Intellectual Property: For music copyrights the beat goes on
Laurens Rensch (pictured), portfolio manager Private Markets at Swiss Alpha comments on opportunities and risks of investing in intellectual property.
Intellectual Property as a Real Asset
Large institutional investors have long included Intellectual Property (IP) as part of their Real Asset investment strategy. The typical characteristics of Real Assets, apply to intellectual property, including the assets’ intrinsic value, recovery in insolvency and inflation protection. Intellectual property assets generally display low correlation with financial assets (such as stocks and bonds) and are able to outperform during inflationary times. In addition, like other Real Asset based strategies, IP has a periodically distributed cash flow component in combination with attractive capital appreciation potential.
IP in practice: Music copyrights
The work of a musical artist, be it a performing artist or music author, is protected under copyright laws. The owner of the copyright can license this musical creation to others for a fee which is called a royalty. In practice the musical artist receives royalties from a vast array of sources such as mechanical royalties (from CD, DVD and digital downloads), performance royalties (from performances on radio, TV, film, live or in public places), synchronization royalties (from adaption in film, TV advertisements and video games) and increasingly from music streaming services (such as Spotify and Pandora and Rdio). The copyright does not expire until 70 years after the death of the musical artist which means that the cash flow are of a very long duration. It is fair to say that never before in the history of the world music business have there been so many opportunities for authors and performers to get their music heard and sold on a global level.
The strength of IP is illustrated well by developments in the music industry. Even though the music industry has experienced a decline for several years due to online piracy and the decline of the CD market, music royalty income has actually increased. Between 1999 and 2012 recorded music sales declined by 4% annually, while copyright royalty collections have increased 2.7% over the same period. Royalty collection levels for music increased between 2007 and 2010 from $7.1 billion to $7.5 billion and finished 2013 at $7.8 billion.
Many investors active in IP
But what does this mean for an investor interested in isolating the IP component? How can one obtain exposure to this regular royalty stream? What are the risks of investing in IP, and how are these risks mitigated? Several leading institutional investors provide valuable guidance on this topic. Large investors like the $155 billion Ontario Teachers’ Pension Plan and the $265 billion CPP Investment Board have made investments into IP, as has €428 billion APG Asset Management. The CPP Investment Board acquired royalty interests as part of its IP investment strategy launched in 2010. According to the CPP Investment Board, royalty investing can provide attractive risk-adjusted returns for their fund. At the end of 2014, CPP Investment Board had deployed $1.0 billion in investments underpinned by IP and continues to look for opportunities in this area. APG has for instance bought a stake in the largest classical rights music catalogue in the world through a partnership with a leading music publishing firm. For its part, Ontario Teachers’ Pension Plan financed Ole, a Canadian music publisher, enabling the purchase of various music catalogues. This does not mean that IP investing is only possible for these large investors. Smaller investors can also gain exposure to music royalties by selecting one or more specialized IP fund managers with a strong network and relationships with the music industry. The benefits of investing in music copyrights for such investors are manifold as it allows them to harvest cash distributions from royalties, provides exposure to lowly correlated assets and access to very attractive industry dynamics.
Risk & risk mitigants
As is the case in other investment categories, investments in IP expose the investor to risks. These risks are generally idiosyncratic in nature and specific to IP. As such, inclusion of IP in a portfolio has diversification benefits. The key risks in IP investing relate to the performance of the IP, the inability to enforce IP rights and credit risk. The correct assessment of these risks is key to extracting value from an IP investment. As mentioned, these risks are idiosyncratic in nature, which means that they can be mitigated by asset selection and diversification.
IP: an attractive alternative
Many sectors rely heavily on IP, particularly media and entertainment, pharmaceuticals, IT, software and hi-tech. Each of these sectors exhibit characteristics that create and support deal flow and opportunities. For an investor with a long term investment horizon IP investments offer recurring current income, diversification benefits and overall attractive returns. While IP might not solve all the challenges an institutional investor faces, it is definitely composed of the right ingredients.