Fine Wine: A Palatable Commodity?

October 30, 2018
In the feature article of this issue of the Commodity Markets Update, we sit down with Patrick Stella, founder of WineCredit, to discuss the extent to which wine is investable, shifting sources of demand and value in the market, issues surrounding wine forgery and tips for people looking to build a collection.

After developing a love of wine in college, Patrick Stella knew that he wanted to work in the wine industry. The question revolved around how he was going to do it. What was ultimately born was WineCredit, a wine lending service founded by Stella in 2013 that allowed him to combine his finance background, passion for wine and entrepreneurial side to solve a burning issue in the wine industry: a lack of credit. We recently had the pleasure of sitting down with Stella in New York City to discuss the extent to which wine is investable, shifting sources of demand and value in the market, issues surrounding wine forgery and tips for people looking to build a collection.

Brown Brothers Harriman: Describe your business and the types of opportunities you look for.

Patrick Stella: Broadly speaking, the goal of WineCredit is to underwrite fine wine anywhere, in any way that we can get our hands on.

The variety is in the financial structuring. We serve many different types of clients and accommodate a lot of different needs. We might help a merchant expand inventory and manage working capital by underwriting wine it holds as inventory, or we might help a private collector create a bridge loan while he waits to receive the liquidity from selling a home.

As for why clients come to us, we provide competitively priced, incremental capital against an asset that isn’t doing anything except sitting around soaking up cash. It’s also an asset that – in a worst case – clients can live without. People often ask me, “Why would anyone borrow against a wine collection when they could get a home equity line of credit, or HELOC, at a cheaper rate?” My answer is that price isn’t everything. Utilizing a wine collection instead of a house to fund an investment can be a great form of risk management. If the investment succeeds, you probably won’t notice that you paid an extra point or two of interest. If it fails, though, you’ll be very happy that all you have to do is sell part of your wine collection. Defaulting on a mortgage is obviously a bigger problem. Discretionary assets like a wine collection may not provide the absolute cheapest capital, but they can be a great match for higher-yielding, higher-risk opportunities from a risk perspective.

BBH: How investible has wine become, and how has storage evolved to keep up with it?

PS: The whole business that I started is an answer to that question. WineCredit’s theory is that wine is investible and that the best way to invest in it is from a credit perspective, not through speculation.

As a collector myself, I know there are transactional and frictional costs when you hold wine as an owner. It’s a market that clears efficiently but with relatively high transaction costs – probably about 20%. And then you have storage and insurance costs.

Wine is not going to tank, but it can be difficult to push your way through the transaction, storage and insurance costs that are just going to drag on your return. You need to have such appreciation to get a strong internal rate of return (IRR) when you factor those in. There are definitely specific producers, vintages and regions where you could have made good money holding them for 10 years, but I think once you factor out all those transactional and frictional costs, you are never going to get a huge IRR. So, wine is investible, but the magic solution is to do it from a credit perspective, not an equity perspective.

In terms of storage, the nice thing is that as the market trends upward, some of those costs are reduced because they are driven by electricity for refrigeration, security costs and square footage costs, not as much by value. Insurance goes up as the value of the bottle goes up, but things like storage, appraisals and inspections are all benefiting from economies of scale as prices rise.

Transportation costs are also relatively lower as prices increase. Shipping a $1,000 bottle of wine from London to New York is much cheaper on a percentage basis than shipping a $100 bottle. We are certainly seeing that the wine market is a lot more logistically efficient now than it was 20 years ago because there is money to be made shipping, selling, buying and trading.

Liv-ex fine wine 100 index from 2002 to 2018, showing increases around 2008, 2011-2012 and 2017

BBH: How have the sources of demand changed over the past several years?

PS: The major components of the fine wine trade are Burgundy (French pinot noir) and Bordeaux (French cabernet sauvignon). Then, you have smaller regions like Champagne as well as Italian and Californian wines, which are respectable parts of the market but not as big. The biggest trend in the fine wine world in the past 10 years is that Burgundy prices have accelerated much faster than Bordeaux prices. There has been a lot of speculation about why that is, and I think the answer is straightforward: It’s supply and demand. Burgundy is produced in much smaller quantities.

The consumers who have gotten into Burgundy over the past few years have destroyed its supply. The previous generation of collectors included many upper-middle-class individuals who were buying fairly large quantities and generally sitting on them. Now Burgundy has become less of a collectible and more of a social wine that people buy to drink at parties. The old wines in the region are virtually gone, and at a dinner where you used to have to bring a 1978 or 1985, you can now get away with bringing a 1999 or 2000. You can really see people moving increasingly up the age spectrum as the supply disappears.

I think that is why Burgundy has continued to outpace Bordeaux over the past 10 years, and it’s still doing it. The first half of this year, Burgundy probably jumped another 25%, and Bordeaux is relatively flat.

The other major factor affecting demand for fine wine has been the rise of the Asian economies, who have been enthusiastic consumers of many luxury products. There is no denying that Hong Kong is a major part of the wine trade now. Asian buyers are probably a solid half of the market now, even if Hong Kong sales are only 25% of the market.

One interesting question from a commodity perspective is how has the supply reacted to these demand shifts? If you think about a commodity like oil, when there is more demand, people go prospect for oil in farther places. They do oil sands and deep-water offshore drilling. The wine market does not really work that way. New would-be buyers have no choice but to just raise their bids to the point where the existing owners decide they will sell it to them at that price. It’s a secondary market rather than a primary market.

BBH: Where do you see value in the market today?

PS: I do not see it in Burgundy – I will say that clearly! I see it in Bordeaux and Champagne, the two regions that have relatively large productions that have kept prices at a saner level. I would say the best value in the wine world is Champagne – the absolute best are still in the $100 to $200 bottle range. They age beautifully, and Champagne has the added benefit that most of the top-end bottles are aged by the winery for the first 10 years until they are ready to drink. 2008 is the next big Champagne vintage that is going to come out. We have had 10 years of watching it in the caves of the producers, so if you factor in 10 years of aging and capital costs along with the availability, it’s very attractive. 

BBH: And open it now or wait?

PS: That’s the beauty of it – it has already been 10 years, so you can open it now. If you want to wait five or 10 years, go ahead, but it will not hurt you if you drink it now. If you buy a bottle of Bordeaux now, though, you are going to be buying a 2015, and truthfully, you should wait 30 or 40 years.

BBH: Counterfeiting is a significant issue in the fine wine industry. How do you address this when you are evaluating your collateral? Does it worry you?

PS: It’s a risk, but it must be kept in proportion. I think it gets a disproportionate amount of press and attention for its actual frequency.

There are really two separate risks when you think about forgery for a company like WineCredit. One is the general diffuse risk in the market, which is to say what percentage of bottles floating around are fake, and it’s a small, manageable number – maybe 0.5% or 1%. The other issue, though, is the more dangerous one, and that is that you accidentally invest with, transact with or lend to the person who is forging the bottles. It’s really an underwriting risk, not a wine world risk.

Instances of forgery are rare, but those that do happen get a ton of press. One forgery happens, and an auction house nearly goes under, movies and TV shows are created about it, people write books about it – the amount of ink spilled per bottle forged is extraordinary.

The way to avoid forgery with individual bottles is to not be arrogant. Do not think of yourself as the person who knows what is real or not and what is good or bad. You have to listen to the marketplace too. You need to do your work and have your opinion, but also ask yourself, “Does the market consider this collection sellable, and are you confident it will remain sellable in the future?”

If everyone else in the market thinks it’s a great bottle, and I have my own personal doubts, it’s not particularly great to say I am not going to work with that collection. The more dangerous thing is that if there are legitimate doubts in the market about a collection, even if I know that it’s real, we cannot underwrite it. We have to be smart and consider the salability of things. The way you put that into practice is that what is not really sellable anymore are large collections of really old rare bottles.

You are in a world of trouble if you do a deal with a forger, but if you ask about how prevalent it is within the industry on a diversified basis, I think it’s manageable.

BBH: What advice would you give readers who are interested in building a collection? 

PS: The easiest thing to do is buy in the primary market, meaning wines in the store that are coming out this year. The secondary market is more complicated and intimidating. You have to go to an auction house and bid. You need to know and buy old stock and know whether it is real or fake, good or bad, well-stored and so forth.

Unfortunately, most collectors say, “I’m going to go to a nice store that has good options where I know it’s real,” and people spin them on all these benefits: “This wine is real and delicious. You’re going to store it yourself for 50 years and have these perfect bottles that your grandchildren will enjoy.” That sounds great, but it’s difficult to do. 

Planning a collection for 40 years is a logistical challenge. You have to allocate the capital, storage costs, space and time. It’s a complicated financial planning exercise to spend the optimal amount of money, buy at the right time, drink at the right time and die with the right amount in your cellar. If you do not spend a lot of time planning, you are likely going to end up with a lot of waste. You will have too much when it’s young and nothing to drink. If you keep buying, you will end up with a cellar full of bottles.

The biggest mistake is that people get excited and begin buying, but then they give up because it’s too young. There are many collection liquidations after five years because owners sit on it for five years and then ask, “When’s the fun part?” – and they have 35 years of waiting left. They’ll say, “I’m tired of paying the storage bill and worrying about this. I never had that epiphanic experience with a magical bottle, so I will just get rid of it.”

The second biggest pitfall is people who power through and keep buying, and then at the end of their lives they are not enjoying the wine as much – their palate has changed. After a certain age, you lose the delicacy in your taste.

My advice is to not underestimate the logistical complexity, and the best solution to that is to not play that game. Take some risks, but educate yourself. Find some competent advisors or friends who can tell you what to do. Put in a little more time upfront and buy older bottles at stores and auction houses now, and then you can buy and drink when you want to. That way, you will always have a good time.

BBH: Patrick, thank you so much for your time and insight.

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