While investors initially took fright last Monday after Hipgnosis Songs (SONG ) slashed the value of its music royalties by 26% (with a 31% drop in net asset value), AVI Global (AGT ) fund manager Joe Bauernfreund viewed the announcement as an important step in a potential turnaround.

The news sparked an 8% fall in Hipgnosis’ share price to 57.9p on Monday 4 March as the board suspended dividends for the foreseeable future to focus on paying off the fund’s $674m debt pile.

However, the shares subsequently recovered to end Friday at 62.7p, just below where they began the week, but still on a significant 31% discount to the new net asset value (NAV) that bargain-hunter Bauernfreund hopes will narrow and boost the return on the investment.   

Bauernfreund (below) believes the board of SONG may well have been ‘kitchen sinking’, or rather presenting all the bad news to investors in one go in the hope that things can only improve from here. He views the NAV announcement as a necessary step so the board and shareholders can understand what the portfolio of 65,000 songs is truly worth.

‘The final number was slightly below where we thought a realistic NAV was but not massively so,’ said the manager of the £1bn AVI Global trust, which targets undervalued companies and investment trusts and holds 5% of SONG.

Hipgnosis’ operative net asset value (NAV) was 92p per share at the end of December, according to new valuer Shot Tower Capital. This is a sharp decline from 142.49p at the end of September, a valuation provided by former valuer Citrin Cooperman.

Board on right track

‘I think the new board is doing the right things. There is a sense they are “kitchen sinking”, but I think that was necessary. We need them to come in and really get to grips with what occurred under the previous board and manager, to understand what we own and what its value is.’

Once this has been ascertained, the board can decide whether to wind up the fund; sell the assets to bidders and return capital to shareholders; or appoint a new fund manager to replace Merck Mercuriadis’ Hipgnosis Songs Management (HSM).

From here, Bauernfreund would like the trust’s contractual arrangement with HSM to be ‘resolved’. Ideally, he would like to sell AVI’s investment at NAV and move on to other opportunities. However, he acknowledged this may not be possible if it comes at a big cost for Hipgnosis.

Asset Value Investors (AVI), where Bauernfreund is also chief executive, has held a position in Hipgnosis since 2020 and increased its stake ahead of a continuation vote in October. At the time, it successfully lobbied other shareholders to vote against the vote and to block a proposed sale of a fifth of the company’s assets to a related party, Hipgnosis Songs Capital (a partnership between HSM and Blackstone).

Investors late to the party

Following a tumultuous year for the music royalties fund, Bauernfreund suggests there are several lessons to consider.

‘I think a lot of investors bought in thinking it was a magic sector that was able to give them uncorrelated returns to equity markets, that were unlikely to ever go down in value and would forever provide them with an attractive income.

‘A number of factors conspired to challenge that notion. First of all, interest rates going up has an effect on valuations. It is pretty basic, but I think some investors forgot that.’

Secondly, he notes the management arrangement with HSM was not set up with the best interests of shareholders in mind. Here, he is referring to incentives for the manager to buy assets that ‘were not fantastic in all cases’ in order to grow the investment trust and management fee.

‘The arrangement between the manager and Blackstone had conflicts built into it and I guess the previous board was not on top of that. Now shareholders find themselves in a situation where they might be aggrieved with the manager but find it very difficult to remove them,’ he added.

Bauernfreund remains positive on the prospects of the music industry in general, particularly in light of the potential growth of streaming services, but says Hipgnosis’ structure and contractual arrangements have caused it to disappoint.

There may also be a broader theme of private investors getting access to an asset class, long after institutional investors, at a point when returns are harder to come by.

‘Over the years we have seen this time and time again. Investors get excited about a new asset class or one that institutional investors have access to. By the time retail investors are invited to the party it is perhaps drawing to a close,’ he concluded.

Worst over for GCP Infrastructure

Elsewhere in the Citywire-award winning portfolio, Bauernfreund has opened a position in GCP Infrastructure (GCP ), the infrastructure debt fund run by Gravis Capital, which has seen its discount fall to 32% following a 20% share price decline over the past 12 months.

An aborted three-way merger between GCP Asset Backed Income (GABI ) and RM Infrastructure Income (RMII ) last year, combined with interest rate rises and negative sentiment towards the sector have all weighed on the investment company.

‘We look at asset classes where we think there is probably some mistrust in the reported NAV, and we possibly have a greater degree of confidence around the NAV.

‘Certainly, given GCP Infrastructure’s discount level, we see a higher margin of safety,’ he explained.

Entain (ENT), the gambling business, represents another new position in AVI Global. Bauernfreund said it appeared on the team’s radar after it started to come under pressure from activist investors to sell its assets.

‘I think there is interesting potential for a sale of the assets, which could be beneficial for shareholders in Entain and other entities we have an interest in,’ the fund manager explained.

Value fund that’s come good

Bauernfreund has run AVI Global for over eight years. In the bull growth market, its value strategy, with a comparatively light 24% exposure to the US, struggled to compete with some of its rivals in the AIC Global sector.

The advent of inflation and higher interest rates over two years ago has turned the tables, however, with the trust generating a 75.2% total shareholder return that beats the 71.6% of the MSCI World index and ranks it third in its 13-strong sector where the average return has been just 58.7%.

On an 8.5% discount is no longer quite the bargain it was last October when the shares lagged the portfolio by nearly 13%.

However, that ignores the potential ‘double discount’ given that 30% of its assets are in UK closed-end funds trading well below asset value. Three of its top 10 positions, for example, are held in private equity funds Oakley Capital (OCI ), Princess (PEY ) and Pantheon International (PEY ) that stand on 25%-32% discounts despite good long-term performance.

A further 17% is allocated to Japanese smaller companies still trading on depressed valuations and high levels of cash where government and shareholder pressure are gradually unlocking value.