What makes litigation finance so attractive vs other asset classes?

The litigation funding market is growing rapidly and receiving increasing global attention as more investors begin to realise the advantages this asset has over established assets. Here, we will look at some of these reasons why investing in litigation finance might be a more prudent move to make instead of investing in other traditional asset classes such as equities, bonds, commodities, currencies, or real estate.

High potential returns

Litigation finance offers investors the chance to generate extremely high potential returns on their initial investments. Cases which pay out many multiple times the initially staked capital are not uncommon. One of the criteria that most litigation finance companies look at when evaluation prospective cases is the ratio of potential damages awarded to the initial investment, and often this must meet a certain threshold to be considered a viable investment prospect.

But how do the potential returns offered by litigation finance compare to other asset classes? A 2016 analysis by Dr Michael McDonald, Associate Professor of Finance at Fairfield University found that the litigation funding industry has averaged an annual return rate of 36% since its inception, and never fallen below 29%.

Compare this to the returns offered by the stock market, which is often considered by many to offer on average a higher rate of return than the other asset classes. The average yearly return rate is going to vary depending on the period and exchange selected but a research note from Goldman Sachs found that US stocks have averaged 10-year returns of 9.2% over the past 140 years – significantly lower than the returns offered by litigation finance.

The paper from Goldman Sachs goes on to speculate that stocks will have a 90% chance of outperforming bonds over the next decade, although in turn it would appear that litigation finance offers the potential to outperform both stocks and bonds over this timeframe.

Worth noting here as well is the relatively short time to liquidity offered by litigation finance compared to other opportunities. According to Jay Greenberg, co-founder and CEO of LexShares, the average civil lawsuit in the US lasts just over 2 years, compared to the likelihood of having to invest in other assets for much longer periods of time to average out market fluctuations.

Risk levels

Many investors have an aversion to the potential unknown risks presented by litigation finance opportunities and prefer to stick to the investments that they are familiar with. It is true that one of the only downsides litigation finance possesses against other asset classes is the greater chance of losing the entirety of an investment if a funded legal case fails. However, there are numerous ways to mitigate against the risk of losing capital when investing in litigation finance.

Risk mitigation is built into litigation finance throughout the process, from the sourcing of opportunities, through to taking out After the Event (ATE) insurance to cover legal costs in the event that a case does not succeed. ATE serves the dual benefit of covering the legal costs and expenses involved in litigation and filters out cases that the insurance providers do not believe have a high enough chance of being successful to insure.

Litigation finance companies have extensive due diligence checks and procedures – in a similar way that an investor would carry out checks on a company before investing – to ensure that only cases which have a demonstrably high chance of succeeding are offered funding. A conservative estimate of a 70% case success rate is not unrealistic for most litigation finance companies to achieve.

A simple way of mitigating against the risk of losing capital in the event that an individual case is unsuccessful is to invest in a portfolio of multiple cases, or a fund which invests in multiple litigation opportunities. Additionally, many litigation funding deals are structured in ways which can offer additional ways of returning capital to investors, such as through asset backed collateral, or ordinary share offerings.

While there is inherent risk in investing in litigation finance, as discussed, one of the main benefits of the asset class is that it can be used to diversify a portfolio, and thus de-risk it from further exposure to the capital markets and the factors which affect them. This is because litigation finance is an uncorrelated asset, with some even arguing that it is countercyclical in nature, and has tendencies to perform better in the wake of economic shocks and the insolvencies they bring.

Ethical investment

Finally, one of the unique qualities that litigation finance possesses against many other assets, is its potential ethical investment status. Many investors are increasingly guided by various ethical principles in their investment decision making, withdrawing funds from companies which do not foster diversity, or by becoming ESG investors.

Litigation finance affords ethical investors the opportunity to provide legal access to justified claimants who may not otherwise have been able to afford it, thus helping to enact positive societal change. Many claimants such as these, with valid cases, are often forced to back down in the face of an opponent who is simply better able to afford the costs of litigation; litigation finance levels the playing field in this regard, and increases the likelihood that corporations and individuals will be held accountable for their behaviour.

If you are interested in finding out more about how our current litigation finance opportunities could benefit your portfolio and grow your returns, please get in touch with us.