This has seen more and more fund pickers recommend alternative assets to fill that diversification gap, with music royalties proving a popular choice.
Isabel Albarran, investment officer at Close Brothers Asset Management, highlighted this factor in the investment case for royalties, noting that it provided "low correlations to traditional asset classes".
The Association of Investment Companies Royalties sector is made up of just two portfolios: Hipgnosis Songs Fund and Round Hill Music Royalty Fund.
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Both operate on the same core basis: buying and owning songs or rather, the associated intellectual property rights of music, and using the royalties to create a reliable stream of income. However, the trusts are built in extremely different styles.
Chart toppers or classic anthems?
Hipgnosis has a bias towards relatively newer music, perhaps reflecting the knowledge of its founder Merck Mercuriadis, who managed Beyoncé, Elton John, Mary J Blige and Guns N' Roses, to name a few.
Round Hill on the other hand invests more in older artists, adding the works of Alice in Chains and David Coverdale to its portfolio this year.
James Carthew, head of investment companies at QuotedData, explained that newer songs Hipgnosis favours "get played quite often and then that decays, initially quite quickly and then more slowly".
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Round Hill prefers what the fund management world may call "steady Eddie" holdings, not shooting the lights or the charts out, but earning a more stable level of income over many years.
Niall O'Connor, manager of SVS Brooks Macdonald Defensive Capital fund, said that when he was comparing the two portfolios this was the deciding factor, and ultimately pushed him to sell out of Hipgnosis and switch to Round Hill.
Inflation-linked asset
Launched in 2018, Hipgnosis was the first of the two trusts to emerge in this space, with Round Hill listing in 2020, at the time becoming the largest new trust in UK.
Today, Hipgnosis is the giant of the two, with total assets at £2.3bn, over four times the size of Round Hill (£481.9m).
Round Hill has outperformed Hipgnosis since it launched, losing just 1.5% versus 24.1%, according data from FE fundinfo.
Carthew said the pitch for these types of trusts was still applicable, as they benefit from increasing streaming revenues and the growing demographic spread of people consuming music online, songs and catalogues available at depressed earnings.
A post-Covid recovery in live music is also behind their success, coupled with better management of the catalogue to expand its revenue via use in adverts and TV shows, and an increase in the songwriter's share of music revenue, which Carthew said "is one of Hipgnosis' main aims".
These were all positive factors that Albarran expects to continue despite rising inflation, which she said investors "clearly continue to be preoccupied by and concerned with".
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She said: "Inflation linkage there tends to be a bias towards performance royalties and streaming revenues… Due to the inelastic nature of music consumption, this should provide some level of inflation-linkage."
This will be buffered by the US Copyright Royalty board increasing the pay-out from 10.5% up to an "inflation beating" 15.1% of revenues over the next five years, she added.
Albarran said this "bodes well for investors as economies continue to grapple with damping down inflation", however, she noted this does not make royalties "totally immune to all macroeconomic issues".
Carthew said there were "questions about what the rising impact of interest rates could have on these companies", while Albarran added that royalties are also under pressure as yields continue to fall relative to their spread over the risk-free rate making fixed cash flows less attractive.
Battle of the bands
To date both trusts have slid to a wide discount, with Hipgnosis and Round Hill now trading at a 41.64% and 32.33% discount respectively, according to data from the AIC.
This has created a buying opportunity but O'Connor firmly favoured Round Hill out of the two, recommending investors "avoid" Hipgnosis.
As mentioned, O'Connor invested in the latter at IPO but switched to Round Hill after modelling the decay rate of the songs in either portfolio. He said that Round Hill's songs would be worth 20% more over the long term.
The discount Hipgnosis is trading at will not narrow anytime soon, O'Connor said, adding that he does "not see much upside".
He said: "Revenues are already declining due to the decay in its newer catalogue. It has grown aggressively and there is a risk it may have overpaid for big name songs."
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The trust has received a lot of high-profile attention in the past 18 months. This time last year, private equity group Blackstone took ownership of the trust as part of a joint $1bn deal in a bid to support the company's expansion of both infrastructure and business functions.
Questions were raised at the time about the governance of the trust, as the full terms of the deal were not disclosed, although Mercuriadis still runs the trust with a minority stake.
Corporate governance concerns reappeared recently when trust announced a $700m debt refinancing programme in order to pay off its existing revolving credit facility.
Experts told Investment Week this programme could provide a greater security for servicing the company's dividend but explained this was not a typical function of RCF. Today (14 October), it started a share buyback scheme, which will run for eight weeks.
Carthew said Hipgnosis is faced with the challenge of proving it can collect the cash that is owed "and more than cover financing costs with cash". He said that if the trust was able to do that, it could re-rate.