Commission Free? Mind the catch…
Quite a curious thing happened last week in the Fine Wine market place. The value of bids exceeded the value of offers on a major London exchange for the first time.
What this means quite crudely is that there are more buyers than sellers, and under those circumstances prices tend to travel north.
It might be worthwhile pausing for a second to examine what exactly we mean by bids and offers, and why it is so important in the world of Fine Wine investment.
When you go abroad you might find yourself at a Bureau de Change that advertises itself as “commission free”. Avoid it like the plague. Buy everything on your credit card and withdraw cash from local ATMs (having first established the rates of exchange with your bank). Your bank, being a bank, operates in the interbank market and therefore is able to deal in tiny spreads. On a recent visit to Abu Dhabi where the exchange rate is 6.1 Dirhams to £1, one of our team noted that the “commission free” airport Travelex (NOT a bank!) was offering a rate of 5.30 to 7. In other words, they would give him 5.3 Dirhams for his £1, or, take 7 Dirhams from him to give him his £1 back.
This, ladies and gentlemen, is the bid/offer spread, and in case you didn’t know, if you deal through the merchants in making your Fine Wine investments, your terms of engagement are just as bad. And it is not the merchant’s fault, because he makes his living by buying as cheaply as he can and selling as expensively as he can, but what you as an investor call the bid/offer spread, the merchant calls his profit margin, so your needs are in disharmony with his. As an investor you have to try to take your business elsewhere.
This has important ramifications for portfolio valuations. We are often asked to value portfolios FOR PROSPECTIVE SALE, and we usually find that the vendor is disappointed by the valuation. This is because many people in the industry tend to give their clients valuations which represent REPLACEMENT COST, and the replacement cost is effectively the merchant’s offer price.
Pricing has been dominated over the years by merchants, the vast majority of whose clients are consumers not investors.This means that they are not expecting the stock to come back to them. They are expecting it to be consumed. So the most authoritative prices you can find are prices at which you can buy, not prices at which you can sell.
When you want to sell, a merchant will give you a price which enables him to make a good profit when he sells it on. Hence merchants’ bid prices, the prices at which you can sell back to them, bear absolutely no relation to your portfolio valuation.
It is crucial that all investors realise that most market places operate around a bid/offer spread. If you sell your car to a garage you will not get the price at which he subsequently advertises it on the forecourt. At APM we deal through the merchants only as a last resort, because their pricing structure is antithetical to making an investment return.
What we endeavour to do is lubricate the market place by matching willing buyer and willing seller at a price which is in the middle of the spread, thereby giving both sides a better chance of making a decent return.