Five Keys To Finding The Next Kentucky Derby Winner

in Investing by

While horse racing is known as the Sport of Kings, lately it’s been the Average Joes that have reigned supreme.  California Chrome, the latest Triple Crown contender, was bought for $10,000 – a bargain, considering he’s won over $3.3 Million in 2014 alone.

No horse has won the Triple Crown since 1978, when Affirmed won the Kentucky Derby, Preakness, and Belmont Stakes successively. In the last seventeen years, nine horses have come to the Belmont Stakes with dreams of completing the trifecta, but all have come up short. Most recently, it was California Chrome who was challenged by the grueling test.

I had always been interested in the sport, but this was the first time I was completely enamored with a horse. I became a huge fan of California Chrome, whose history of beating the odds led me to have an unbelievable (read: irrational) amount of confidence that this would be the first horse since Affirmed to pull the feat off. California Chrome had been the first horse from California to win the Kentucky Derby since Swaps in 1955. Chrome’s trainer was Swaps’ exercise rider. Swaps is part of Chrome’s lineage. It didn’t hurt that I’m also from California. As an incredibly superstitious person, it was hard to ignore the abundance of signs pointing to racing immortality.

Chrome was the progeny of Love the Chase (bought for $8,000) and Lucky Pulpit ($2,000), who between them had four wins in twenty-eight races. Chrome’s owners had never been the sole owners of a horse before, and spent eight months researching pedigrees before selecting Love the Chase and Lucky Pulpit. When they bought Love the Chase, one of the stablehands declared that only a “dumbass” would be wise enough to shell out for the filly. Not only did Chrome’s owners buy the horse, but they agreed upon a name for their partnership: Dumb Ass Partners. I was hooked.

Chrome won the Kentucky Derby in impressive fashion, and was victorious at the Preakness. The only thing standing between him and immortality was the Belmont, a mile-and-a-half race that is longer than both the Derby and the Preakness, and favored endurance racers, which Chrome was not. Chrome got off to a strong start, but from the beginning jockey Victor Espinosa knew he was off. The horse was exhausted, and ended up finishing tied for fourth, with dreams of joining the ranks of Affirmed and Secretariat dashed.

Though Chrome was unable to complete the Triple Crown, his story has generated interest in the field of horse ownership due to his discount price and amazing earnings. Horse ownership is becoming an increasingly popular and affordable hobby. The American Horse Council estimates that 1 out of every 63 Americans is involved with horses. Furthermore, 34% of horse owners have a household income less than $50,000, and 28% have an annual income greater than $100,000. Here are five things to keep in mind when you decide to take the plunge and invest in your first racehorse.

FIVE TIPS TO FINDING THE NEXT KENTUCKY DERBY WINNER

1. Only Invest What You’re Comfortable Losing

Investing in a race horse has often been compared to micro-cap investing. Odds are that you will lose your initial investment, but if you do manage to hit it big, your returns will be spectacular. As a result, the first rule is to only invest what you’re comfortable losing, and be mindful of the fact that horse racing carries high variable costs.

Horse ownership can begin to get expensive when considering the fees that owners will rack up throughout a thoroughbred’s racing career. Known as upkeep, these fees can include annual training, trainer fees, food and supplements, and shoeing, and can cost $50,000-plus annually, according to the Wall Street Journal. Additional services may include veterinary fees, insurance coverage, commission for the buyer if you choose to buy into a syndicate, legal fees, and sales tax on the initial purchase price of the horse. A smart way to offset these fees? Claiming your horse is for business use (as opposed to personal use) for tax purposes. Doing so provides a variety of tax benefits for both race horses and broodmares, ranging from an attractive depreciation schedule to generous write-offs.

Again, only invest what amounts to play money. As for the rest of your portfolio, check out this post about how to ensure your portfolio is properly allocated outside of your horse ownership stakes.

2. Form or Buy Into a Racing Syndicate

Building upon the micro-cap metaphor, buying into a racing syndicate is like investing in a mutual fund. By purchasing a small share of the syndicate, you receive broad-based exposure to a stable of horses. Doing so provides access to a larger range of horses that mitigates any single-horse risk, allowing owners to participate in various races and receive an appropriate share of the syndicates’ earnings.

Syndicates are a popular avenue for first-time owners to navigate the world of thoroughbred ownership, offering an economical way to experience the thrill of racing while minimizing the impact on their checkbooks. As mentioned earlier, high ongoing fees are the largest con of ownership. Joining a syndicate allows investors to pay reduced recurring expenses in proportion with their share in the partnership.

The Thoroughbred Owners and Breeders Association has a fantastic website detailing the ins-and-outs of syndicate ownership, ranging from costs of ownership to pedigrees. Think of this like owning a diversified portfolio. 

3. The Younger the Horse, The Riskier the Investment

There are three stages at which horses are typically bought: 1) the weanling stage (six-to-eight months after the horse is born and is taken off its mother), 2) the yearling stage, or 3) at two-years old. The younger the horse is at the time it exchanges hands, the riskier the investment is thought to be due to the horse’s physical immaturity, its lack of racing history, and questions regarding its potential for future success.

Weanlings are often the toughest to judge due to the fact that they are not yet physically mature, and have yet to step onto the track competitively. Purchasing a weanling and expecting it to be a phenomenal racehorse down the road is pure speculation. Granted, expecting any racehorse to be the next California Chrome is pure speculation, but this is especially true in the case of weanlings.

Unlike weanlings, yearlings are fully physically mature at this point, giving possible owners a better idea for the potential of the horse. However, at this point the horse still has not competed on the track, providing some ambiguity regarding their chances at excellence on the track. The difference between yearlings and two-year olds is the fact that the two-year olds have been tested on the racetrack.

After turning two, horses are eligible to race in age restricted events, allowing them to compete with horses of similar age and experience. It should be noted that not all horses will be ready to race as soon as they turn two – horses can be temperamental, immature, and have big personalities that can prevent them from effectively competing. The Kentucky Derby, Preakness, and Belmont Stakes all have a three-year old age requirement.

The best way to go about making this decision? Know exactly what your risk tolerance is, keeping in mind that the greater the risk, the greater the return.

4. Pedigree, Pedigree, Pedigree

In much the same way that real estate is all about location, location, location, investing in a horse with a great pedigree should be paramount for investors. The reason is that even if the horse isn’t successful on the track, its bloodlines will make it an attractive partner to breed with or sell, providing owners with a cushion to fall back on. This sort of insurance policy is another hedge for owners to consider, but, as expected, it is often the horses with the best pedigrees that command the highest prices on the market. Those with the best pedigrees are akin to blue-chip stocks – regardless of their performance on the track, you know they’ll still be profitable in other avenues (more below). Unfortunately for mom-and-pop investors, these horses can fetch seven figures at auction.

Be mindful of the fact that spending eight months studying pedigrees, as California Chrome’s owners did, does not guarantee a horse will be successful on the track, and will often result in a waste of eight months’ time. Chalk this one up as another instance in which Chrome’s owners got incredibly lucky.

5. Cashing Out

Even if a horse isn’t successful at the track and doesn’t possess a sterling pedigree that would attract breeding partners or generate excitement at auction, it can still generate a nice return for its investors. Horses can be re-trained to compete at other equine events, such as endurance riding, show jumping, polo, or even rodeo. Each of these events requires a horse with a different skill set, yet provides an attractive alternative for owners looking to maximize their return. Additionally, horses continue to be used for official duty, such as police work, as well as entertainment value, such as the Clydesdales, the unofficial mascot of Anheuser-Busch. Investing in a horse can be an attractive opportunity due to the plethora of liquidity events that can take place down the road.

Want a simple comparison? Think of the two ways you can generate income from investing in equities: dividend payments and stock appreciation (assuming a future liquidity event). Investing in a horse is similar in that there is a possibility for multiple income streams, but different (in a good way!) considering that there are more than two options.

CONCLUSION

When deciding to invest in your first racehorse, keep these five principles in mind. Hopefully, with a little planning and a whole lotta luck, you can find yourselves in the winner’s circle at Churchill Downs.

Ever consider investing in a race horse before? Are you now after reading this post? Interested in another hobby that might generate attractive returns? We wrote about another popular hobby investment in wine.

Photo Credit: Thoroughbred  Racing Dudes

The following two tabs change content below.
Arun Sundaresan

Arun Sundaresan

Arun Sundaresan is a Portfolio Management Intern at Personal Capital. Arun has previously worked at Citigroup in London, and spent time at Personal Capital last summer. He is currently studying Finance at Washington University in St. Louis.

One Response

  1. Financial Samurai

    Good post Arun! Making a $3.3 million return on a $10k investment in one year ain’t that bad at all. Interesting how there are lots of other opportunities for the horse and investor if he doesn’t work out.

    Horse investing sounds like a hobby for the very rich or those who just love the industry. A syndication sounds like the way to go, just like how individuals invest in pro poker players who have to share their winnings accordingly.

    Reply

Leave a Reply

Your email address will not be published.

Disclaimer. This communication and all data are for informational purposes only and do not constitute a recommendation to buy or sell securities. You should not rely on this information as the primary basis of your investment, financial, or tax planning decisions. You should consult your legal or tax professional regarding your specific situation. Third party data is obtained from sources believed to be reliable. However, PCAC cannot guarantee that data's currency, accuracy, timeliness, completeness or fitness for any particular purpose. Certain sections of this commentary may contain forward-looking statements that are based on our reasonable expectations, estimate, projections and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not a guarantee of future return, nor is it necessarily indicative of future performance. Keep in mind investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money.