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How to invest in luxury goods

by maria
gawdo

By Simon King (Chief Investment Officerand Alastair McRobert (Investment Manager) of Vermeer Partners

Many looking for strong returns on their investment will be attracted to luxury brands. This could start as a fondness for a brand they respect and likely own themselves, coupled with a knowledge of the handsome margins on luxury products and impressive long-term share price performance. Investors often have a tangible knowledge of these products by owning them, and understanding these brands’ value can be appealing to private investors. It helps to explain how we define luxury. These are consumer brands that invest in

control over their brand, they are in charge of distribution, pricing and relationships with their customers. This is why you do not see sales in Apple

stores, or purchase discount Lululemon in TK Maxx. One helpful rule of thumb is to consider whether these goods depreciate over time. By this definition Aston Martin may not be considered true luxury, as the car can lose 15% of its value once driven off the lot. By comparison a Ferrari typically does not depreciate, and can become a valuable vintage vehicle.

marketing and make high-quality products. As well as having total

Every luxury brand is built on aspiration, which is why it is the only sector that will advertise to an audience that is not its target market. Most people will recognise a Rolex or a Tesla, regardless of whether or not they can afford it. This is particularly relevant for the growing middle class in emerging markets, which are driving the long term growth of luxury stocks.

These factors all contribute to our own luxury investment theses at Vermeer Partners. But there is more to the sector than high prices and prestige. Successfully investing in luxury requires deep knowledge of a complex sector that touches on geopolitics, pricing power and sustainability. Here are some tips to consider before getting started.

Think global

While heritage, brand and quality are important, the crucial factor when assessing a luxury investment is consumer spending. As the world has become more globalised in the last two decades, this has been driven by spending in emerging markets, as countries in parts of Asia and the global south are continuing to drive economic growth post-covid, swelling the global middle class. Assessing future luxury demand is no longer a function of identifying the spending patterns of the ultra-wealthy in a handful of rich countries, it is more about an understanding of demographics and the way that consumer spending develops in an economy over time.

China is always held up as the primary example of this trend, and research from Bain & Company showed that China’s share of the global luxury goods market doubled in 2020, and the country is on track to become the world’s largest consumer of global luxury goods in 2025. This explosion in demand from China’s middle classes was driven by western brands with savvy online strategies, so it can be useful to consider a brand’s online exposure to China when projecting growth.

While China is a potential source of massive growth, it is also a double-edged sword. Concerns over the country’s human rights record, accusations of cyber attackers stealing intellectual property, and animosity regarding China’s manufacturing success have created considerable hostility with the West, particularly the US. This has spilled over into the possibility of a trade war, which could in turn lead to luxury brands being targeted for sanctions. We are already seeing early evidence of this with Nike, which has considerable exposure to China both as a manufacturing base and as a consumer market. When Nike expressed concerns about forced labour in Xinjiang, Chinese consumers protested with their wallets, leading Nike to record a 59% drop in online sales on Alibaba’s Tmall during April.

As an investor, it is important to always look beyond first-order effects and ask uncomfortable questions. One might examine why it is that Asian consumers have been willing to spend so much money on Swiss watches, Italian suits or French handbags, and conclude that it is because of the brands heritage and a favourable view of European craftsmanship. But on further examination this position of stress may become more precarious, as geopolitical events may cause effective boycotts almost overnight. So it is important to price in political risk in emerging markets when considering an investment in luxury.

Durability of luxury

Luxury goods are high quality and tend to last for a long time, and spending on luxury goods is similarly durable. During times of economic prosperity demand for luxury goods is high, leading to high returns on investments. This is because as overall wealth increases, individuals are more inclined to treat themselves to jewellery or designer clothing. This is evident across all spending categories, regardless of income or wealth. During downturns, the more affluent buyers who represent the core market for luxury goods are not affected enough to adjust their spending habits, leading to a smaller reduction in demand than one may expect.

This combination of aspiration and brand loyalty makes the luxury market less vulnerable to economic factors than other sectors and this has been amply demonstrated during the pandemic. That said, it remains highly vulnerable to political risk.

Political considerations

Buyers of luxury goods are historically affluent people who are increasingly concerned about sustainability. They also expect brands to echo these values, and to be outspoken on political issues. Any brand that is associated with excessive carbon emissions, unfair labour practices or racism (even historical racism) may be targeted by campaigners and suffer financially.

This can create significant pressure on brands to meet new and changing ESG requirements. Prada instigated racial-equity training after displaying racist imagery in its stores, while Gucci was forced to withdraw a jumper that resembled blackface.

It also poses a challenge for the most successful luxury brands that are vertically-integrated and control supply tightly. The McKinsey State of Fashion 2021 predicts a growing antipathy towards waste-producing businesses, meaning high-end brands that would previously destroy unsold seasonal stock may struggle to maintain this control. French lawmakers banned this practice in 2019, forcing brands like Louis Vuitton to innovate.

While these controversies can cause revenue hits in the short-term, they are often driven by social media, making them more ephemeral. Most long investors will expect a public relations campaign that addresses this issue, and ultimately a recovery of the brand over time. This is not the case when it comes to China, where cancellation can be more lasting, and can come with government backing. Burberry saw a significant backlash in China after voicing concerns about cotton sourced from Xinjiang. Investors should be able to tell the difference between short-term social media criticism and facing the wrath of interventionist governments.

Final thoughts

Many investors will have a strong knowledge and familiarity with luxury goods, and this is a useful basis to consider adding the stocks to your portfolio. If this is something you are considering, then look out for control of distribution, pricing and brand, remember the enduring value of the sector and research geopolitical relationships between China and the West.

There are many potential companies to invest in ranging from large entities with a stable of brands to specialist operators that focus on one market. When deciding where to invest, it is sensible to use your own experiences and views on whether a brand is truly aspirational and durable, rather than being vulnerable to the whims of fashion and trends. Look for companies that have demonstrated pricing power and brand control over a period of time and where investment and marketing in the products has been consistent.

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