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The View from the Watermark

By Andrew Davison 10 Dec, 2017

Those who keep a regular eye on our Trading Page will have noticed a gradual shift taking place: the price quotes have been increasingly focused on vintages from 2005 onwards. Given our particular strategy, it is only natural that as new vintages enter the market then, provided attractive opportunities exist within those vintages, other vintages may begin to look less appealing. The last three vintages released from Bordeaux – 2014, 2015 and 2016 – have all been brimming with opportunities, and this means a number of other wines/vintages have moved out of our sphere of interest.

So we thought this might be an appropriate moment to post a description of our strategy which could perhaps be best referred to as narrow focus relative value trading.  
By Andrew Davison 17 Oct, 2017

After the frenzied activity (if only for a few brief periods) of the en primeur campaign, it is not unusual for the Bordeaux market to be fairly quiet in the summer months. It is a bad time of year to be moving wine around in any case and so many merchants and traders take an extended break. Activity in July was particularly subdued but bids remained firm and prices were stable despite the lower volumes.

This mood continued into August but over the course of this month sterling suffered a period of virtually relentless weakness against both the USD and EUR but particularly the latter. In the second half of the month we consequently saw a significant surge in activity originating from buyers in Europe scooping up whatever cheap stock they could find in the London market. Demand was focused on first growth Bordeaux and, as prices firmed, we began to wonder with anticipation what might be in store for September once all market participants were back at their desks: could a re-run of last year’s excellent (post referendum) third quarter perhaps be on the cards?

Well it did not take long to get the answer. After hitting a low against the Euro right at the end of August, sterling made a vicious recovery bouncing right back to pre-summer levels. With inflation data and central bank comments leading some to expect an interest rate rise sooner than previously thought, GBP/USD also soared to a 12-month high. GBP prices for younger vintages inevitably pulled back a little from the August highs. These wines tend to be the most sensitive to exchange rates as inventories in Bordeaux, priced in EUR of course, are heavily weighted towards younger vintages. However, although the wind was somewhat taken from the market’s sails, prices generally proved very resilient to this bout of GBP strength. After all, as we have observed before, there is no reason why stock snapped up cheaply from the UK market during GBP weakness should come flooding back if the currency recovers. A significant amount will have gone to private cellars in Europe, the US and Asia never to be resold. In other words, the reduction in prices, as seen by non-UK consumers, creates a genuine spike in global demand. The scale of the effect is meaningful because of the relatively large value of stocks offered for sale in the UK (and, importantly, on which the seller measures his cost in GBP).

September saw a series of international releases including high profile wines from Champagne, California, Chile, Italy and the Rhone. These distractions undoubtedly contributed to the slower pace of trading in the secondary market. However, as we enter the final quarter of 2017, the focus is once again returning to our core Bordeaux market with Asian buyers in particular upping the pace over the last couple of weeks. The wind might just be picking up again and it is still blowing in the right direction.

By Andrew Davison 04 Jul, 2017
We were recently asked if we publish our performance reports.  These are sent to shareholders every quarter but since we are not currently open to new investors, there has seemed little point in making them more widely available.  But we thought we would post the latest one here; if nothing else the commentary might be of some interest.  Some portfolio information which is a little market sensitive has been removed and we have had to rejig the layout from the original single page to make it legible in this format.
By Andrew Davison 07 Mar, 2017
Regular readers will know that we have been an enthusiastic backer of the 2014 first growths since release. Back in Spring 2015, when 2014 Bordeaux was offered en primeur, we argued exhaustively that the release prices for virtually the entire vintage were much more attractive than was implied by the rather lukewarm response of many purchasers within the established UK trade.  We presented a rigorous relative value analysis to back this up and concluded that collectors should discard the obsolete rules of thumb being applied by their London merchants and simply fill their boots.

Needless to say, we bought across the board: first growths for our core strategy but also a spread of more modest wines (some of which have performed spectacularly well).  All the wines are now bottled and are starting to trade as physical stock, so we thought we would take a look at how the vintage has performed in comparison to the wider market.

As can be seen below, the first growths have all significantly outperformed the Livex50 index (this index contains 50 components – namely the five first growths from 2004 up to 2013).  
By Andrew Davison 22 Nov, 2016
Watermark’s strategy is of course a perfectly formed combination of active trading and portfolio management but it is always interesting to check out the latest management reports from the various pure investment funds. Some are a little cagey about divulging much information and others tend to write nothing but vacuous variations on “the wine market will go up; if it is not going up now then it will soon”. To be honest it is hard to blame them; the level of liquidity, even at the best of times, is so limited that for a fund of any size the option of significantly reducing exposure rapidly simply does not exist. This makes it hard to talk with any frankness about the short term if one happens to be bearish. There are no prizes for predicting a downturn if you cannot alter your position to take advantage of it.

The classic analogy for managing an investment in illiquid markets is that of steering an oil tanker. To avoid a hazard ahead, action needs to be taken a long way in advance and taken gradually without sudden movements. Only so much can be transacted without alerting the market to your plans and prices moving against you.

Managing the EUR 115m Vintage Wine Fund gave us plenty of opportunity to experience this first hand. When sub-prime raised its head in summer 2007 several canny investors immediately said they were reducing risk exposure across the board and were going to redeem. Others were sure to follow. We set about selling and in what seems a gravity-defying period had almost a year to work through as great a quantity of disposals as we dared without spooking the market. By the time the collapse of Lehman Brothers finally kicked the stool away, a third of the investors had already exited with profits intact.

For those who remained there was a stark choice: get out now in a collapsed market which had virtually seized up, or stick it out. Thankfully, many investors chose the latter and a second bite at the cherry came with the Asian rally. This time, it was the ludicrous prices paid in the Hong Kong ex-cellars Lafite auction in autumn 2010 which set the alarm bells ringing. Again, we had some time and our disposals included a dedicated auction with Christies in Hong Kong in March 2011. When the bottom fell out of the market with the Chinese anti-corruption clamp down that summer, investors were already substantially cashed out.

Substantially, but not entirely. There is no denying the fact that the few investors who remained endured a pretty torrid period while the Fund completed the process of winding itself up. With a bit more time in the run up to summer 2011 we could definitely have done better for that small minority.

The point of all this reminiscing is that while perusing the reports of The Fine Wine Fund we couldn’t help noticing something. The Fine Wine Fund is managed by Wine Asset Managers (WAM) whose reports have always been of the more interesting and meaningful variety. They also happen to publish the proportion of the fund actually invested in wine as opposed to held in cash. In August 2015 this proportion was 99.8% but has fallen steadily until in September 2016 it was just 21.9%. The fund has been selling solidly for well over a year.  We do not wish to speculate on the reasons for this but the interesting part for us is that the market has clearly absorbed a significant amount of stock and has done so without ill effect.  Not only is that indicative of an orderly and well-managed program of selling by WAM; it is also indicative of a market in good health which is encouraging for all of us. 
By Andrew Davison 11 Sep, 2016
Anyone who has read our numerous posts on wine pricing will be familiar with our view on how, in the current economic and interest rate environment, the prices of young wines should relate to those of older vintages. Young wines inevitably become older wines and so the value of a young wine should be lower bounded by the discounted expectation of its value when older. In terms of pricing, the current utility of a wine, i.e. the pleasure of consuming it or the joy of simply owning it, only becomes relevant when it is greater than the (maximum) discounted expectation of its value when older. This does not stop many commentators from misguidedly invoking a lack of current utility to argue that young wines are too expensive. Those interested in a rigorous mathematical formulation will find one in Dimson, E. et al. The price of wine, Journal of Financial Economics (2015):

It is therefore interesting to look at the following plot of good (but not outstanding) physical vintages of first growths. Each wine price is expressed as a proportion of the average price across all included vintages of that wine.
By Andrew Davison 15 Jul, 2016
Watermark’s business is clearly one which makes interaction with trading partners throughout the EU a daily routine. There has therefore been no shortage of opportunities to chat about the result of the UK’s referendum on EU membership and these conversations have been fascinating. First however, there are a few points concerning the referendum upon which it is simply impossible to resist the urge to comment.

It would be greatly to the benefit of us all if we could dispense with the flawed notion that the motivations of voters on either side can be inferred from the content of the respective campaigns . The question on the voting card was “Should the United Kingdom Remain in the EU or Leave the EU?” Voters were not asked to express an opinion on immigration or the refugee crisis or NHS funding. The result of the referendum illuminated the view held by the population on membership of the EU, and that is all. I think this is important for two reasons: firstly, if we are to unify behind this national project then we will need to view each other without pre-conceptions concerning our beliefs on any particular issue (or indeed on our general level of intelligence); secondly, when our government comes to respecting the democratic will of the people, any detail which is finer than “Leave the EU” is open to negotiation.

Now, while every detail of any ultimate agreement with the rest of the EU should be on the table the one thing that must be off the table is the possibility that we might not leave. There are some who argue that we did not know exactly what we were voting for and that when we have negotiated a more detailed exit we should have another referendum: negotiate the best deal possible and then vote. Sounds familiar but at least when David Cameron was negotiating the EU had an incentive (albeit one they seemed able to resist) to offer the UK concessions on continuing EU membership in an effort to entice us to vote Remain. Now that we are negotiating terms of leaving, the idea of a second referendum merely provides an incentive to make any exit deal as unattractive as possible. The most important thing we can state on the first day of negotiations is that there are precisely two end results: we leave with a deal if one can be agreed or we leave with no deal at all.

We have heard some argue that because the campaign included half-truths, wild speculation, breath-taking bad taste and blatant lies (so in that respect was typical), the electorate has been deceived and must vote again. That is to accuse voters of an inability to sift the truth from the lies. This I would strongly dispute. Moreover, voters are perfectly aware when certainty is just not possible and can be trusted to treat with deep scepticism those who would claim to predict the future with accuracy.

None of the above is intended as an argument for or against Brexit, but it certainly is a criticism of those who would seek to disregard the result of the referendum, or re-run it. Whether it is some legal technicality, or some criticism of the campaign or some idea that the motion was too vague, it all amounts to saying that the electorate got it wrong. You either believe in democracy or you do not. If, as the referendum has been characterised, this was a moment where ordinary people with all manner of social backgrounds and political allegiances finally got their voice heard above that of the elite then there is something distinctly distasteful about the lengths to which some seem willing to go to ignore what was so clearly proclaimed.

Coming back to conversations with our trading counterparties it has been interesting to observe a hopeful anticipation about how the result of our referendum may influence reforms within the EU institutions. It is hardly news that disillusionment with the EU extends beyond the UK; but there is also a real appreciation of why we, as a country not needing to disentangle from the Euro, might feel it viable to deal with these ever increasing concerns by simply leaving. And although the result was clearly a surprise to many of our partners, there is certainly no sense of insult. Why should there be? It was the EU and Brussels we could not stomach, not Europe or Europeans. One of the more absurd ideas put forward since the referendum is the one that states we have caused such offense that we will now find it difficult to have relationships, be they business or social, with other Europeans. I would suggest that a friendship which is dependent on our membership of the EU is a fairly peculiar one.

The highest priority from everyone we have spoken to is to continue to do business. There is a clear determination to ensure our trade together continues to flourish despite this change. And that is what matters. The same determination will exist in businesses big and small throughout Europe and they will all take a dim view of any politician or negotiator who is seen to be raising barriers out of some fit of establishment pique.

I referred earlier to Brexit as a national project. I hope that the understandable disappointment felt by those who wished to remain in the EU will fade. It may not be the result they wanted but we can all feel fortunate to have had the chance to express our wish. The path has been chosen and there are expanses of new territory to explore ahead. Surely, regardless of how we voted, we can all get a bit excited about that even if we are also a little apprehensive. No-one can deny that Brexit creates challenges but it is equally undeniable that new opportunities will now present themselves. For all the time spent fretting about the outcome of the forthcoming negotiations with the EU (and indeed the rest of the world) the surest route to success is for individuals, families and businesses to embrace the future with optimism and vigour.
By Andrew Davison 10 May, 2016
Just in case anyone is worried, we do not propose to repeat our lengthy analysis of en primeur pricing from last year. For anyone interested in our thoughts – essentially a much more benevolent view of Bordeaux’s recent approach based on rigorous analysis – we would direct them to our earlier posts “Getting it Right” and “Comparing Apples with Pears”. But it is impossible to resist entirely the temptation to comment on the 2015 releases which are now coming thick and fast.

The biggest problem this year is deciding exactly where the new vintage sits in terms of a general classification of vintages which, to use some commonly employed terms, might be: good, excellent, outstanding and extraordinary (aka vintage of the century). To call a vintage anything less complimentary than “good” has been illegal for some time. The problem with 2015 is that it is a rather different story depending on which part of Bordeaux you are talking about. A very illustrative case in point is the recently released Malescot St Exupery – from the Margaux appellation where quality in 2015 is high and consistent.

As can be seen from the chart below (reproduced from Liv-ex), consumers are being offered Malescot 2015 at a price which sits in between the level of the great vintages and that of the “also-rans”.
By Andrew Davison 10 May, 2016
Quick update of our post about GBP/EUR. The graph below, reproduced from the Liv-ex blog, is revealing. Two main things to notice:

In February we predicted that the sharp drop in GBP vs EUR would, if it persisted, lead to a significant upward shift in London market prices to compensate. At the time of writing EUR/GBP was at 0.772 and the Liv-ex 50 index was at 270. Current levels are at 0.795 and 283 (time of writing late April 2016). So we have indeed seen a healthy 4.8% appreciation of young first growth prices in sterling terms but with GBP continuing to tumble we are still some way from fully compensating for the FX moves. Assuming we do not see a sharp rebound in sterling, there could be plenty more upside.
By Andrew Davison 13 Apr, 2016
Last week, as I was leaving Chateau Lafite Rothschild after tasting the 2015 vintage, I overheard a well-known merchant ask his colleague:

“What did you give it?”.
“95 to 97”.
“Mm, I thought it was 96 to 98+”.

I mean, they would not have spoken about the art on the wall or the view through the windows in such a vacuous and degrading manner but had absolutely no shame in discussing the wine, the star of the whole show, in these terms.

At least the opinions being so brutally expressed by the pair above were their own.  I received an offer today from a merchant encouraging me to buy wines with high ratings from Robert Parker on the basis that as the critic enters retirement we are “getting close to the day when 100RP wines…are no more.”

My thoughts on critics’ ratings and, perhaps more importantly, how those ratings are used by merchants, have been fairly emphatically expressed in an earlier post.  But this latest approach is perhaps the most nauseating yet.  This is not just the lazy adoption of Parker scores as a definitive measure of quality, but goes a step further and blatantly embraces the idea that wines without a rating from Parker (and therefore all wines of the future) are less desirable.

The culprits are just one of the horde of wine merchants who have simply dispensed with the notion that it is the wine, the liquid in the glass and the sensations it arouses, which gives their customers pleasure.  They have formed the view that their customers derive enjoyment only from the knowledge that they are drinking wines which have the approval of Mr Parker.  The worrying thing is that they may have formed this view based on the behaviour of their customers; in other words, they may be right.

So it appears that before Parker emerged on the scene we had no way of telling whether a wine was giving us pleasure or not.   We may have tried drinking it and perhaps had an inkling that it was rather nice but without a score from Parker how could we possibly know whether we really liked it?  During the period of his activity over the last few decades we have been in a joyful state of certainty about what wines are good, or bad, or “modern day legends” or even “perfect”.  But we are about to be plunged once more into the darkness.  We will sip at a wine and swirl it in the glass and sniff it and wonder whether we are enjoying it or not and we will look into the distance and forlornly ask ourselves “What would Parker have thought about this?”
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