asset class, and fine wine is no different. Although Bordeaux wines have tended to dominate most investors’ portfolios in the past, diversifying with wines from Burgundy, Champagne, Italy, and California will ensure that you don’t over-expose yourself to one part of the market.
Personally, I am big on Burgundy (it makes up 65 percent of my portfolio), but I am not an investor: I am a collector. From an investor viewpoint, 40 percent Bordeaux, 30 percent Burgundy, 12.5 percent Champagne, 10 percent Italy, five percent California and 2.5 percent from other regions (such as Egon Müller and Keller in Germany, and Penfolds Grange and Henschke Hill of Grace in Australia) would be what I would recommend. Of course, like all asset classes, there is a degree of correlation between the different regions: they could all rise and fall together, albeit at differing rates of change.
Storage
How you store your wines is every bit as important as what you invest in. I recall going to see my aunt who lives in Paris. She was eager to show me her collection of great Bordeaux wines, which she thought was worth something in $80,000. Indeed, I looked at the collection and there were some great wines from the likes of Château Petrus, Château Lafite, Château Latour and Château Haut-Brion. The problem was that she had been storing them for the last 15 years in a cupboard next to the boiler. I told her the wines were now worthless. She didn’t believe me, so we cracked open a few bottles of what was now the world’s most expensive vinegar.
Over in the United Kingdom, there is a bonded warehouse system for fine wine: professionally managed warehouses, specifically designed to age fine wine, that have the additional advantage that the goods are deemed not to have entered the country from a tax viewpoint. Only if you take the wines out of bond will tax be payable, although you can trade the wines between different bonded warehouses without tax implications.
The barrel room at Château Mouton Rothschild | © @deepixstudio
By being in bond, whereby the wine was originally imported directly from the winery or négociant (wine trader), the chain of title is not broken—which is key to determining provenance. As a result, there exists one of the most curious phenomena I have ever seen in respect to any tradable asset. Wine in bond, which has not yet been charged duty and VAT at 20 percent, is worth more in the market than wine out of bond which has already been subject to duty and VAT.
Think about that and you’ll realize the importance that the market in the UK puts on provenance. In the US, there is no bonded storage system. This is not to say that Americans don’t care about provenance, but it’s not an integral part of their system and therefore there is not the same ability to apply diligence to the chain of title. This might explain why I know so many American collectors who also keep a portion of their collections in the UK bonded warehouse system.
Storage Costs
Most fine wine investors forget about storage costs, mainly because at, say, $12 (plus VAT) per case of 12 bottles per annum, it does not register on their sub-consciousness. However, if you are starting out on your investing journey and wanting to dip your proverbial toe into the waters, you might end up with a portfolio where the average case value is, say, $1,200. In this instance, one percent of your purchase cost is going on storage costs each year.
If you hold that case for a decade before selling, that’s a whopping 10 percent of your original cost going on merely storing your wine (not including the annual VAT charges). For this reason, I strongly suggest you focus your efforts on a smaller number of higher value cases to ensure that your returns are not eaten away by storage costs.
American Strip Labels
For readers outside America—unless you intend to drink your wines or sell them in America—having imported wines with an American ‘strip label’ on the bottle (a US government requirement for alcohol arriving from abroad) will automatically down-value the wines if you decide to sell them overseas. There are historical reasons relating to transatlantic shipments which unfairly taint the market’s perceptions of these bottles, especially in an era of refrigerated freight and airborne transportation.
The barrel room at Château Mouton Rothschild | © @deepixstudio
For this reason—and to keep your options open when it comes to selling in London, Paris, Singapore or Hong Kong, which might elicit higher prices for your wines than selling in the US—many wine investors will not buy American strip label bottles.
Packaging
Packaging is another potential pitfall, again principally due to the perception of provenance. Most Bordeaux wines come in original wooden cases (OWC), whereas most Burgundy cases come in original carton cases (OCC). If the wines are not kept in OWC or OCC, many buyers will just not be interested or will demand deep discounts. The key, therefore, is to only buy in OWC or OCC, or where you can only buy a portion of the bottles in the case, insist on those bottles being kept in the OWC or OCC packaging.
Insurance
Believe it or not, some of the biggest collectors and investors in the world of fine wine today do not insure their bottles against damage, breakage, theft and any other impairment that is possible while the bottles are not in their possession. In the UK, many bonded warehouses, such as Octavian Vaults, charge storage charges that include the cost of insurance. In the US, this is not the norm and you really need to understand whether your bottles are properly insured. Even scuffing or water damage on the labels can make your bottles unsellable or subject to severe discounts.
Site Inspection
Every couple of years, I head down to the various bonded storage facilities in the UK where my wine is lying to check that my name is on the cases. The reason for this is that, in the event of insolvency—of either the wine merchant with whom my bottles are stored or the bonded warehouse—I am at risk of the insolvency administrator claiming that I am a mere unsecured creditor.
Wine tanks at Domaine Leflaive | © Serge DETALLE
If that were to happen, I almost certainly would never see my bottles again, and might also see very little financial recovery compared to the value. Again, very few investors or collectors either realize this or, if they do, can be bothered to schlep to a cold warehouse in the middle of nowhere to check their precious cases of wines.
Taxation
How you decide to gain exposure to the fine wine market might have different tax implications depending upon which country you are resident in for tax purposes. This, in turn, could have a material impact on your real returns.
For instance, for those who are UK residents for tax purposes, provided they own the wines directly in their name, no income tax or capital gains tax charges will be applicable when they finally decide to sell. This is because wine is deemed to be a ‘wasting asset’, and as such, any losses they make on wines will not be offsetable against tax returns either.
The exception to this rule is if the seller is deemed to be in the business of buying and selling wine, as would be the case with a wine merchant or broker. Therefore, investing in a fine wine fund or through a corporation would make little logical sense as they would be subject to either income tax or capital gains (depending on how the fund or corporation is structured) on their investment returns.
In the US, the tax rules are different, and my understanding is that tax is applicable on your gains as America has no equivalent to the ‘wasting asset’ rules that exist in the UK.
Calculating Real Returns
Real returns on your portfolio of fine wines are hard to calculate. To do a proper analysis, you need to factor in the costs of storage and insurance, as well as the likely costs of disposal when it comes time to selling your assets (what financial traders refer to as ‘slippage cost’). If you’re holding your wines for many years, you really should factor a holding cost of capital into your calculation given that wine does not pay an economic rent like stocks (dividends) or bonds (interest coupons).
Harvest time at Il Marroneto Brunello di Montalcino | © Bruno Bruchi fotografo SIENA bru
Selling costs can be high: 10 percent through a wine merchant and perhaps higher through an auction house. But that doesn’t paint the true picture. If you want to sell a lot of wine and/or sell it quickly, you’ll have to accept that you are unlikely to get the current market price. This is because fine wine is an illiquid market, and prices assume that you have all the time in the world to sell one case at a time. When the wine investment funds started puking out stock after the 2008 financial crisis and, then again, in the mid-2010s, they often found they could only unwind their trades if they were willing to accept deep discounts—20 percent or more on the market price.
What this tells you is that the frequent articles you read about the fine wine market having gone up 20 percent in 2021, or having beaten the stock market over 20 years, do not tell the whole picture. In short, don’t believe the hype. The only true return is based on actual net proceeds received after having factored in your total purchase, holding and slippage costs. If you do that analysis, you will find that your returns are a lot less attractive than you thought they were. You might end up thinking that you would have been better off—and endured a lot less hassle and headaches—putting your hard-earned cash into an S&P 500 tracker fund.
Lewis Chester DipWSET is a London-based wine collector, member of the Académie du Champagne and Chevaliers du Tastevin, co-founder of Liquid Icons and, along with Sasha Lushnikov, co-founder of the Golden Vines® Awards. He is also Honorary President and Head of Fundraising at the Gérard Basset Foundation, which funds diversity & inclusivity education programs globally in the wine, spirits & hospitality sectors.
Read an original version of this article on The Robb Report’s official website here.