This paper examines wine specialty funds as an emerging alternative investment vehicle for portfolio diversification. It reviews the evolution and mechanics of traditional mutual funds, introduces real estate investment trusts (REITs) as non-traditional holdings, and analyzes wine as both a consumable and investment-grade asset. The paper demonstrates how wine investment funds—professionally managed portfolios of premium wines—offer investors exposure to uncorrelated assets with demonstrated double-digit returns, while discussing regulatory challenges, storage costs, and the specialized knowledge required for prudent wine investing.
In the complex world of investments, there are many vehicles in which one can invest. Mutual funds are an excellent way for investors to gain market exposure without spending a large amount of time in portfolio research and management. As mutual funds have gained in popularity and become the principal investment vehicle for countless investors, the mutual fund market has flourished. As new funds constantly enter the marketplace, we see a wide diversity of strategies and holdings—from funds devoted entirely to gold and gold-related industries to global funds that seek ultimate diversification. A fund trend that has gained some following internationally but has yet to appear in strength on U.S. shores is the wine fund. Wine funds are more like REITs than traditional mutual funds, in that they hold physical, non-commoditized assets.
The combined assets of the nation's mutual funds increased by $237.1 billion, or 2.1 percent, to $11.209 trillion in March 2010, according to the Investment Company Institute's official survey of the mutual fund industry. Clearly, the mutual fund industry is a booming business, but what draws investors to mutual funds? The key to the success of mutual funds lies in their inherent diversity. For investors seeking diversification, the mutual fund is the easiest vehicle to maximize diversification while maintaining constant surveillance of the underlying securities. For an individual investor to manage a widely diversified portfolio would require countless hours, as well as knowledge and skill that the majority of individual investors simply do not possess. By utilizing the economic principle of comparative advantage, we see that it is infinitely more efficient to outsource the management of investments in order to maximize the amount of investable income. Thus, we see the advent of the mutual fund. People from all backgrounds become able to invest competently with minimal outlay of time, in return for a fee charged by the fund manager who spends all of their time managing those investments.
Mutual funds come in all shapes, sizes, and varieties. The breadth of the market enables investors to select investments suitable to their individual risk level and investment objectives. The scope of mutual funds covers all sectors of the economy. One can invest in funds that only purchase technology sector securities, or in a fund that only invests in manufacturing company securities. Other funds invest based on investor risk tolerances—funds are often categorized as aggressive, moderately aggressive, moderate, or conservative. Still others are segmented by market capitalization, focusing on securities within different market cap sectors such as small cap, mid cap, and large cap. It is this diversity that emphasizes the need for non-traditional funds. By being able to diversify away from the securities markets, one is able to hedge against market volatility and the inherent instability of all investors being in the same market.
A beta is a measure of risk that, when applied to investment portfolios, provides useful statistical information. It indicates a fund's past price volatility relative to a particular stock market index. Most mainstream equity funds have betas in the range of 0.85 to 1.05 (fairly close to the 1.00 beta represented by the market in the aggregate). Especially conservative stock funds may register betas as low as 0.75, meaning that in a minus 10 percent market decline, their values might be expected to fall 7.5 percent. Aggressive funds with betas of 1.25 might see their values fall by 12.5 percent. The same general dimension of relative volatility also prevails in rising markets.
Traditional mutual funds can flourish in both bull and bear markets. Arguably, the more specialized the fund, the more subject it is to market fluctuation in the particular specialty. The catch-22 of this situation is that without a certain amount of risk—which means being specialized to some degree—there is no way to beat the collective index. Complete diversification results in sub-standard returns. As we see in Table 1, the more specialized the fund, such as the global equity fund, the higher the return. The correlation between specialization and returns indicates that diversification is the destroyer of fortunes rather than the builder of them. However, as we know from practice, an undiversified portfolio is not only irresponsible but also reckless.
This inherent requirement for specialization creates the need for non-traditional investments. In order to create a balanced portfolio with diverse offerings, investors are being drawn to all kinds of new investment opportunities.
REITs, or real estate investment trusts, are becoming a popular vehicle for diversification in the U.S. A REIT is a company that owns, and in most cases, operates income-producing real estate such as apartments, shopping centers, offices, hotels, and warehouses. Abroad, some REITs engage in financing real estate and their shares are mostly traded on stock exchanges. REITs come in three forms: equity REITs, mortgage REITs, and hybrid REITs. Equity REITs own and operate income-producing real estate. Mortgage REITs lend money directly to real estate owners and their operators, or indirectly through acquisition of loans or mortgage-backed securities. Hybrid REITs are companies that own properties and make long-term loans to large real estate buyers as well as intermediate and short-term construction loans to builders and developers.
A REIT company, as currently structured in most countries, must have most of its assets and income tied to real estate investment and must distribute at least 90 percent of its taxable income to its shareholders annually. In practice, most REITs abroad remit at least 100 percent of their taxable income to their shareholders and therefore owe no corporate tax. Shareholders then pay taxes on the dividends, including any capital gains received.
The emergence of REITs shows the market's desire for alternative investment vehicles as opposed to just holding securities. REITs offer many advantages, but also have several inherent disadvantages. REITs have much more potential risk than traditional mutual funds and have higher inherent costs. The costs of REITs are one reason that they are not ideal for all investors. A constant stream of taxes, upkeep, maintenance, depreciation, and insurance costs, paired with the volatility of the real estate market, make for a tricky investment. Looking beyond REITs while staying in physical assets leads us to the main focus of this paper.
Wine has been around since 6000 B.C. A fermented beverage made from fruit, it has very humble beginnings, but throughout history it has come to be a mainstay of society. Various foods and beverages have come and gone, but wine has been almost universally embraced throughout time and across cultures. An attribute that makes wine unique is its status as both a consumable and an investment. The value of wine is always changing, and a small group of people have realized the upside potential of investments in wine.
What makes an investment-grade wine that appreciates in value different from a bottle of wine that decreases in value? Certain regions and particular châteaux, domains, and estates are regarded as investment-grade wines. Classified Bordeaux, grand cru Burgundy, vintage and prestige Champagne, and vintage port have been the traditional markets. There are a few "new world cult wines," generally from Australia and the U.S., that have become hugely sought-after and their prices have jumped considerably. On the whole, investment-grade wines are long-living red wines—but there are a few whites, notably sweet wines of Sauternes in Bordeaux and Château d'Yquem.
These wines are subject to a unique economic principle: they are known as Veblen goods, goods for which demand increases instead of decreases as the price rises. Taking advantage of this principle can make for a very lucrative investment.
Investment in wine has seen exponential growth in recent years with the American resurgence of interest in wine and the booming market for premium wine in Hong Kong. This growth in the wine market has solidified wine as a valid investment that has marketability and sustainability within a group of investors. The following table illustrates typical price appreciation for investment-grade wines from the 2000 vintage:
The returns shown here are typical of a good vintage seeing good returns. Not all vintages are good, and not all years are optimal for selling wine. But just as one must be selective in purchasing securities, the selection of wine is an equally important decision. Realizing the potential of this investment and investing prudently is not for everyone. One must be fluent in the language of wine and capable of recognizing superior vintages. To make things even more complicated, many investment wines are offered on a futures basis. This can lead to an inexperienced wine enthusiast purchasing large quantities of wine that he or she has not even sampled, basing their investment solely on the marketing of the futures and the strength of the brand—an investment strategy more akin to gambling than prudent investing.
Conversely, wine futures offer a chance to purchase superior wines for significantly reduced prices ahead of the market, essentially giving one insider information into an upcoming vintage while still being both legal and ethical. Care must also be taken in storing and eventually marketing the wine. Just as investing in individual securities is not for everyone, investing in individual wines is also not for the weak of heart. Fortunately, we have seen the advent of the wine investment fund to help investors who feel that wine is a good investment but are not confident enough in their palates to invest sizeable sums into said wine.
"Professionally managed wine portfolios and returns"
"Barriers and requirements for wine fund adoption"
You’re 78% through this paper. Sign up to read the remaining 2 sections.
Sign Up Now — Instant Access Already a member? Log inAlways verify citation format against your institution’s current style guide requirements.