Considering alternatives

We believe alternatives look attractive for income-oriented strategies as the fixed-income rout continues.

Key points

• We believe alternatives, specifically renewables, asset financing and music streaming, look attractive.
• We expect long-term power-price assumptions to rise as Europe tries to reduce its power dependency on Russia. This should benefit many of the renewable companies’ valuations.
• Ship and aircraft-leasing companies are benefiting from rising transport costs and a post-pandemic recovery in travel.
• We believe people paying for music via streaming platforms represent a significant growth opportunity, particularly among audiences in emerging markets.

At the start of 2022, government bond yields moved higher as monetary policies in developed markets started to tighten in order to address inflationary pressures. Comments by the US Federal Reserve (Fed) that it would tighten its policy “methodically” added fuel to a bond rout that had already this year driven US Treasuries to their worst losses in decades. Moreover, recent comments by Fed Chair Jerome Powell suggesting the Federal Reserve “won’t hesitate” to raise interest rates above the “broadly understood levels of neutral” indicate that the sell-off may not be over. Meanwhile Russia’s invasion of Ukraine, and the scale of the resulting sanctions and increases in energy costs, have the potential to derail the emerging economic recovery as the world exits from Covid-19 restrictions. Against this volatile backdrop and the dwindling appeal of bonds, we would point to alternatives – namely renewables, asset financing and music streaming – as offering potential sources of inflation-protected returns that can also provide diversification in a more stagflationary world.

Renewables

On the renewables side, battery-storage companies that help with the transition to renewable power have seen strong upgrades in revenue generation. These companies can gain additional revenues from providing capacity availability to the grid. Furthermore, renewable-energy companies in general have contributed strongly in the high-power-price environment following Russia’s invasion of Ukraine. Power prices remain elevated and we expect that long-term power-price assumptions will have to rise as Europe tries to reduce its power dependency away from Russia. This should benefit many of the renewable companies’ valuations.

Asset financing

Elsewhere, we would highlight the asset-financing sphere where ship and aircraft-leasing companies have benefited from escalating transport costs and a recovery in travel following the pandemic. The costs to hire a ship for a day are increasing owing to supply constraints, exacerbated by Russian ships not being able to dock in Western countries following Russia’s invasion of Ukraine. There has also been a lack of certain types of ships being built over the last decade. Essentially, there is a shortage of shipping capacity, particularly in the smaller and mid-size ships that transport cargo to smaller ports that don’t have the ability for large vessels to dock. The aviation sector is also benefitting as airlines get the Airbus A380s back off the ground and issue positive commentary about continuing to use the aircraft over the longer term.

These assets might not have inflation-linked revenue like renewables or infrastructure, but in many cases their secondary-market values are rising on the back of higher commodity, energy and labour costs. In addition, companies are considering the overall costs of running older assets for longer, versus replacing them with new ships or aircraft.

Music streaming

While the Covid-19 pandemic largely decimated the live music and entertainment scene, recorded music revenues hit an estimated US$12bn in 2020, with streaming accounting for a reported 83%.¹ Streaming services can, however, be deemed controversial given that the top 1% of artists account for 80% of all streams, according to a UK Intellectual Property Office report.² Other data suggests some artists can receive as little as 2% of the royalties from streaming.³ However, we are optimistic that record companies, streaming platforms and recording artists can reach a more equitable agreement over royalties and ownership. For one, the UK government appears to have concluded that there should be a fairer split of streaming royalties.

Overall, the shift towards a subscription-based streaming model has transformed the economics of the music industry, enhancing the visibility of revenues and allowing for significant margin expansion through lower distribution costs and operating leverage, while gaming, social media and emerging-market growth increase addressable markets. Indeed, we believe people paying for music via streaming platforms represent a significant growth opportunity, particularly among audiences in emerging markets such as China, India, Africa and South America. Another strength of investment in music royalties is that the performance of the asset class is relatively uncorrelated with the economic cycle, at least so far.

Sources:

1. Wall Street Journal. Recorded music revenue hits $12 billion in 2020 amid pandemic streaming boom. 26 February 2021
2. Intellectual Property Office. Music creators’ earnings in the digital era. 23 September 2021.
3. MPs on the House of Commons Digital, Culture, Media and Sport Committee, House of Commons Committees. Music streaming must modernise. Is anybody listening? 15 July 2021.

Authors

Paul Flood

Head of Mixed Assets Investment