What's The Similarity Between Catastrophe Bonds And Litigation Finance?

You should expect investors to continue to put money into litigation finance in the years to come.

What’s the similarity between catastrophe bonds and litigation finance? 

They’re both non-correlated investments.   

(I don’t think your six-year-old is going to appreciate that riddle.) 

Let me explain:  Since the great recession, most classes of investments have marched in tandem.  Stocks went up; bonds went up.   

But portfolio theory says you want to diversify your investments.  You’d rather invest in some things that lose value when other assets are gaining value, and vice versa.  Diversification helps your portfolio do reasonably well in most markets. 

When stocks and bonds march in unison, investors search out non-correlated investments.  Commodities are a possibility; so is real estate. 

But what’s certainly not correlated with how the stock market is doing?   

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The wind!  There’s no relationship between stocks and bonds and whether a hurricane will hit the east coast of the United States. 

So insurance companies shared some of their risk by creating instruments that paid interest if no hurricane hit the east coast but could lose money if a hurricane hit:  Catastrophe bonds.

Those bonds performed relatively well over the past decade, although 2017 turned out to be a pretty grim year for people who bet against hurricanes.  (It was a pretty grim year for people who lived in the path of hurricanes, too, but that’s another story.)

What other investments don’t correlate with the performance of stocks and bonds?

Litigation!  There’s no relationship between stocks and bonds and whether a plaintiff will win a particular lawsuit.

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So the similarity between catastrophe bonds and litigation finance is that they’re both non-correlated investments.  They’re thus also both attractive to large investors trying to diversify their portfolios.

That explains in part why investors have recently been pouring money into litigation finance.

Another part of the rush to sink money into litigation finance is the eye-popping profits that some litigation finance firms have generated in recent years.

Given those two factors, you should expect investors to continue to put money into litigation finance in the years to come.

You should also expect profits in the litigation finance field to compress, as new entrants into the market reduce the profitability of the field as a whole.

That means that litigation finance firms that hire the right staff — people who can more accurately predict the results of individual cases or groups of cases — will thrive, and litigation finance firms that hire the wrong staff will suffer.

This probably also means that the pressure to permit law firms to be publicly traded will grow.  After all, if folks can create firewalls that avoid ethical concerns when third parties finance litigation, folks can probably develop similar firewalls to overcome ethical concerns when non-lawyer-shareholders own law firms.

So hold onto your hat.  We wouldn’t want some 150-mile-per-hour gust to leave you bareheaded while you were watching the litigation finance show.


Mark Herrmann spent 17 years as a partner at a leading international law firm and is now deputy general counsel at a large international company. He is the author of The Curmudgeon’s Guide to Practicing Law and Inside Straight: Advice About Lawyering, In-House And Out, That Only The Internet Could Provide (affiliate links). You can reach him by email at inhouse@abovethelaw.com.