Intellectual property is a critical component of today's knowledge-based economy, with intellectual capital contributing significantly, and increasingly, to global GDP. While the transition away from agriculture and manufacturing has occurred to varying degrees across emerging, developing and developed markets, in our view, the change nonetheless has paved the way for strong growth in intellectual property and its importance to the economy.
Today, the intellectual property market represents a large and diverse universe of investible assets. As this universe has evolved, IP assets — from music copyrights to pharmaceutical patents to image rights — have attracted increasing attention from institutional investors, particularly those with long investment horizons or those looking to express a specific sector opinion in their portfolios. While there are several different ways an investor might choose to invest in intellectual property — public equities or venture capital, for example — a somewhat lesser-known strategy is through direct ownership of the IP assets themselves, or of the companies built specifically around those assets.
For many investors interested in intellectual property, the "bucket" into which these assets fit isn't immediately clear. At first blush, IP certainly looks different from what many may consider traditional "real" assets like timber, real estate, commodities or infrastructure. Currently, there is no one accepted definition of real assets, and similarly, no single real asset exhibits all of the characteristics investors attribute to the asset class.
Over time, however, the practical experience of investing in real assets has led to the conclusion that certain types of IP, as part of an institutional portfolio, actually function quite similarly to more traditional real assets. Investors might be well-served by broadening their thinking beyond tangible asset-based investments to include an expanded set of criteria that tend to persist across traditional and non-traditional real assets.
Defining real assets
We consider the following attributes as hallmarks of the class:
- Inflation hedge: Positively correlated with U.S. or European inflation.
- Intrinsic value: Likely to preserve value in periods of macroeconomic instability.
- Scarce input: Should stand to benefit directly from increasing scarcity of production inputs.
- Economic infrastructure: Are often essential to economic infrastructure.
- Asset-liability matching: May offer risk-and-return properties that match long-term liabilities.
Not all real assets will offer all these traits, which should not be surprising given the diversity of the real asset investment universe. However, it is that same diversity that makes real assets such a compelling area for portfolio construction within real assets and portfolio enhancement for broader institutional portfolios.
How IP fits
Analyzing intellectual property, and "scoring" it according to the above framework, creates a compelling case for considering IP within the scope of real assets.
Take, for example, music copyrights. Much like infrastructure or other more traditional real assets, music copyrights often have long, profitable life spans — for example, songs produced 30, 40 or 50 years ago are still being consumed today. An investment in a song's copyright preserves its value under transfer of ownership control, and ownership rights can be long-lasting. In the U.S., for instance, a song's copyright does not expire until 70 years after the death of the last living songwriter.
This long economic life provides a basis for the generation of relatively stable cash flows — in the form of royalties — and a diversified earnings stream that might be suitable for funding long-term liabilities. The owner of a song will get paid not only when someone downloads or streams the song on iTunes or Spotify, for example, but also when that song is played on the radio, performed live in concert, or used in a commercial, movie or video game.
In this respect, music copyrights tend to hold their value through periods of instability, a characteristic we often see across other real assets sectors. This is perhaps best demonstrated with a real-world example — the vast transformation the music publishing and recording rights industries have undergone in the past decade as consumption patterns have changed, with MP3 players and streaming services replacing CDs (which replaced cassette tapes, etc.). Despite this seismic shift, and even as CD sales have declined, music publishing revenue has increased.
In fact, the proliferation of smartphones and streaming services has arguably added to the intrinsic value of the asset class, as it has allowed more customers to be reached around the world more profitably (e.g., without the costs of the old physical distribution model). We view this adaptability as an indicator that these royalty-producing copyrights will likely hold their value as technology and consumption patterns evolve.
While there are certainly nuances particular to specific segments of the IP market, most segments tend to demonstrate some combination of the above mentioned characteristics, and as such, can play a meaningful role in investors' portfolios. As IP becomes an increasingly important part of the global economy, and the investment universe it represents expands both in size and diversity, the opportunity set — and potential benefits to investors — should only continue to grow.
Jonathan Rotolo is head of private equity/real assets for Barings LLC, based in New Haven, Conn. This content represents the views of the author. It was submitted and edited under P&I guidelines but is not a product of P&I's editorial team.