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Investing in Wine – Interview Transcript with The Wine Investment Fund (TWIF)

An ‘Inside the Industry’ Opinion on Wine Investment

by Frank Quin

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1. The fund’s website indicates that the great bulk of its investment of client funds is in Bordeaux wines. According to my reading, top Bordeaux vintages performed poorly in 2012, at least as regards London wine auctions. Accepting that this is just one year, is there not in any event a risk in putting all eggs in that particular basket?

TWIF invests only in Bordeaux wines, for risk management reasons. Bordeaux has a unique balance of two factors. First, a limited supply (restricted by law to the geographical area of Bordeaux) which then falls as the wines are consumed, tending to push prices up over time. This may also be the case in many other areas, particularly in Europe, such as Burgundy, Barolo, etc. Bordeaux, however, has the second factor which those areas do not - and that is sufficient production for there to be deep and liquid secondary markets.

As an investment fund, our job in producing absolute returns is to manage risk. A - or perhaps the - key risk in certain areas of the wine market is liquidity risk. Many wines can be bought and sold on the secondary market, but most do so in markets which see only infrequent trades and have wide bid-offer spreads. This means that if it is necessary to take or dispose of a substantial position in these wines, the Fund would have to suffer a loss relative to the valuation price. Hence TWIF’s concentration in stock picking only from the most liquid secondary markets for fine wines - those from Bordeaux.

To illustrate this, a typical Bordeaux château will produce around 15,000-20,000 cases of wine per year. By contrast the most frequently traded Burgundy, Romanée-Conti, makes around 500 cases per year.

With the more liquid markets of Bordeaux, we are able to execute trades which actually make a profit relative to our valuation price - by around 2-3% on average when buying, and the same amount when selling.

Investing in the most liquid wines has two other advantages. First, these wines have long and reliable price histories which allow us to model and predict future price movements, helping us to invest in the wines with the best prospects. Second, our valuations (which are carried out independently by Liv-ex, the fine wine exchange) are accurate and realistic. This is important because in the past, wine investment managers which have got into trouble have usually done so as a result of unrealistic valuations.

2. More specifically, does the success of Australian wine at the inaugural Decanter magazine Asian Wine Awards – particularly in winning the Bordeaux category against French entries – suggest a tide beginning to turn against the historical preference for French wines in the investment community?

Our preference for Bordeaux is based purely on its suitability as an investment, and in particular the need to manage risk. It is not an observation on the relative quality of wine from elsewhere – indeed New World wines have been winning such competitions for many years, beginning with the famous ‘Judgement of Paris’ in 1976.

New World wines are currently missing two key characteristics to become, in our view, investment wines: first they do not have a limited supply (a producer can simply buy in additional grapes or plant another vineyard to increase production), and second they do not have liquid secondary markets.

3. A related question – does TWIF have a strategy, and the ability, to move in timely fashion from Bordeaux to other wines (eg New World) should the market suggest such a move? Or is it Bordeaux come hell or high water?

As described above, we do not believe that wines outside Bordeaux currently have the right characteristics to be considered as investment wines. It is possible that this might change over time, but we do not expect to diversify outside Bordeaux in the immediate future.

4. Further on performance, the fund website gives ‘net asset values’ for investment tranches since commencement in 2004 (http://www.wineinvestmentfund.com/latest-figures/index.aspx) . These have been in negative territory for all tranches since December 2009, with the December 2010 tranche down 29% on its investment cost (as we understand the data). Would TWIF management care to comment? Don’t these figures suggest, contrary to claims typically made by investment funds, vendors etc, that fine wine has been as susceptible to the global economic downturn as other investment products? Or are we misreading the data?

Your understanding of the data is correct (although the figures have now been slightly updated). The wine market certainly experienced a very difficult 18 months from the middle of 2011, with 2011 and 2012 the only time in recorded history when there have been two consecutive years of price falls. We have commented extensively on this, and on the recovery which has taken place over the last few months, as well as on the prospects for the future - please see our commentary on the market attached.

However please note that we do not subscribe to the simple view that fine wines and other asset classes are not linked. Our research in this area suggests that, in fact, whilst this may be true in normal market conditions, in extreme conditions such as the 2008 financial crisis and the 2011 eurozone crisis, there is some degree of correlation. A more detailed paper on this issue is available on request.

Finally, although Bordeaux prices were weak in 2011 and 2012, the asset class still showed good longer term returns: in the five years to end 2012 the Liv-ex 100 fine wine index has risen by 8%. The FTSE 100, in comparison, fell by 9%. Using the longest available time series, the Liv-ex Investables index, fine wine prices have risen by 12.0% per annum since 1988; the equivalent figure for the FTSE 100 being 4.9%.

5. What is TWIF’s stance on the legal status of fine wine investment under UK law? In particular, that investment in fine wines does not qualify for ‘regulated’ collective investment status and therefore may not be promoted to ordinary ‘Joe Public’ investors. Why should fine wines be discriminated against in this way? Is there an argument that, subject to adequate disclosure and oversight, ordinary investors should be free to choose whatever investment product they prefer?

This question opens a wide debate about the nature of regulation. Our view is that we undertake to operate (and have done so since inception 10 years ago in 2003) to the highest standards in the investment management industry. This means that we act as if we were a regulated entity, irrespective of the legal status of fine wine.

In any event, the rules on promoting regulated or unregulated collective investment schemes is clear and is related to the product, rather than the underlying asset class. So, we have TWIF, which is an unregulated collective investment scheme (UCIS) and may only be promoted to certain categories of investor. We also have The Wine Enterprise Investment Scheme Limited, which is not an UCIS, which may be promoted to others. Both invest in fine wine.

6. What, if any, ownership or security interest do investors have in the wine purchased by the fund? Where do individual investors rank in the event of a liquidation of the fund? (We appreciate these questions may well be covered in the investment pack documentation.)

TWIF is a mutual fund which means (i) that investors invest in the Fund (not the Fund’s underlying assets) and (ii) the Fund owns the wines purchased for the Fund.

In the event of a liquidation of the Fund, as in the case of any such fund, there is a prescribed statutory order in which interested parties are paid out – ie:

(a) secured creditors (the Fund has no secured creditors); (b) costs of the liquidation; (c) debts due to employees (the Fund has no employees); (d) preferential debts (the Fund has no debts, preferential or otherwise); (e) debts secured by a floating charge (the Fund has no secured charges); (f) unsecured debts (the Fund has no debts, unsecured or otherwise); (g) debts due to shareholders (the Fund has no debts due to shareholders); and (h) shareholders’ equity.

Each category of debt must be paid in full before payment of creditors in the subsequent category, with any surplus assets then distributed to shareholders. As the Fund has no creditors (see above) other than day to day operating creditors (if any), the assets of the Fund are essentially distributable to the investors.

In any event, investors are able to redeem their holdings at will – ie at any time.

7. How would TWIF characterise the fine wine investment market going forward, say over the next 12 months / three years / five years? In particular, if fine wine is indeed counter-cyclical to mainstream investment products (ie, stocks and bonds) and if there is significant economic recovery over such time-frames, is there an appreciable risk that investors will seek to bail out of fine wine to get back into mainstream investment products?

As the attached commentary sets out, the market looks well positioned on both a short term and medium/long term outlook. In the short term, prices appear to have begun a recovery phase and being well below trend they have the potential to rise sharply.

In the longer term we believe the economic climate is very favourable for wine as an asset class. The key point is that wine is a physical asset which is immune to inflation and its value cannot be eroded by the actions of governments. This is in the context of the very loose monetary policies (low interest rates and the printing of money, known as “quantitative easing”) being pursued around the world which are likely ultimately to lead to inflation. Just last month Japan, for example, explicitly raised its target inflation rate and set out policies to achieve this goal.

Finally, in the next few years we are also likely to see new sources of demand for fine wine from developing countries such as India, Brazil, etc. This is a recurrent theme in the market: in the past we have seen sharper than usual price rises with the entry to this market of the USA, Japan, Russia, Korea and most recently China. In this context it is interesting that a trade agreement between the EU and India to bring down import tariffs is expected this Spring, and also that the leading auction house Sotheby’s noted a sharp increase in Latin American buyers at its sales last year.

8. In any event, is there an appreciable risk in the short/medium term of fine wine production, in France or globally, outpacing investment demand and so depressing market prices?

No, not when considering investment wine as we define it (i.e. only wines from Bordeaux). As described above, production in Bordeaux is restricted by its geographical definition, and, in fact, if anything production levels have been reduced slightly as the châteaux focus ever more on quality. Demand (for drinking and for investment) is relatively robust and likely to increase for the reasons set out in the previous question.

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