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What I'd Like for Christmas 2007

Brett Arends

Diamond Cartier earrings. A Jaegre-LeCoultre wristwatch. A handbag from Coach. A bottle of 25-year old Talisker single-malt scotch.

I don't know what you unwrapped under the tree on Christmas morning, but if it ran to the wonderfully luxurious it probably made three people happy: You. The giver. And Caroline Reyl in Geneva. She runs one of the most delightful mutual funds on the planet: the Premium Brands fund offered by the small, innovative Swiss fund management company Pictet.

When it comes to screening stocks for her 64 million euro fund, Reyl has very refined tastes. Only the most exclusive brands need apply. That means companies such as Richemont (which owns Cartier, penmaker Montblanc and watchmaker Jaegre-LeCoultre, among other assets), Valentino, Polo Ralph Lauren, Coach and drinks giant Diageo, the leading distiller of single-malt scotch.

"We look across consumer segments for quality and aspirational brands," she says. "Our concept is very original. We don't just focus on luxury goods but also on the high-end range for all products, such as food and sporting goods."

Isn't this the greatest idea for a mutual fund? High margins. Strong brands. Growth. And, of course, the ability to walk down Rodeo Drive reflecting that every well-heeled shopper wielding a platinum card is paying you for the privilege.

The Pictet fund is not currently sold in the U.S. And it is depressingly predictable that our dismal mutual fund companies offer no equivalents. Of course, they're too busy churning out dull little "mid-cap blend" offerings guaranteed to underperform the market.

I approached Fidelity Investments in Boston, which runs a great range of sector funds, but I was told it has no plans to launch one targeting the luxury goods market. Marks for creativity and style: Zero.

It's more than a shame. Pictet launched the fund 18 months ago, and it's already showing results. The fund is up 30% in euros -- twice as far as the MSCI world "consumer discretionary" index.

"The concept has worked very well in 2006, and we believe it will continue in 2007," Reyl says.

The biggest reason? China. Luxury goods sales are skyrocketing in the newly industrialized country. Hard to believe, but Reyl says China -- including Hong Kong -- already accounts for as much of the world's luxury goods market as either North America or Western Europe. All three have about 16% of the market, she says. A year ago, China was "in single digits."

Japan remains the mother lode of luxury sales. The Japanese account for 40 cents of every dollar spent worldwide on premium-branded products. But Chinese sales are likely to grow at 25% a year for the next five years, Reyl estimates.

"These guys are going crazy," she says. "We are saying that within 10 years, the Chinese will be the leading consumers of the luxury market. You can see it when you talk to luxury companies. They are all figuring out how to grow in China."

On a smaller scale, you can see the same thing going on throughout all the emerging markets, from Bangkok to Budapest. As these people make money, they want to flaunt their new wealth. The same thing has happened in every industrial revolution in history.

Of course, you run the risk of pirated copies, but veteran observers in Hong Kong say they are witnessing a curious phenomenon. Shoppers from the former British colony, who have long been accustomed to luxury goods, get on the ferry to the mainland to buy cheap knockoffs. Coming the other way: the newly rich mainland Chinese, who are coming to Hong Kong to buy the real thing. They've never owned it before.

The growth in luxury goods sales isn't just about emerging markets, either. Sales are rising quickly in industrialized countries, too, even if it's at a more modest 7% or 8% clip.

In the West, says Reyl, a picture of consumer spending used to look like a pyramid, expanding from a small luxury goods industry at the top to a huge mass-market industry at the bottom. Today, she believes, "it looks more like an egg shape." The top and bottoms are growing. As an investor, you don't want to get caught in the middle.

Among her favorite stocks is Valentino, which trades over the counter and is a play on the Hugo Boss brand. Valentino owns a majority stake in the chic German design house, which accounts for about three-quarters of its sales and is taking off in Russia and Eastern Europe. Reyl sees earnings growth of 15% to 20% a year for the next four or five years.

She also likes the Italian company Luxottica (LUX Quote). You may not know the name, but you probably came across the company the last time you were in LensCrafters wondering whether you could believe your eyes -- at the prices of designer glasses. Luxittoca owns the retail chain as well as Sunglass Hut; it bought both to push its main business: making those designer glasses. The company owns the Ray-Ban name and licenses lots of others -- including Prada, Bulgari and Ralph Lauren -- for eyewear.

"It's not so well-known by U.S. investors, but 75% of their sales are in the U.S.," Reyl says. "It's very high margin. They are buying retailers and then placing their own products in the stores. This has been very successful for them."

Richemont(RHMSF Quote), which trades on the pink sheets, is a curious company controlled by the Ruppert family in South Africa. It owns Cartier, Montblanc, Dunhill, Jaegre-Le Coutre and IWC. It also has a big stake in British American Tobacco(BTI Quote) and a pile of cash that the management uses to buy back shares.

Reyl likes shirt-maker Phillips-Van Heusen (PVH Quote), which owns the Calvin Klein brand. I assumed that this was years out of date, but Reyl says it is "growing a lot worldwide." Ditto Polo Ralph Lauren (RL Quote). Years after everyone in America got bored of those polo shirts with the pretentious logo, they're booming in Asia.

Among her blue-chip holdings is Diageo(DEO Quote), the world's biggest drinks company. Brands include Smirnoff vodka, Bailey's Irish Cream, Johnny Walker scotch and a variety of single malts. For years, when I still owned individual equities, it was my favorite personal holding for its awesome cash flow and its growth potential in China. It also meant St. Patrick's Day in Boston was a time for celebration for me, even though I am not Irish and I don't drink: Diageo also owns Guinness.

Rounding out the fund's top 10 holdings are Christian Dior, Coach(COH Quote), French drinks company Pernod-Ricard (PDRDF Quote) and New York-based Starwood Hotels (HOT Quote), which owns up-market brands such as Le Meridien and Sheraton.

Among her offbeat picks is Dufry, an Italian company that is aggressively buying up duty-free retailing franchises in international airports.

If you were out shopping for That Special Someone two weeks ago, you know just what a great business the world's leading luxury goods companies are in. These are high-margin intellectual-property businesses with some pretty strong defensive moats.

I don't care how hard they try -- I doubt anyone is ever going to dislodge Swiss watchmakers, French champagne makers or Scotch whisky distillers from their perch. I find it hard to believe the lesson was lost on all the stock brokers, mutual fund managers and other investment "professionals" who were in Tiffany's earlier this month. So what I'd really like for Christmas 2007 is a U.S. fund like the one Caroline Reyl runs in Europe. Is that so much to ask?