Wine can be a tasty way to diversify your investment portfolio.

I've never invested in fine wine, but I can think of plenty of reasons why people do.

First, wine is fun. Although I've made money from investing in semiconductors and barrels of oil, I wouldn't want to spend a whole evening with one.

You can also impress fellow diners and wine waiters by knowing the difference between a Lafite and Latour, or being able to sniff out a Haut Brion with one nostril tied behind your back.

And as James Bond discovered in Diamonds Are Forever, knowing that Mouton-Rothschild is a claret can save your life.

Best of all, wine has one clear advantage over every other type of investment -- if it underperforms you can always drink your losses.

Wine bubbles
Another attraction is that wine doesn't correlate too closely with equities, which can give your portfolio a smoother finish.

But like any other market, wine can also be frothy, and not just the bubbly stuff. It went flat after the tech collapse in 2000, but as the global economy powered on investors started pouring back into the sector.

Recent returns have been highly quaffable. The Liv-ex Fine Wine Index, which plots the prices of the most sought-after fine wines, grew 14.7% in the 11 months to December 2009.

The index soared from 105 on September 2005 to 264 on June 2008, and although it dipped by around 20% slightly last autumn, it quickly recovered and now stands at 235, a respectable 12% off its peak.

Global guzzle
Traditionally, most wine investors came from Europe, the US, Hong Kong and Singapore, but now the sector is enjoying increasing demand from major emerging economies China, Russia, Brazil, Mexico and India.

With only finite supplies of wines such as top clarets, rising global demand could push prices higher and higher. Some vintages of Chateau Lafite at rose by more than 50% in 2009.

By contrast, the Champagne market has gone flat due to oversupply, with even some vintage brands losing up to half of their value.

The market is likely to rebound next year, when growers will put the fizz back into the price by leaving up to half of the grapes to rot on the vine, reducing production from 405 million bottles to 230 million.

Nose for a bargain
Investors in fine wine should see another fruitful year in 2010, according to fine wine investment specialist Andrew della Casa, director of the Wine Investment Fund. Investor thirst remains undiminished in Asia, while investors in traditional markets such as the US and Europe are also getting their appetites back.

He predicts at the Liv-ex index will finish 2010 at 280, a rise of 18%. So should investors pour in?

The case for wine
Investors typically buy through a merchant such as Berry Bros & Rudd, Corney & Barrow and Farr Vintners. The standard investment unit is one case of 12 bottles. Many collectors never get to taste the wine, which seems a pity, but if you break the original case it reduces the value.

Some investors purchase wine before it goes on sale to the market, called en primeur, but this is risky, because you don't know whether the wine will prove to be a good vintage.

Most people typically invest in wine produced between 1982 and 2005. Older wine has mostly been drunk while younger wine is more risky, because you don't know whether it will prove a good year.

You should also beware of over exposing yourself to a single producer or vintage, and turn your nose up at wines nearing the end of their drinkable life.

Old world rules
Bordeaux makes up around 90% of the wine investment market, with first growth clarets like Lafite, Latour, Margaux and Haut Brion considered top-of-the-range, followed by Cheval Blanc, Petrus, Le Pin and Ausone. Burgundy, Rhone Valley wines and famous champagne brands Crystal, Krug and Dom Perignon can also prove good investments.

Many investors restrict themselves to Bordeaux, because there is a solid market for this. The market for New World wine isn't as stable.

Beginners should bone up on their terminology, buying specialist books and subscribing to magazines such as Decanter. You have to know what you are doing.

A Classe of its own
Alternatively, you can invest in specialist funds such as the Wine Investment Fund, which invests predominantly in investment-grade Bordeaux Cru Classe wine. It invests in only the top 5% of all Bordeaux, with a market size of around £6bn.

Since launch in 2003, the fund has produced annualised returns of 13.8% a year after all fees and expenses. In 2008, it outperformed the FTSE 100 by 26% and the Liv-ex 100 wine index by 10%, which is pretty tasty.

I'll drink to that
Drinking wine isn't taxing, nor is investing in it. The taxman views wine a "wasting asset" and exempts it from capital gains tax (CGT), unless he considers you are actively "trading" in wine.

You also have to store the wine -- many investors leave it at their wine merchant for safekeeping. Merchants typically charge you a broker fee of up to 10% when you sell, taking a generous swig of your profits.

Wine can be a risky investment -- investors lost millions after wine merchants Mayfair Sellers and Uvine collapsed in 2006. The attraction of investing in vintage wines is that the supply can only go one way -- down people's throats. That should force prices up in the longer run. A glug of fine wine could nicely lubricate your portfolio.

More on alternative investments:

Podcast on Fine Wine
Art For Art's Sake
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