With financial markets crashing, investors selling anything there’s a bid for to raise cash, big and small corporations wondering how to cope with lost revenues and so many people worrying about their health and how to make payments, we probably all need a stiff drink right now.
Over-indulging is never the answer though. What investors need is an alternative, stable asset with steady returns that are not correlated to bonds, equities or mainstream commodities like oil and gold.
Is it conceivable to get both at once?
On March 18, Los Angeles-based registered investment adviser Wave Financial launched Wave Kentucky Whiskey 2020 Digital Fund, the first tokenized US whiskey barrel fund available to investors.
This will invest in up to 25,000 barrels of premium Kentucky bourbon distilled by one of the state’s up-and-coming premium producers, Wilderness Trail, which are laid to age.
The ageing process is crucial to value creation in American whiskey. A barrel of bourbon might cost under $1,000 to produce, mainly thanks to high-cost capital equipment.
The initial distilling process is quick, perhaps four or five days. Stored alcohol then responds to rising daytime temperatures, infusing into the wood of its barrels before coming out again in the cool of night to develop its flavour over many months.
By year five, the value of the whiskey in that same barrel might have risen to $3,000, or as high as $5,000, implying an internal rate of return of around 20%.
That might not have been so interesting just a few months ago but it sounds pretty tasty right now.
The fund is being sold to high net-worth investors. It will be too small – perhaps $20 million – for the armies of American independent financial advisers (IFAs) at firms such as Morgan Stanley and Merrill Lynch to promote, but it is an intriguing starting point for opening up a previously inaccessible source of value to outside investors through the tokenization of fractional ownership.
Benjamin Tsai, Wave Financial
Wave Financial is a digital asset management company staffed by investors with long experience in mainstream finance.
Benjamin Tsai, president at Wave and portfolio manager of the fund, spent 15 years at Merrill Lynch running structured products across Asia before moving to the buy side as head of alternative investments Asia at AllianceBernstein.
He came back to his hometown of Los Angeles initially to manage his own money, investing in fintech and seeing the potential of blockchain and tokenization to build new ways for financial investors to capture cashflows and returns from previously inaccessible assets.
Tsai looked at real estate, solar panels, even racehorses while searching for products with longer time cycles. He eventually hit on the investment thesis for whiskey and the ageing process that creates value. He talked to distillers, consultants, lawyers.
What struck him most?
Tsai tells Euromoney: “People in the business in Kentucky are mostly focused on the art and craft of making whiskey rather than on the return profile, which is what we found to be the most interesting.”
He adds: “There is also a bottle-neck in the scarcity of production capacity. However, we have been able to secure this from Wilderness Trail, and we hope that this capacity might be available on an annual basis for investors in subsequent funds.”
For Wilderness Trail, a young company pioneering new production processes but already established at the premium end of the market, selling a portion of its production to investors in the fund raises cash for investment that is normally not thrown off during ageing. This provides an opening for outsiders to take direct exposure not to the company – this is not equity or secured debt – but to the whiskey itself.
Euromoney considers the extraordinary prices that wine aficionados will pay for certain Burgundies and other varieties, but Tsai rejects the comparison.
“Wine is much more fragmented, with different grapes, regions, styles and vintages," he says. "For American whiskey, corn is corn, rye is rye, wheat is wheat. It is much more commodity-like. Yes, there will be enthusiasts that buy into the fund. But this is not investing in collectibles.”
The fees look very hedge fund-like: not quite two and 20, but a 5% upfront acquisition fee, 1% per annum management and then a 15% fee on performance. What justifies them?
Tsai explains: “When we start to sell barrels, we will return cash to investors. The timing of that is important. It requires constant monitoring of prices which are not transparent, and this is not a case of selling all in one go. Sell too early and you might miss the best value creation, but wait too long and it starts to taper off.”
There are a couple of markets for selling barrels, Tsai says: “You can sell back to the original distiller that may not have had the balance sheet to hold the whiskey but can buy it back, put its own premium brand on and market it. You can also sell to non-distilling producers who are like downstream operators that may buy from different sources, blend the whiskey, brand it and distribute it, perhaps to overseas markets. And you have enthusiasts.”
Tokenization and the listing of holdings in the fund on digital asset exchanges may allow investors an additional source of liquidity if other buyers come forward. But it is not a defining feature of the fund.
Tsai says of the projected returns: “We have been modelling off generic whiskey prices while this is a premium brand. We are comfortable there is a floor under prices. In a crisis, people don’t drink any less. They may not go out so much but they drink at home.”
The data does show a slight dip in bourbon consumption in 2009, but the overall demand for whiskey has been growing strongly both at home and abroad, with exports rising to Spain, Japan and Australia and signs of increasing interest from India and China, a big importer of Scotch whisky.
“The data from Scotch whisky suggests that if anything consumption rose in 2008,” says Tsai. “This is not a bad time to put down an investment, leave it for a couple of years and then by years three to five we might be selling into a recovery.”
And even though the fund is aimed at high net-worth individuals, Tsai argues: “It is a great investment thesis for institutional demand in the alternatives bucket of endowments and even pension plans. It’s quite stable, it’s not particularly risky and it’s not super weird.”
We’ll raise a spreadsheet of Sharpe ratios to that.