Roseman: How to capture wine value
Investment Week
By Joe Roseman
05.10.12
http://www.investmentweek.co.uk
One of the drawbacks from investing in assets like silver, wine, art or gold (SWAG) is that mainstream analysts typically default to rejecting the asset class because it lacks an income stream.
Finance 101 has taught such analysts that an asset needs an income stream in order for it to have an implied value. Yet, as Dylan Grice of Soc Gen so eloquently put it: “Suppose we think of a typical SWAG asset. It has finite supply and stable to rising demand, but it offers no cashflow. When we discount its future cashflows, they sum to zero. So using a discounted cashflow model, such an asset has zero value. Therefore, a Picasso has a zero value. But a Picasso clearly does have a value. So the model is clearly limited.”
It is seemingly easy to dismiss many tangible assets like wine precisely because it does not fit into the typical valuation metrics of most asset classes. What would happen if analysts started to evaluate assets like wine in a more quantitative manner?
What would happen if the tools and techniques that are applied to mainstream asset classes were leant to evaluation of an asset class such as wine?
Ian Ayres is an econometrician and Professor of Law at Yale University. In his book, Super Crunchers, he puts forward a simple equation that he shows captures the expected price of Bordeaux wine. The equation is:
Wine value = -12.145 + 0.00117 x winter rainfall + 0.6164 x average growing season temperature – 0.00386 harvest rainfall
Here is a quantitative approach to capturing wine value. I would argue that the equation would not prove stable over time as it fails to recognise the structural rise in demand from areas such as the BRIC economies. Like all econometrics, the assumption of linearity will likely be the undoing of the equation in the end. Yet, the concept of quantitatively capturing wine ‘value’ is intriguing.
Another approach to this issue has been embraced by Albany Portfolio Management, which is about to launch an EIS scheme utilising their algorithm that attempts to evaluate wine value. Interestingly, their approach looks at various factors such as the rating of a specific vintage according to specific experts, the ratings of specific wines, the initial pricing of a wine at release, the cru classe status, the Liv-Ex brand power rating and a number of various other proprietary measures. The angle taken by Albany is it uses the algorithm to rule out wines its algorithm views as over-valued. It is an algorithm that aims to identify bad investment potential as a way of restricting investment into just good ‘value’ wine.
The ability to remove big losers from an equity portfolio results in a staggering improvement in the overall performance of the portfolio. Albany’s testing suggests the same will apply to fine wine.
Albany will aim to trade in fine wines using their proprietary algorithm within the framework of a government sponsored EIS. For a UK taxpayer, this means that an investor placing £50,000 into the EIS would immediately be entitled to a tax rebate of £15,000 so long as the investment is held for the minimum three-year term.
After this minimum term, any gains are free from capital gains tax. Further, should the value of the shares in the EIS have fallen below the net amount invested (ie in this instance £35,000), the loss can be set against either other capital gains or income. The net effect is to limit the investment exposure to just 42p in the pound for a 40% taxpayer or to 35p in the pound for a 50% taxpayer.
I love this approach. First, wine is a SWAG asset that has the tailwind of restricted supply and expanding demand. Over the medium term, this supply/demand dynamic when allied to the government recourse to money supply expansion will provide a general underpinning of prices.
Secondly, Albany attempts to use a quantitative algorithm to isolate wines that have historically proven less appealing from an investment perspective in order to exclude such investments from their process. Such an algorithm does not guarantee that the future will be like the past, but it does at least provide some rigour to the investment selections.
Finally, Ben Graham would have been thrilled to see the substantial margin of safety provided by the government EIS scheme. Wine value? Maybe it is not so surreal.
Joe Roseman is the founder of BMO Economic Strategy and a former economist at Moore Capital