Chinese cravings cause a boom in Bordeaux

Many years ago I was in the Hong Kong home of a wealthy Chinese banker. His wife proudly showed off her display cabinet containing a collection of miniature flowers made from crystal glass and jewels. They were worth a fortune. Each year,' she bragged, I go to Milan to buy another piece for my collection.'

When it comes to conspicuous consumption, the Chinese have few equals. And one luxury market that they have really set alight over the last few years has been fine wine. Popping open a top-end vintage has suddenly become a status symbol at banquets all over China. And this has sent prices into the stratosphere.

Last year prices jumped by some 40% and Andrew della Casa reckons the trend will continue. He is offering those willing to stake a minimum of £10,000 the opportunity to invest in The Wine Investment Fund. To launch this new fund with a suitable fanfare he is predicting that fine wine prices will rise a further 21% in 2011.

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Should we invest??

Why this fund is making 16% a year

Now there are some things that I like about this new fund - but others that I don't. This is, to my knowledge, a unique opportunity to invest in an AIM-listed fine wine fund and the management team undoubtedly has a good track record.

And since setting up in 2003 investors in previous fine wine funds run by della Casa's team have been rewarded with annual returns of some 16% per annum. This return is after all expenses and, better still, is tax free because the Inland Revenue regards wine as a wasting asset. A decent enough performance.

I also like the approach of the management company. In contrast to others who simply buy a load of wine and stick it in a warehouse, della Casa has adopted a more analytical approach. He has looked carefully at past performance to determine where the best opportunities for price appreciation lie.

What he has found is that fine wine prices do not go up in a straight line but in a series of identifiable steps. He calls this the Price Step Theory'. According to this theory, the best time to invest in wine is when it becomes drinkable and is first consumed by wine drinkers and discussed by critics and journalists. This is the point where rising demand meets diminishing supply. Eventually, this price rise prompts some holders to sell and the curve levels out. Later when the wine matures further, and with remaining stocks getting lower, a second period of price appreciation can begin.

So the Wine Investment Fund will not buy wine at the en-primeur (pre-bottled) stage, as is usual for wine investors. Instead, it will look to buy wines at the stage when they are first drunk. It will also have a very selective approach, buying wines only from thirty-five chateaux from Bordeaux.

This has certainly been a successful formula so far, but that does not necessarily mean that it will be as successful in the future...

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I would go nowhere near this fund

The returns from this wine fund have been partly due to this selective approach, but mainly because wine prices generally have been rising. The very speed at which wine prices have gone up is a warning in itself.

Anything that appreciates by 15% per year doubles in five years and quadruples over ten. The resources of even the Chinese are finite. While they may think nothing of shelling out £46,000 for a case of Chateau Lafite 1982, as happened recently, a price tag of £92,000 or even £184,000 may be beyond even their pockets.

What really puts me off though is the fund's charging structure, and its performance-related fees. Della Casa is hoping to raise £30m, which at the 1.5% investment management fee would enable his team to pocket £450,000 per year. Running a wine fund narrowly based on Bordeaux is not, to my mind, an especially demanding task, and certainly not one that requires a huge team.

£450,000 per year sounds like good money to me. However, as sadly has become customary these days, della Casa intends to levy performance-related fees on top of this with a hurdle rate of 8%. The only way that investors can beat this form of institutionalised rip-off is to simply refuse to invest in funds that charge performance fees. I would not put my money into The Wine Investment Fund on this point of principle alone.

The other bit of nonsense spun into the argument is that wine can provide valuable portfolio diversification, because returns from wine are not correlated to returns from other asset classes.

As I have pointed out before, you could go out and buy old milk bottles if you liked. Because their value does not go up and down in line with shares, bonds and property, you could argue that these would dampen down the volatility and provide diversification.' Being unrelated to the market doesn't make something a good investment.

This article was first published in Tom Bulford's twice-weekly small-cap investment email The Penny Sleuth.