What's happened to music royalty funds?

From these extraordinary economic and market conditions emerged, according to David Merriam, investment manager at Evelyn Partners, "a lot of alternative income products".

He notes: "Clients who were used to 5 or 6 per cent from income-paying assets moved into other areas, and there were lots of esoteric investment trusts launched, including in the music royalty space."

Now, however, sentiment has soured quite dramatically, as prospects for long-term returns look ever more diminished. It is possible two trusts, who were initially successful, could cease to exist entirely. 

Two investment trusts came to market focused on buying the back-catalogues of big name musicians: Hipgnosis and Round Hill Music.

The former of these launched in 2018, by Merck Mercuriadis, a former manager of Beyonce, and Nile Rogers, the music producer behind many big hits in the late 20th century.

Our main concerns centre on the fact that we do not understand the price elasticity of the streaming services.Simon King, Vermeer Partners

The Hipgnosis trust started well and raised lots of capital, and its market cap rose well above £1bn.

Performance has been tepid however, with the trust’s share price down 21 per cent over the past five years, despite initially performing well. 

In October, shareholders will vote on whether they wish to wind up the trust, and return the capital to investors.

It remains more than £1bn in size.

That vote comes in the immediate aftermath of the other music royalty fund, which launched in the aftermath of the global financial crisis, Round Hill, which is £450mn in size and also recently agreed to be taken over.

Data from our sister publication Asset Allocator indicates that some of the largest wealth managers in the country had placed their client’s capital into these assets; both of the trusts mentioned above are owned by three of the allocators that publication covers. 

So what was the appeal? 

Merriam says: “The trust had an initial appeal for investors as the yields were north of 4 per cent. The advent of music streaming meant that songs could have a longer lifespan, while there were also changes in how musicians were paid for their music, which I think could be a long-term trend.” 

But he says that while there may have been good underlying reasons to own music royalties, and believes the sector will continue in some way, the structure and management of the assets in the products that advisers and their clients could access “has been poor”.

He said that in addition to the money raised from investors, “both of the trusts borrowed to buy music catalogues, then they would, during a period of buoyant equity markets, issue new shares at a premium to repay the debt.

"But when interest rates rose, the debt costs rose, and that happened at the same time as equity markets fell, so they were not able to issue shares to pay down the debt they had.”

Tone deaf? 

Simon King, chief investment officer at wealth management firm Vermeer Partners, says he never invested in these funds. 

“Our main concerns centre on the fact that we do not understand the price elasticity of the streaming services and the fact that millions of new songs are written each year that compete with the back catalogues. Also we [challenge] anyone to fully understand the byzantine nature of the rights system.”

Price elasticity is a term to mean the responsiveness of the demand for a good or service to changes in the price. 

King’s view is that the music streaming services only came into existence and grew during a period when no recession happened, so the durability of these companies, and so of the revenues they provide to the investment funds, may be more negatively impacted if a recession were to happen as consumers tend to cut discretionary spending first. 

Conversely, Paul Flood, multi-asset investor at Newton Investment Management, said in a note to clients that the changed economics of music – whereby one subscription offering access to thousands of songs is now cheaper than it used to cost to buy a single album – may mean that music subscriptions are more durable in an economic downturn than might be expected. 

Flood says he strongly believes in music royalties as an asset class, commenting that many consumer view access to music as being "a utility", and so as important to them as broadband.

For this reason he has investments in such products as a major part of one of the themes that underpins his multi-asset funds: digitalisation. 

He tends to run his multi-asset funds in a thematic way.

Traditional values 

One of the issues that may have brought matters to a head for investors in these vehicles is the way the music catalogues were purchased. 

Round Hill’s sale comes at a price lower than that of the book value of the assets, that is, the music catalogues were valued at a level in the trust’s accounts that is higher than the price at which they are now being sold. 

King says “these funds paid too much for the catalogues”, and adds it is difficult to actually understand what the value of the assets may be.

This point is elaborated on by Merriam, who notes: “Most funds that invest in unquoted assets get independent valuations performed by well-known accountancy firms such as Deloitte or Mazars.

"But in the case of both of these music royalty trusts, they used a firm that wasn’t well known in the market, and so there has been a lot of scepticism around the valuations as a result." 

He adds that one of the key metrics when it comes to understanding the true worth of the assets is the “decay rate” of the songs, that is, the extent to which the music continues to be played in future years.

He says that as the trusts got bigger, the quality of the music catalogues deteriorated and so the decay rate increased. 

Concerns around corporate governance and valuation are also central to the reason Investec analyst Alan Brierley recently cut his rating on the Hipgnosis trust.

He says the recently announced deal by Hipgnosis to sell some of its catalogues has the benefit of allowing it to repay debt, and this should reduce the volatility of the share price.

But he adds that the valuation being paid for the catalogues equates to about the share price when the trust launched in 2018, implying either the catalogue has been sold too cheaply to a related party now, or that the intrinsic value of the asset has not risen in five years.

Sachin Saggar, analyst at investment bank Stifel, says he believes the valuation of the music catalogue being sold by Hipgnosis is accurate now, but the problem is "the price (adjusted for expenses etc) is 26 per cent below the previous portfolio fair value.

"This is a material difference compared with a valuation that the board and manager have robustly defended for the past few years, despite our scepticism."

He says if the shareholders voted to reject the sale and wind up of the trust, it could get "messy" as the assets would all have to be revalued downwards and the debts of the trust may be called in. 

Both of these music royalty trusts used a firm that wasn’t well known in the market, and so there has been a lot of scepticism.David Merriam, Evelyn Partners

Brierley said these factors “raise significant corporate governance concerns”, and as a consequence he feels investors may take the view they are better off voting to disband the trust and have their capital returned, when they have the opportunity to do that in October. 

Merriam cannot comment on which direction his employer will go in during the continuation vote of the Hipgnosis trust, but says his personal view is that shareholders will vote to wind the fund up.

While Evan Lovett-Turner, director at Numis Securities, says he believes shareholders in the Round Hill trust will vote to accept the takeover offer despite the bid being at 11.5 per cent below the value of the assets in the accounts.

If both votes go as expected, it will bring the curtain down on music royalty funds as an asset class, ending what has been a rather expensive lesson for some advisers and their clients. 

David Thorpe is investment editor of FTAdviser