Alternative Investments and its Costs - Part 1

Many of us might have the experience of being approached by sales representative to invest in alternative investments such as investing in fine wine, watches, collectibles, arts and etc.

I attended a wine investment talk the last week and here is some notes:

• 10-12% compounded annual return in the last twenty years.
• Focus investment on Bordeaux chateaux and only from top vintages.
• Supply of top vintage Bordeaux chateaux is scarce naturally and also limited by law whereas demand is growing significantly over the years and mainly comes from the developing world.
• The inventory of Bordeaux chateaux will only deplete from time to time due to consumption.
• Therefore, all factors suggest that the prices of fine wine will only go higher and higher in the future.
  
• Return from S&P 500 over the past twenty years is roughly 8% per annum V.S. Return of 23% per annum on a certain brand of fine wine
• Long term investment perspective is required. They recommended a period of 3-5 years and average clients normally have a 3 years investment horizon.
  

IS IT an ATTRACTIVE INVESTMENT?

Many people in the room appears to be interested.


What are the questions you need to ask ?

1. How to value fine wine?
2. Is the projection of past performance into future reliable? What are the assumptions behind this projection?
3. What are the COSTS of investment?

Basically, they avoided to answer the first question and saying that the history had proved itself. This led me to ask the second question. They answered that it was 'guaranteed' and all factors pointed to this conclusion.

Let's say you agree with them and fine wine is a great investment. What about the costs?

• 5% of the value of your initial investment. It comprises their commission and first three years of insurance and storage costs.
• 2% per annum start from the fourth year of investment. This is for the storage and insurance costs.
• Another 5% selling costs based on the exit price.
  

They insisted that it is cheap. Agree? How much is your brokerage fees? Do you think that is cheap?

Let's consider a scenario. Assuming that the price of fine wine will rise at the historical maximum of 12% a year in the next three. What is your net return (compounded annually) after 3 years?

A. 12%
B. 10%
C. 8%

Answer is C, 8% per annum.
Where is the other 4% per annum?

Conclusion:
Costs are always very important in investing. It will eat away our future profits. Future profits are not guaranteed but costs are guaranteed to be incurred.

I don't know much about investment in fine wine and i don't know how to place a value on it. It might be a good investment given the special limiting factor over its supply and the strong demand from China and Russia.


Additional information:
What are the tricks they usually use?
1. Comparing a single investment/product against S&P 500. They might choose a high return investment on hindsight and compare it against the AVERAGE return on stocks. This is not a fair comparison.
2. When they start to use the words 'Confirm', 'Guarantee' and etc. You need to be careful.
3. They tends to avoid discussing about the costs of investment.