Are music royalties a new alternative investment?

If your clients have a song in their hearts, they might be able to buy the royalties to it.

Royalty Exchange helps owners of music royalties find buyers. Since March 2016, the company has auctioned off royalties from 150 songs, including:

• Barry White’s “You’re the First, the Last, My Everything”

• Kanye West’s “Mercy”

• A collection of “Sesame Street” musical themes and segments

Many times – as with the Barry White and Kanye West works – the seller isn’t the recording artist, but someone else who collaborated on the song. And what’s being sold represents only his or her portion of the royalties. With “You’re the First,” the auctioned royalties, which went for $73,000, represented 25% of the 1974 hit’s total royalties.

In the case of the Sesame Street collection – which included “Elmo’s World” and music from other classic childrens’ movies – the songwriter, Tony Geiss, bequeathed his share of the royalties to charity. His estate auctioned them off for $580,000, distributing them to his designated causes.

Music royalties last 70 years beyond the longest living participant’s life, which, if all goes well, makes a very long-lived income stream. Just how long that stream lasts and how much it pays is very much an open question, however, and one of the key determinants of a royalty’s return on investment.

The auctioned-off portion of the Barry White song had earned $6,705 in royalties in the previous 12 months. At the auction price of $73,000,a purchaser would need to collect that amount every year for 11 years to recoup his or her investment – a rough equivalent of a price-to-earnings ratio for a stock.

And that’s where things get tricky. Earnings depend on how long you think a song will remain popular worldwide. “Voir La Nuit S’Emballer,” performed by French artist Matt Pokora, for example, generated $8,843 in royalties in the 12 months before it was auctioned. The royalties sold for $16,500. “I’ve seen multiples as low as 1,” said Jeff Schneider, president and CFO of Royalty Exchange.

Should a song be used in a movie soundtrack, or sampled on another artist’s record, royalties could increase. The death of the original recording artist usually increases sales, and thus royalties, too. The movement towards streaming music subscriptions could also mean higher royalties in the future, Mr. Schneider said.

Why invest in royalties? In an era when stocks and bonds look expensive, royalties represent an unappreciated asset class, Mr. Schneider argued. “It’s not correlated to the stock market in general,” he said. “We’re at the tail end of a nine-year stock market run, and uncorrelated assets seem more interesting compared to something that’s bound to correct at some point.”

But as with any alternative asset, due diligence is essential before plunging into a royalty investing, advisers caution. “I would want to see three or five years’ royalty payments and see if they are steady or declining – and if they are declining, at what rate they are declining,” said Ray Ferrara of ProVise Investment Group. “Then I’d do a discounted cash value over time to see how it’s valued.”

Of course, there are other factors – such as your ability to find timeless songs up for auction. “I’d also think that the older the song, the less likely it is to be picked up in something new: Getting a large spike in royalty is less of a possibility as time goes by and tastes change,” Mr. Ferrara said.

And,while alternative investments are appealing as bargains when the stock market keeps hitting new highs, investors should keep in mind that stocks have produced 9% annual gains over the long term – which means that long-term investors might not have to worry about alternatives, he added.