Royalties – a diverse asset class with income potential

People consume regardless of economic conditions: they eat, drink, listen to music online, and need medical care. Investments in Royalties tap into precisely these enduring needs.

What are Royalties?

The term “royalty” has its origins in medieval England. At that time, the Crown granted mining rights to mineral resources to private operators. These operators were permitted to extract the resources and, in return, paid a portion of their revenue to the royal administration. These payments were referred to as Royalties.

Today, the term refers to ongoing payments made to the owners of an asset in exchange for its use. The underlying rights can vary widely. These include, for example:

• Music and copyright
• Trademark rights
• Pharmaceutical patents
• Publishing rights
• Raw material exploitation rights
• Water and mineral rights

Royalties are often referred to as licensing or participation income. Like other assets, these rights can be traded, bought, or sold. Funds that acquire and manage licensing rights thereby generate recurring cash flows whose performance often correlates only to a limited extent with fluctuations in the stock markets:

• The value of water rights, for example, is largely independent of the global economic situation.
• The use of streaming services remained stable or even increased even during economically challenging times.

The underlying returns are therefore often influenced by factors different from those affecting traditional capital market investments.

Royalties as a financing tool

The granting of Royalties is often used to finance a company and is classified as “mezzanine financing”. Unlike equity investments, such as shares, investors do not receive a share of the company’s profits but instead can participate in the revenue generated from the rights of use.

This structure enables companies to access capital without taking on additional debt or issuing shares. Investors, in turn, can share in the ongoing income generated by the commercial use of the rights.

Real-world examples

A well-known example can be found in the music industry. Streaming services such as Spotify pay licensing fees for the use of music rights. The owners of these rights receive ongoing revenue for each use of their works. In many cases, these rights are wholly or partially owned by specialized investment companies or funds.

In the pharmaceutical sector, Royalties are often granted for market-ready medicines. By selling the revenue rights, the pharmaceutical company receives immediate capital that can be used, for example, to develop new medicines. In return, investors receive a share of the future revenue generated by the respective medicine.

Key characteristics of Royalty investments

Low correlation with the overall economy

The performance of Royalties is often less dependent on capital markets and corporate valuations than that of traditional asset classes. Rather, the revenue generated by the underlying assets is the key factor.

Many sectors in which Royalties are used also exhibit comparatively robust demand. Music, pharmaceuticals, water rights, and certain natural resource deposits often remain relevant even during economically challenging times. Since Royalty investors receive a share of revenue rather than profits, rising costs or falling margins on the part of operators do not directly affect the amount of the Royalty.

As long as revenue is generated, there is generally also an entitlement to the agreed-upon license payments.

Stable income streams and potential protection against inflation

Since Royalties are typically structured as a percentage of sales, they can benefit from rising prices. If a product’s selling prices increase due to higher inflation, the resulting Royalty payments often rise as well.

At the same time, Royalty investors generally do not bear any operating or investment costs. Rising production costs or declining company margins therefore have a significantly smaller impact on cash flow than they would with a direct equity investment in the company.

Self-liquidating structure

A key feature of many Royalty investments is their self-liquidating structure. A large portion of the expected return is generated through ongoing cash inflows and is not solely dependent on a future sale of the investment. This reduces dependence on market prices and exit valuations, which can be particularly advantageous during periods of market volatility.

Regular cash flows

Royalties often generate a steady stream of income. Even when revenue declines, cash flows may decrease but do not necessarily cease entirely. As a result, they can have a stabilizing effect within a diversified portfolio.

Opportunities and risks

Opportunities

• Ongoing and often predictable income
• Potential protection against inflation through revenue sharing
• Less dependence on traditional capital markets
• Diversification within a private markets portfolio
• Exposure to long-term consumption and usage trends

Risks

• Economic fluctuations, interest rates, or geopolitical events can have a negative impact on projects and companies.
• Declining revenue directly leads to lower Royalty payments.
• In the event of insolvency, Royalty claims are generally subordinated to traditional debt, such as bank loans or bonds.
• Compared to equity investments, the upside potential is often more limited, as investors participate only in the agreed-upon revenue shares and not in the company’s total profits or increases in its valuation.
• There is a risk of losing the capital invested.

The role of Royalties in the portfolio

Within a diversified private markets portfolio, Royalties can be an attractive addition. This asset class is characterized by regular cash flows that are often independent of traditional market movements. As a result, Royalties can help stabilize the risk-return profile.

Their strength lies in particular in the combination of recurring cash flows, limited dependence on traditional capital markets, and the opportunity to participate in long-term economic trends. At the same time, the risks associated with revenue trends and the contractual structure should be carefully considered.

 

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