"Rock n' roll returns are here to stay"
James Altucher

January was a shipwreck for hedge funds. After having a horrible mid-2004, all of the hedge fund indices breathed a sigh of relief in the last few months of the year when whatever angel rules the global markets and their respective correlations, smiled kindly on our friends in the "alternative" universe to help them eke out a positive year. But then January came and that smile wiped away and became a vicious smirk. The hedge fund indices were down between a few basis points and 2 per cent while pop-star hedge fund favorites like John Henry started off the year with double-digit losses. The oxymoronic traditional alternatives are no longer working. Stockpicking is best left to monkeys with darts and fortune tellers. The way to really make money is to look for the pockets of inefficiency where you can perform a service and charge handsomely for it. I like the asset-backed lending space because it usually involves significantly higher-than-prime interest rates, and assets backing the coupon payments in the case of a default. I've written here about asset-backed lending in the past and mentioned a few hedge funds that do this sort of lending ranging from subprime auto-finance to life insurance premium financing, to mortgage-backeds. But, more importantly, I just bought an iPod and I've downloaded a special selection of "Fame", "Heroes", and "Rebel, Rebel" by David Bowie, as well as "I Feel Good" by James Brown, "Ain't No Mountain High Enough" by Ashford & Simpson and "Its Your Thing" by the Isley Brothers. Why those songs? Because they are all assets that have been used to form Pullman Bonds, developed by David Pullman. Pullman started these with the so-called Bowie Bonds, constructed in 1997 - a $55m deal securitized by the assets from David Bowie's extensive catalog of 25 gold albums and paying a 7.9 per cent interest rate. The bonds are self-liquidating, meaning every year the remaining balance goes lower. Moody's has an investment-grade rating of BBB+ on the bonds. In the extreme case of a default, the bondholder would own the masters. In other words, the principal and 7.9 per cent interest rate is backed by an asset that continues to generate more income each year than the year before, despite MP3, Napster or filesharing. What I like about these assets is that they are completely uncorrelated to stocks and even economic cycles. If you hear "Heroes" playing in the background in a department store, someone is getting paid a royalty even though you are hearing that music for free. After that initial Bowie deal, Pullman worked with artists such as James Brown, The Isley Brothers, Ashford & Simpson, and even the estate of John Steinbeck and the creators of cartoon character Casper the Friendly Ghost (hey, diversification). So I called Pullman to find out more. How did it start? What's the next step? And how can investors get a hold of his product? "David Bowie was thinking of selling his masters and I was working with his business manager at the time and we decided it would be in his better interest to securitise the cash flows instead. So now he still owns the masters, the income from the songs are better than ever, and the investors are happy since the principal has gone down every year because these are self-liquidating bonds, plus they got the 7.9 per cent interest they signed up for." What's involved in the due diligence on these assets? "I've looked at over 1,000 transactions," Pullman told me, "and unlike when doing due diligence on a mortgage where you have to make sure the owner has the deed to the house, with these assets you have to deal with all the disparate parties that might have some claim on the cash flows - songwriter agreements, assignments, who owns the rights, the publishing, etc. Also, we analyze how consistent the cash flows are and we try to go over all the different things that can happen in the music world that could change those cash flows. A great example is MP3 and Napster. This was great for us. We got payments on the copyright litigation which the copyright holders won." And what about peer-to-peer filesharing? "James Brown is making more money on "I Feel Good" than when it was a #1 hit in 1965, adjusted for inflation, despite MP3, Napster, filesharing, whatever. There's been a proliferation of outlets for music. Apple sold 4m iPods last year. That's an entire industry of people buying songs online now. The cash flows for the top-charted artists of all time are bigger than ever and that's who we like for these deals. When Moody's downgraded EMI to junk in March, 2004 they only downgraded the Pullman Bonds we put together for David Bowie to BBB+ which is still investment grade. In other words, Bowie's cash flows are rated higher than the record label's cash flows." "We are looking for quality assets all over the entertainment world, pooling them together and creating value out of the diversification. Then we are securitising the cash flows on this pool and selling it to insurance companies, high net worth families, banks, anybody who wants diversification out of stocks, bonds and other asset classes." The writer is a managing partner at hedge fund firm Formula Capital and the author of Trade Like a Hedge Fund.

E-mall him at james@formulacapital.com