What is the Alternative? Aircraft Leasing & Music Royalties

Within our ongoing ‘What is the Alternative’ series we have detailed our thinking on portfolio construction and how an allocation to long only return focused real assets may be beneficial and help improve risk adjusted portfolio returns. This note focuses on the asset finance sector and details specific opportunities in aircraft leasing and music royalties.

Regulatory changes since the Global Financial Crisis have reduced banks’ financing and lending activities, resulting in inefficiencies and asset finance opportunities across a number of sectors. When combined with an increasingly competitive business environment, asset financing, such as the use of operating leases can be an attractive option to deliver growth and optimise the capital structure.

Underlying assets are long term in nature with attractive cash flow streams from products or services. Such cash flows can be both a function of price, often tied to a contractual agreement at inception, but in many cases linked to volume with throughput tied to underlying economic conditions or asset use.

One such sector is aircraft leasing, which offers a differentiated return profile to traditional risk assets and an attractive annual income stream. Provided the asset (aircraft) is leased to a strong counterparty an investor can expect to receive this income over the lease term.

The aircraft market is a cyclical one, however; there is a distinct correlation between the global economic and aircraft cycles and investors need to be comfortable with (a) the airline credit (or, lessee) and (b) the underlying asset. Where the credit is strong then investors can expect continued lease payments as agreed. Where the asset comes to the end of its lease term it is returned and the owner needs to either re-lease, change use, sell or scrap. Clearly a cyclical downturn could be troublesome in different ways for each of these, however a high quality asset in general demand globally is likely to find a home relatively quickly, particularly as passenger demand continues to rise (as it did between 2007 and 2009).

The income and total returns available to investors can vary depending on the deal structure, credit rating of the underlying aircraft operators and terminal value of the asset, in this case the aircraft. Initial yields of circa 8% for listed specialist aircraft leasing companies with the potential for double-digit total return’s appear a compelling proposition in the current market environment.

A further specific asset finance opportunity is Music Royalties. Akin to the aircraft leasing sector returns are uncorrelated to traditional risk assets. The music industry initially suffered from the advent of the internet as unlimited access to free music via online downloads was catastrophic for the music industry business model. However, as the chart below highlights, subscription based music streaming services such as Spotify and Apple music are growing strongly and replacing the traditional physical purchase of content.

US Consumer Spending on Physical Music, Concerts & Subscriptions 1984-2017Source: Citi Research, Waverton

This has positive implications for songwriters and artists and thus the music royalties sector, which may be one of the greatest winners from the ‘move to mobile’.

This trend and resultant investment opportunity led us to invest in the recent IPO of the Hipgnosis Songs Fund. As with other opportunities within the assert finance universe, we focus on understanding whether the management team have the requisite experience and skill to execute effectively, the capital structure and most importantly the quality of the underlying assets and cash flow stream.

Music is a people and relationship business, and the Hipgnosis CEO, Merck Mercuriadis, brings a lifetime of experience within the industry having managed successful artists such as Elton John, Guns N’ Roses and many others. In conjunction with this, established artists such Nile Rogers have been appointed to the board. This gives the team the insight, experience, relationships and ability to effectively purchase the most attractive music royalties in order to deliver value long term.

Once fully invested, the company aims to deliver a 5% annual dividend, with potential for NAV appreciation through the aforementioned growth in music royalty revenue from streaming services, active management of each catalogue to ensure songs are best placed within streaming playlists, with added positives from synchronisation and performance fees from individual songs through advertising or other specific initiatives.

The recently launched Waverton Real Asset fund provides exposure to both these specific real assets and a range of other opportunities across the asset finance sector. Given the challenges facing investors, we are finding a rich opportunity set in long only return seeking alternatives to complement existing portfolio holdings.

Luke Hyde-Smith 

Head of Third Party Fund Selection

7th January 2019

Risk Warnings

The views and opinions expressed are the views of Waverton Investment Management Limited and are subject to change based on market and other conditions.  The information provided does not constitute investment advice and it should not be relied on as such.  All material(s) have been obtained from sources believed to be reliable, but its accuracy is not guaranteed.  There is no representation or warranty as to the current accuracy of, nor liability for, decisions based on such information.

Changes in rates of exchange may have an adverse effect on the value, price or income of an investment.

Past performance is no guarantee of future results and the value of such investments and their strategies may fall as well as rise.  Capital security is not guaranteed

The information relating to ‘yield’ is for indicative purposes only.  You should note that yields on investments may fall or rise dependent on the performance of the underlying investment and more specifically the performance of the financial markets.  As such, no warranty can be given that the expressed yields will consistently attain such levels over any given period.

A copy of the Waverton Real Asset Fund’s Prospectus and Key Investor Information Document (KIID) are available from Waverton or the administrator. Details can be found on our website: www.waverton.co.uk/investment-funds