While some of the UK’s largest pension funds are taking a bet on royalties, it is clear the asset class is not without risk. Since payments are based on the success – or otherwise – of the drug in question, any change in the fortunes of patients or if competing medicines come onto the market, the value of the drug will fall.
Porat says: “Risks include anything that reduces the level of product sales [including] lower pricing and safety restrictions which effectively reduce the patient population. New products or alternative therapies which can provide similar or better outcomes can also impact sales.” It is possible to mitigate some of the sales risk, however.
Healthcare Royalty Partners’ Futch says in some cases it only takes royalties on the first tranche of sales. Consequently if the drug’s sales then tank, the fund does not suffer.
Futch adds: “We receive royalties on a safe strip of sales. For example, if a product is projected to generate $100m in sales, we may take our royalty interest on the first $50m of sales to protect against underperformance.”
CONTINGENT ASSET
While royalties are still not commonly found in UK pension fund investment portfolios, Whitney says trustees are familiar with the asset class as part of alternative financing and contingent asset deals.
In cases where the DB sponsor wishes to secure its pension fund without promising huge outlays of additional cash, offering access to brand and trademark alternatives has proved a reasonable alternative.
Whitney says she anticipates a wider use of this kind of funding for DB schemes but warns trustees to ensure they understand the true value of such an asset in cases where the sponsor’s future strength is at stake.
“People have to ask themselves what the value is of that [royalty] in the worst case scenario. These are investments not called on in the normal course of events, they are investments that are called upon in the worst case scenario so trustees need to think what it is really worth,” Whitney says.
SMALL BUT PERFECTLY FORMED
Superficially, investing in royalties has the feel of many of the other niche asset classes such as fine wines or classic cars, but below the surface the asset class seems to have much more to offer.
Aside from diversification, royalties offer regular income streams while a lack of correlation helps steady the ship in stormier times.
However, this kind of asset class will only ever form the tiniest part of an already small allocation to alternatives so irrespective of its positive attributes, royalty investment can only ever play a limited part for UK pension funds.
