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Finding the next Triple Crown contender

As the auctions in Saratoga got underway this week, the energy was electric. Women decked out in elaborate hats weaved through the crowd as billionaire businessmen stood poker-faced in huddles with their equine advisors. The booze flowed freely.

But the real stars of the evening emerged one-by-one from nearby stalls, manes carefully coiffed and coats buffed to gleaming. These are the pedigreed Thoroughbreds everyone was here to seeand take home. Trainers led them past the bystanders to the auction ring's podium where the wealthiest horse enthusiasts in the world placed bids that quickly ratcheted up into the six- and seven-figures.

A horse is on display during the 2014 Fasig-Tipson Sarasota Sale.
Fasig-Tipton Photos
A horse is on display during the 2014 Fasig-Tipson Sarasota Sale.

This is Fasig-Tipton's annual yearling sale in Saratoga Springs, New York, and it's one of the most exclusive race horse auctions in the world. Over the course of two days, more than $33 million traded hands for 114 yearlings from across the U.S., breaking down to an average sale price of nearly $292,000, with the most sought-after specimens commanding more than a million.

"This is a very special sale," said George Bolton, chief investment officer of WestEnd Capital Management and owner of a 60-horse racing operation. "It's a select group of yearlings where the average horse will bring in $300,000so not average to start with."

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Yearlings refer to 1-year-old, unproven horses yet to be fully trained. Saratoga's "Hips"the yearlings are numbered since they are still too young to have namesare bred from racing royalty, the well-documented descendants of multiple generations of successful racers. A long line of champions have traded hands at this annual auction, from this year's Belmont Stakes winner Tonalist (who beat Triple Crown contender California Chrome) ranging back to Man o' War, which was widely regarded as the greatest race horse in U.S. history.

"You are looking for an athlete," explained Gatewood Bell of Cromwell Bloodstock, a company that assesses and invests in horses. "Then the pedigree determines the price you are going to pay."

As the ultimate discretionary purchase, the horse marketbetter known in race circles as the bloodstock businesssuffered in the downturn. Fasig-Tipton President Boyd Browning said activity at its auctions plummeted 50 percent in 2010 from 2006. Since then sales have stabilized and begun to return. "We're probably at 75 to 80 percent of where we were at the height, but we're at a more sustainable level now."

Bolton noted that the stock market tends to lead the horse business by six to 12 months. "When Lehman went down in '08, the horse business felt it on '09," he said. "Now it's coming back to almost '07 levels but it's lagging the stock market by 12 months."

Prices at this year's Saratoga Sale were nearly flat from last year, with the average price down about 1 percent. However, 6 percent more horses traded hands.

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Harry Herbert of Highclere Thoroughbred Racing said the uptick in activity can be partly attributed to new international buyers in the marketincluding one of his clients. Herbert advised Sheikh Joaan Al-Thani of Qatar, a deep-pocketed new force on the global racing scene who is rapidly expanding his Al-Shaqab operations both internationally and stateside.

But it was actually another royal family that spent the most at Fasig-Tipton's sale: Sheikh Mohammed al Maktoum of Dubai. His advisors spent more than $5.3 million on 11 yearlings during the two-night sale.

Herbert said international buyers from the Middle East and China have been lured by the top-notch pedigrees and the fact that purses at U.S. races are increasing.

Prize money is important: it provides one possible return on a pricey investment. And while racing is certainly a passion for the wealthy owners that frequent auctions like Saratoga, many also see this as an alternative investment, looked upon similarly to art or luxury real estate.

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Take celebrity chef Bobby Flay, who buys, sells and races horses. "I do it all because it's a business. I can't afford to just keep everything and hope for the best on the racetrack. There are a lot of people that are interested in the families I purchase and the breeding that comes out of it."

Flay said he approaches racing the same way he approaches the stock market: carefully picking investments for long-term gains, expecting to realize profits some years, while suffering losses in others. For that reason he prefers to buy fillies with strong pedigrees that can yield steady returns through breeding.

But the biggest returns can come from stallions, which run the biggest races like the Kentucky Derby and the Preakness. "I think breeding is more predictable but racing is more fun," said B. Wayne Hughes, the billionaire co-founder of Public Storage, and the owner of Spendthrift Farm in Kentucky. "You can get very lucky very quickly. If you are trying to forecast your economic future with races, than you want to be on the stallions."

Bolton added that stallions can be a high-margin businessif they are winners. Champion stallions pull in prize money while racing and then command top dollar as sires.

Another strategy that plays out at yearling sales like Saratoga's is "pinhooking," or horse-flipping. Some investors, like Bell, purchase yearlings, train them, and then bring them back to auction as two-year olds. It's the riskiest of the three strategies, but one that can pay off in multiples if done correctly with a promising horse.

Still, owners say the key to making any of this work is scalehaving enough horses to pull in multiple revenue streams while hedging against any that underperform—and many do underperform.

"You can hit the homeruns but you can also go to zero. There are injuries that can happen. It's not like putting your money in a Spyder Index and watching your money go up," Bell said.

"It's a great way to make a million dollars, if you start with 10 million," Hughes said. "Now, we are making money and I like that better."

—By CNBC's Morgan Brennan

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