The Ultimate Liquid Asset

According to Mahesh Kumar, author of "Wine Investment for Portfolio Diversification," the fine wine industry is booming, and owning a few bottles of France's finest can spread out risk and provide superior returns. Blue-chip wines, especially those from Burgundy, Bordeaux, the Rhone Valley and Champagne, have significant resale value and are actively traded in the global secondary market through auction houses. Just as important, wine can act as an effective hedge investment, says Kumar, who is president of Roman-Boston Consulting Corp., an investment- and management-consulting firm, based in British Columbia.

"I'm not suggesting you don't invest in stocks, bonds or real estate," he says. "Having wine in there can increase the overall expected return of the portfolio, and reduce overall risk of the portfolio."

Over the 21-year period from 1982 to 2003, the Fine Wine 50 Index (a portfolio of 50 investment-grade wines constructed by Kumar) averaged about a 12% annual return. Another indicator of the fine wine phenomenon is operated by the London International Vintners Exchange, an electronic trading platform for fine wine launched in 2000. Its Liv-Ex 100, a benchmark that tracks the prices of 100 wines, is up 40% year-to-date, already more than double the 18% it rose in 2005. For the first nine months of 2006, the turnover volume on the exchange is 2.5 times higher than the same period last year, according to the exchange's web site.

Despite its growth, the wine investment market is still a niche one. It's known mostly in Europe, and particularly the U.K. But Kumar says wine investing is gaining more traction; as of the spring of this year, the U.K. government relaxed regulations to allow individual investors to hold alternative investments such as wine and cars.

SmartMoney.com spoke with Kumar about what kind of wine belongs in a portfolio, how individuals can invest and the risks involved.

SmartMoney.com: What makes wine a good investment?

Mahesh Kumar: I can answer that question the same way you'd answer what, in general, makes a good investment vs. a bad investment. The reason why wine does incredibly well — and has done well over the last 20 to 25 years — is first thing, there's always a finite supply of wine being produced each year. And we're just talking about investment-grade wine, not consumption-grade wine — the wine you and I drink everyday. So the first thing to know is that supply is finite. The moment it starts getting consumed, the supply of that wine falls, but people are still chasing the fewer number of bottles, and prices continue to escalate. That's first thing to know about fine wine prices. Also, people are generally are drinking better quality wine. People are more interested in paying a better price for investment-grade wine; they have a higher level of disposable cash. Consumers are more sophisticated in terms of their consumption.

Another reason why it makes a good investment is because the fine wine market is not correlated with the financial markets. Take stocks, for example. If something happens in the economy, in the financial markets, stocks will either suffer or do really well. There's a strong correlation between the economy and stock prices, whereas with fine wine prices, prices are uncorrelated with stock prices or bond prices. The only thing going to affect wine prices is a global recession — global being the key word there. We haven't experienced that for years. So we haven't seen a huge downturn in fine wine prices. That's what brings about the diversification benefits.

SM: Investing in expensive wine sounds like a niche endeavor. How does it fit in a traditional portfolio that holds equities, funds and bonds?

MK: When you hold different asset classes in your portfolio, with alternative investment, the reason some portfolio managers do better than others is because they have a more diversified portfolio. Fine wine is an effective investment as part of a diversified portfolio. I'm not suggesting you don't invest in stocks, bonds or real estate. Having wine in there can increase the overall expected return of the portfolio, and reduce overall risk of the portfolio. The idea is to create some space within one's asset allocation [strategy] for wine investment. How much depends on your attitude toward investing in those alternatives.

Recently, in April and May of this year, the U.K. gave the go-ahead for pension funds to invest in fine wines. That's quite significant. There have been a lot of issues with blue-chip organizations; pension funds are not having enough to meet their liabilities, and pension-fund managers are looking at alternative ways to generate returns. Bonds are great; they can give you a fixed rate of return. But they still can be quite volatile. Pension managers are looking for more secure ways to make sure there's enough money in the pot to pay for pensions.