Litigation Finance, Litigators, Money

Fulbrook Using Big Data To Get Ahead In Litigation Finance

Litigation finance still has plenty of low hanging fruit available with data analytics.

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big data analytics moneyFor a financial data scientist like myself, there is nothing more exciting or vindicating than seeing the recent announcement that Fulbrook Capital Management has hired Metonymy Labs to help them with using data analytics and Big Data to value risk in their portfolio. Fulbrook is run by Selvyn Seidel, one of the co-founders of Burford, and a true industry leader, so it is great to see them embracing the power of quantitative finance in their business. (Full Disclosure: my firm regularly does Big Data consulting for clients similar to what Metonymy is doing.)

Fulbrook is smart to be embracing data analytics at this stage. The litigation finance market is presently making very limited use of data analytics. The industry is at the same stage of sophistication that banks were at in the 1950s — data is gathered, but it is rarely used effectively.

Regression analysis for pricing is non-existent, risk management tools like VAR or modified convexity don’t exist, there is no Black-Scholes equivalent, and there are few personnel to help with such issues.

On a recent conference call, a partner at one of the top 10 litigation funding firms disclosed that his biggest difficulty in trying to grow the firm was the lack of finance background at the firm. (I’d argue that outside consultants can help with this issue, but then I’m predictably biased.)

The broader point is that litigation finance still has plenty of low hanging fruit available with data analytics. For example, predictive models could help estimate expected life span of cases or valuation of those cases. Data analytics could also help with expanding the deal funnel and optimizing efforts to bring in the kind of big deals that litigation funders are looking for.  Data analytics can also help litigation finance funds to benchmark themselves against the industry and understand where their own opportunities lie.

Regular readers of my columns will know where I stand on the litigation funding market. Litigation finance is a huge, largely untapped opportunity. According to industry figures from the Litigation Finance Journal, global law firm revenue is roughly $800B annually — back of the envelope calculations suggest that the investible market in litigation claims of all sizes is upwards of $1 trillion. That’s far smaller than the roughly $20 trillion in US equities, but it is competitive with other major asset classes like municipal bonds and senior secured bank loans.

Yet most litigation finance firms remain very small comparatively speaking. IMF Bentham, one of the giants in the space, just announced a $200M fund focused on the US. That’s a drop in the bucket given the potential size of the market.

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So what is holding back litigation finance from its true potential?

The answer is complex — lack of familiarity with the market certainly plays a role — but the biggest factor might be the informality of the industry. Angel investing and venture capital investing offers a similar parallel.

Angel investing simply means investing in small start-up businesses, often run by family and friends. The returns to the business are great, but the markets are highly informal and lack sophisticated valuation and risk management methods (see example research study here.) Angel investing has been around for centuries, but the lack of formal and professional quantitative methods in finance has always held it back.

Venture capital is essentially just formalized and highly quantitative angel investing. Once formal investment firms started to get involved and demonstrate rigorous attention to valuation and risk, the asset class grew explosively.

The same thing could happen in litigation finance, and the Fulbrook/Metonymy Labs alliance opens the door to the start of that process.

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Michael McDonald is an assistant professor of finance at Fairfield University in Connecticut. He holds a PhD in finance. Michael consults extensively with organizations ranging from Fortune 500 companies to start-up businesses on financial matters through Morning Investments Consulting. Michael has served as an expert witness in legal disputes, and is an arbitrator with the Financial Industry National Regulatory Authority (FINRA). Michael can be reached at [email protected].

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