Litigation finance has become an increasingly popular investment approach for investors in recent years. As a new form of alternative investment, litigation finance provides investors with opportunities to fund lawsuits and legal claims in exchange for a share of the settlement or award if the case succeeds. With proper evaluation of case merits and effective risk management, litigation finance investments can generate attractive risk-adjusted returns uncorrelated with traditional asset classes. This article will illustrate the importance of litigation finance through examples, analyze its risk and return characteristics, and discuss best practices for investing in litigation finance.
Profitable litigation finance investments require careful case selection and risk management
The key to successful litigation finance investing lies in rigorous evaluation of case merits and plaintiff credibility. Investors should focus on cases with strong legal arguments, favorable venues, experienced legal teams and credible plaintiffs. For example, a winning case financed litigation fund Burford Capital generated a 436% return by funding an oil and gas company’s legal claim against the Venezuelan government. Burford’s investment team conducted extensive due diligence and determined the claim has high chance of success. Effective risk management is also critical. Diversification across law firms, case types and jurisdictions can mitigate concentration risk. Burford Capital has capital deployed across 90+ law firms in over 40 jurisdictions worldwide. Portfolio construction should also aim to balance risk and return. While larger cases may have higher returns, smaller investments in varied cases can reduce volatility.
Litigation finance can provide high returns uncorrelated with traditional assets
Unlike stocks and bonds, returns of litigation finance investments are not tied to broader market movements. The idiosyncratic nature of each legal case creates diversification benefits for investors’ portfolios. For instance, Lake Whillans, a litigation finance firm, generated a net IRR of 89% in 2020 despite volatility in public equity and credit markets. The performance was driven by successful resolution of various individual cases rather than macroeconomic factors. Research by Burford Capital also shows that its litigation finance investments have had near-zero correlation to public equities over the past decade. The uncorrelated returns allow litigation finance to improve portfolio efficiency. Moreover, the high cost of litigation creates inefficiencies that litigation funding can exploit to generate Alpha. Skilled investors can target the pricing inefficiencies and generate market-beating returns.
In summary, litigation finance is an attractive investment opportunity that provides high returns uncorrelated with traditional assets. However, thoughtful case selection and risk management are indispensable for investment success. As litigation finance continues to gain mainstream acceptance, it has great prospects to enhance portfolio returns.