Overcommitted to property? Worried about equities? It is natural for investors to start looking at alternative assets such as gold and timber. And, given the number of oenophiles in the UK and the regular publicity accorded to the high prices paid for certain vintages, fine wine seems a potentially attractive investment asset.

Enthusiasts claim wine is negatively correlated with most other asset classes (if true, this makes it a useful source of portfolio diversification) and that there has been no rolling five-year period in the past 20 years in which a blue-chip Bordeaux wine has delivered negative returns.

But even those who can tell a Château Lafite from a Chilean Merlot might balk at the expertise needed to decide which vintages will offer the best returns. That creates a market niche for wine funds, investment vehicles that offer specialist expertise and the benefits of a diversified collection.

Then there is the problem of storage. Store your wine at the wrong temperature and it will be ruined. So the wine needs to be held at a professional storage centre, something the wine funds can arrange.

Nevertheless, it is a good financial principle that, when a lot of funds start being created in an asset class, investors should become cautious.

One potential problem of investing in wine via a fund is the tax treatment. Because wine eventually becomes undrinkable, it is classed as a “wasting asset” by the Inland Revenue, which means that no capital gains tax is due on any profits. Were wine to be bought in a conventional unit trust structure, the fund itself might be exempt from capital gains tax (CGT) on its trades, but investors’ gains from buying and selling the fund units would be subject to tax.

So the wine funds have attempted to devise structures around this problem. Will Beck of Wine Asset Managers (which runs the Fine Wine Fund) says the fund has been set up as an association of members who will collectively own the stock.

Peter Lunzer of the Wine Investment Fund says each of his group’s funds are set up as an “unincorporated association” and an unregulated collective investment scheme. “This means all investors are owners of the stock and we believe this will qualify for CGT relief,” he says.

It is important to remember, however, that the Inland Revenue does not tend to approve schemes in advance. It may decide that CGT does apply or indeed the government might change the rules if it thinks wine investment is being used as too much of a tax dodge (think back to the idea that fine wines could be part of a self-invested pension plans (Sipp)). So the funds could be sandbagged by tax at a later date. Andrew Davison of OWC Asset Management, who runs a Cayman Island-registered wine fund aimed at the institutional market, thinks investors would be foolish to rely on the wasting asset principle.

The second potential problem with investing in fine wine funds is the fees. These are remarkably similar to hedge funds in their scope. For the Wine Investment Fund, investors pay a 5 per cent initial fee, 1.25 per cent of subscription fees plus 20 per cent of the overall gain, above a hurdle rate of 50 per cent. For the Fine Wine Fund, investors pay a 2 per cent annual management fee plus 15 per cent in performance fees (there is no hurdle rate but there is a high watermark: the fee is only paid if the asset value is above its previous high).

Wine is first released into the market as en primeur . There is currently quite a lot of excitement about this year’s vintage, which some think will be so good it will justify a price of £3,000 per case. But there are problems with buying en primeur. Peter Lunzer of the Wine Investment Fund says his group has “never touched en primeur because prices often plateau immediately afterwards. If the 2005 vintage is as good as expected, those who paid high prices for the previous year’s vintage will be in negative equity for six to eight years.”

A further problem is that en primeur prices have risen quite sharply in the past 12 or so years. Essentially the growers have noticed the high premiums achieved in the second-hand wine market and have demanded their share of the cut. Andrew Davison says, “Château owners are business-minded individuals who know what their wines fetch in the aftermarket.” Other things being equal, higher en primeur prices mean lower returns to the end investor.

So both the Fine Wine Fund and the Wine Investment Fund tend to buy in the secondary market. “We buy stock that’s five to seven years after harvest but we won’t buy stock that’s overhyped or has shot up in value,” says Lunzer. “We believe that wine prices follow a price-step pattern, with steep rises followed by plateaux.”

Fine wine investment is almost exclusively focused on the French region of Bordeaux and on châteaux such as Petrus, Latour and Mouton Rothschild. Contrarians might wonder whether there is more scope for profit potential in New World wines, particularly after a recent blind tasting in which Californian wines beat their French counterparts. But the wine fund gurus refuse to countenance the thought. “The French wines are the only ones which the newly made millionaire wants to see on the dinner table,” says Davison.

“No case of wine is really worth £8,000. What you are buying is the prestige value,” says Beck. “In terms of prestige, the big brand names in fine wine are predominantly French. The first growth châteaux of Bordeaux produce a lot more wine than their Californian counterparts; Lafite can produce 20,000 cases a year.”

One problem, ironically enough for a literally liquid asset, is that other markets are illiquid. “You really need to start with top-end Bordeaux,” says Chad Delaney, sales director at wine merchant Justerini & Brooks. “With other areas, you are playing much smaller stock. With cult Californian wine you need to wait for the right time to sell, whereas it is easy to sell Bordeaux.”

Timing is also everything. Wine improves with age, for a while, but eventually turns to vinegar. But in the meantime, people are consuming the stuff. This works in the investor’s favour. “As people drink the wines, the supply contracts, adding to the scarcity value,” says Beck.

So a balance is needed between investors and consumers. “Our main base is still the drinkers of top-end wine and, as an investor, you need a drinker to realise your profits,” says Delaney.

What kind of returns should be expected? Liv-ex, a wine exchange, has a claret chip index of fine wines, which started at 7.67 in 1983 and has reached 189.9 this year; there have been only three down years over this period, the latest being a very small fall in 2004.

The Wine Investment Fund says the 2003 tranche is up 43.6 per cent since launch (before fees), the 2004 tranche 46.2 per cent, the first 2005 tranche 18.9 per cent and the second 2005 tranche 4.6 per cent. Davison’s Vintage Wine Fund is up 32 per cent since launch in 2003.

But, given the limited size of the market and the youth of some of the funds, this really is an area where past returns are no guide to the future.

Philip Coggan is the FT’s investment editor.

Fine Wine Fund, tel: +44 (0)020-7937 0090; www.thefinewinefund.com

Wine Investment Fund, tel: +44 (0)20- 7720 4200; www.wineinvestmentfund.com