Hipgnosis vs Round Hill: Which song fund has the X-Factor?

Technology proved first a curse and then a blessing for the global music industry. The advent of the internet rapped revenues as piracy affected sales of music in physical form (mainly CDs). They went into structural decline, tumbling from $23bn in 2001 to $4.2bn in 2020, according to the IFPI Global Music Report 2021.

Digital revenues have now virtually filled the gap. Music streaming allows consumers to listen to music in a cost-effective and convenient way, and revenues from this have grown by an annualised 20% or more for the past 14 years – to $13.4bn last year from a standing start in 2004.

‘Streaming is now the largest single component of recorded music revenues and should benefit from double-digit revenue growth rates for digital music platforms as they continue to expand,’ said Liberum analyst Conor Finn. ‘New licencing agreements with emerging platforms provide additional revenue opportunities.’

Music copyright royalties – whereby income is paid to the owner of the copyright every time a song is downloaded, streamed, played, performed or otherwise used – are steadily gaining traction as an investable asset class with long-term growth prospects, underpinned by an expected continuation in double-digit growth in streaming revenues and opportunities to generate additional income through online media placement and usage.

Artists, writers, publishers and record labels typically own rights to the music they help produce. It is a large and lucrative market. ‘All I Want for Christmas Is You’, a festive favourite since 1994 and part of the soundtrack to the film Love Actually, has reportedly earned co-writer Mariah Carey more than $60m (£43m).

Music rights typically last the best part of a century – for 70 years after the last co-writer of the composition passed away – and the secondary market for them is increasingly active.

‘An artist approaching retirement that has a future income stream that could potentially last another 100 years may be more inclined to try and crystallise that sooner rather than later,’ said Paul Flood, a multi-asset and global income manager at Newton Investment Management.

‘Additionally, proposed tax changes in the United States could mean that an artist may have to pay a higher tax rate if they sell their royalties at some date in the future, so they’re now incentivised to sell their catalogues before this tax change comes into force.’

The potential of the nascent investment sector has not been lost on fund  manager M&G. It banded with experienced music executives in July 2020 to establish Seeker Music Group. It aims to acquire smaller, under-utilised music catalogues with a maximum value of $20m and, crucially, actively manage the assets.

‘Creative licensing teams are looking to tap into future growth drivers as well as current opportunities, including digital-first media platforms that combine audio, visual and social content and immersive entertainment such as virtual reality and augmented reality,’ said William Nicoll, chief investment officer of private and alternative assets at M&G.

‘Digital media platforms, such as Instagram, YouTube, Reels and TikTok, where music has become a greater part of the business model, are expected to continue to grow and generate incremental revenue streams for copyright owners.’

Once the relatively niche domain of music labels, publishers and private investors, two UK-listed, Guernsey-based investment companies offer public market access to catalogues of music royalties for the first time.

Since Hipgnosis Songs Fund (SONG) raised £200m in its initial public offering (IPO) in July 2018 royalties have been hitting the right notes for investors, multi-asset managers in particular, seeking a genuine alternative to increasingly correlated stock and bond markets.

‘Individuals’ music habits don’t necessarily change with gyrations in capital markets or the economy,’ said Flood at Newton, an early backer of the trust and now its largest shareholder.

SONG has amassed significant scale with numerous well-subscribed raises taking its assets to more than £1.5bn. Its growth, however, could be tempered by competition from a new rival – Round Hill Music Royalty Fund (RHM). It raised $282m (£203m) at its flotation last November and now has assets of £237m.

According to Refinitiv, CCLA (the Church of England’s investment manager), Handelsbanken Wealth & Asset Management and Hawksmoor Investment Management have stakes in both trusts.

AXA, Brewin Dolphin, Investec, JO Hambro and Jupiter own SONG, while Aberdeen Standard Investments, BMO Global Asset Management, Brooks Macdonald, Fidelity, M&G and Schroders are among RHM’s shareholders.

While both trusts have bands of ardent supporters, there are differences in their approaches and portfolios.

‘Although they end up in much the same place with ownership of music intellectual property, Hipgnosis and Round Hill Music have taken different investment approaches,’ said David Liddell, a director of online advisory investment service IpsoFacto Investor, who made a personal investment in SONG this summer.

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Investment advisers

Both funds seek to combine investment and music industry experience, albeit the founders of their investment advisers have backgrounds in either camp.

Merck Mercuriadis, founder of London-based The Family (Music), investment adviser to SONG, has forged a reputation as a bit of a rock star in City circles. He used to manage globally successful recording artists like Elton John, Guns N’ Roses, Morrissey, Iron Maiden and Beyoncé, as well as hit songwriters like Diane Warren, Justin Tranter and The-Dream.

Josh Gruss, founder of New York-based Round Hill Music LP, investment adviser to RHM, is a trained guitarist and spent a brief spell at Warner Music but most of his experience is in asset management. The quality of his music industry relationships is reflected in a management and investment team that has decades of music industry experience.

‘We got involved in Round Hill Music Royalty at the IPO in November after a number of meetings,’ said Scott Spencer, an investment manager in the multi-manager team at BMO. ‘Having been impressed by the overall quality of the team we felt they were exceptionally well placed to benefit from both the increasing demand for streaming and also the ability to place the songs in their catalogue in other forms of media – an exciting element of future growth in revenue that is not reflected in the valuation or NAV [net asset value].’

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Investment approaches

At its listing RHM acquired an existing catalogue that its adviser had built up since 2011 in a private fund that held the copyrights on artists such as the Beatles, Marvin Gaye and Celine Dion. At the time, its investment adviser was ranked the seventh largest music publisher in the US.

By contrast, SONG has mainly dealt directly with artists in acquiring music copyrights and has built its collection from scratch, albeit it had a pipeline of potential investments at flotation. Its portfolio includes songs by iconic rock artists like Neil Young (Buffalo Springfield, Crosby, Stills, Nash & Young and solo), Steve Winwood (Spencer Davis, Traffic, Blind Faith and solo) and Lindsey Buckingham (Fleetwood Mac and solo).

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Portfolios

SONG’s portfolio comprises 138 catalogues, representing 64,098 songs, while RHM owns 39 catalogues of more than 118,000 songs. There are noticeable differences in genre of music and vintage.

A key differentiating factor for RHM, especially at the time of flotation, is its tilt towards older music and genres. Most of its portfolio by vintage is from the 60s and 70s with more than 95% dated pre-2010. It recently bought the royalties of Dennis Elliott, the original drummer of rock group Foreigner.

SONG’s initial approach was to buy modern, superstar catalogues. This focus has reduced considerably of late with 60% of its portfolio older than 10 years as of 31 March 2021, compared to just 32.5% a year earlier.

Nevertheless, its higher weighting to pop music (46% versus 25%) could see it reap greater rewards from entirely new revenue sources – think video-sharing network TikTok and workout streaming app Peloton – which it expects to represent up to 15% of overall revenues in due course.

‘While these platforms occasionally enable rediscovery of classic hits, Hipgnosis’ sizeable remaining interest in current pop stars likely leaves it well-positioned to benefit,’ said Shavar Halberstadt, an analyst at Winterflood Securities.

Conversely, BMO argues that growing adoption of streaming in emerging markets, such as India, Africa and China, and among older generations may be of greater benefit to RHM.

‘Older catalogues may be more beneficial as older songs tend to be more well-known and have higher potential to be placed in other forms of media,’ said Spencer.

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Analyst ratings

JP Morgan Cazenove has an ‘overweight’ rating on SONG and a ‘neutral’ stance on RHM on the basis that the former has ‘built an even better portfolio with more upside potential’. Analyst Adam Kelly emphasised the independent nature of its research despite JP Morgan Securities being joint corporate broker to SONG.

One point its analysts make is that SONG stands to benefit more from ongoing judicial reviews that promise to redress the balance in revenues accruing to recording artists and songwriters relative to large recording labels: ‘first because it has more exposure to songs than master recordings and second because its master recording exposure is mainly via the recording artists’ share, while RHM owns most of them directly’.

Stifel, meanwhile, has a ‘positive’ rating on RHM. It recently downgraded SONG from ‘neutral’ to ‘negative’ on the basis that its revenues could wane from 2021 due to a decline in ‘right to income’, or exceptional income relating to acquisitions, as growth through equity issuance and acquisitions slows. Stifel analysts believe this is exacerbated by the vintage breakdown of the trust with catalogues under six years of age expected to show revenue decay.

Although RHM’s entrance coincided with enhanced disclosure by SONG, previously an area of concern for some investors, Stifel called for ‘greater transparency’ on its accounting methodology surrounding ‘right to income’. It believes this revenue source could encourage the fund manager to run the trust aggressively and close as many deals as possible just before the year-end.

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Double-digit returns

The sector offers attractive income and growth prospects. SONG aims to generate total returns of more than 10% per annum, with a high dividend yield and the prospect of capital growth in the form of rising net asset values (NAV). RHM targets similar total returns of 9-11% a year. There is not much between them either in the prospective dividend yields of 4.2% and 4.4% they respectively offer investors.

Parallels can be drawn between this alternative source of income and another investment trust sector offering regular income characteristics and attractive yields – infrastructure.

While listed infrastructure and renewable energy infrastructure trusts yield more on average, at 4.9% and 5.7% respectively, Kepler Partners deems dividend yields from music royalties attractive because of the added potential for capital growth and the uncorrelated nature of the returns, which in theory, is distinct from mainstream stock markets.

Aside from an improving background to earnings, the music industry shift towards subscription models could lead to important changes to the way revenues are valued, said co-founding partner William Heathcoat Amory.

‘An improvement in the predictability of revenues means that discount rates could move lower, offering a potential boost to returns,’ he added.

Independent third-party valuer Massarsky Consulting uses a discount rate of 8.5% in valuing both trusts. This could reduce as revenue visibility becomes clearer pushing up the price of royalties.

‘Much of the NAV gain for infrastructure funds has come from a decline in the discount rate and this may well be the same for these royalty funds,’ said Liddell. ‘Investors should look on these funds as income-producing assets, with any capital gain being a bonus.’

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New shares

Investors’ affinity towards the sector is reflected in both music royalty trusts which until recently had traded at around a 6% premium above operating NAV, their preferred measurement distinct from the official NAV they have to disclose under IFRS accounting rules.

For Liddell, this ‘looks reasonable value’ relative to the double-digit premiums attached to many infrastructure funds.

Recent share issues by both funds has eroded these premiums, with the stocks trading at around the operative NAV.

Peel Hunt analyst Markuz Jaffe suggests waiting to buy until new shares are issued.

‘Much like other investment companies that are seeking to grow, both SONG and RHM have been issuing equity recently,’ he said. ‘Therefore, investors would be well served to not overpay for shares in the secondary market if they can wait to participate in a future equity raise at a lower price.’

However, Fidelity International analyst Tigran Manukyan cautions against waiting too long to allocate a small part of an overall portfolio to the asset class.

‘Waiting on the sidelines and allowing this asset class to become more widely established in public markets, with greater scale, liquidity and investor understanding, could be prudent,’ he said.

‘However, those willing to participate early could benefit from greater returns and margin of safety before investor interest intensifies further. In the meantime, this asset class already hits the right notes on simple criteria such as scarce supply, growing demand and a lack of structural leverage. Prudent sizing in the context of investor objectives and the rest of the portfolio can help strike the right balance.’