The Appeal Of Litigation Finance To Institutional Investors
Why are institutional investors showing increased interest in this asset class?
Will litigation finance continue its meteoric rise? The answer to this question rests in significant part in the hands of institutional investors, and whether they’ll continue to pour their considerable funds into this asset class.
To get a better sense of how institutional investors view litigation finance, last week I attended a panel at IMN’s second annual litigation finance conference entitled “Risk/Reward: Institutional Capital Perspectives,” featuring the following industry experts:
- Steven Huttler, Partner, Sadis & Goldberg LLP (moderator)
- Drew Kelly, General Counsel, Delta Capital Partners
- Lee Drucker, Co-Founder and Principal, Lake Whillans Litigation Finance
- Brian Roth, Senior Managing Director, EJF Capital LLC
- David Spiegel, Managing Director, GLS Capital
- Evan Wein, Partner, Mercury Capital Advisors LLC
Huttler kicked off the discussion by asking the panelists: what are you hearing these days from institutional investors?
Drew Kelly sounded a theme that should be familiar to anyone who follows litigation finance: uncorrelated returns. When you finance a litigation, you’re investing in a legal claim — and whether that claim pays out generally bears little or no relation to how the overall equity market is doing.
This makes litigation funding an attractive asset class for investors looking to hedge some of the risk they have through exposure to the market writ large. And if and when we enter a recession and the stock and real estate markets take a hit, institutional interest in litigation finance should only increase (as should opportunities to invest in cases connected to bankruptcy or failed deals).
In recent years, the returns in litigation finance have been not just uncorrelated but also robust, according to Brian Roth. It’s not uncommon for a fund to report returns in the double digits. Such strong performance is a good thing for the industry, because as David Spiegel pointed out, some investors expect a higher return in the space given the volatility and relative youth of litigation finance as an asset class.
The newness of litigation funding as an asset class can cause some institutional investors to ask tough questions before investing. As Lee Drucker of Lake Whillans noted, when institutional investors review his firm’s appealing historical returns, they will sometimes ask: can your firm, one of the earliest entrants into the space, maintain these returns now that there’s more competition?
Drucker remains optimistic about the returns available in the field, noting that the market today remains very inefficient. Along similar lines, Kelly said that although he has been in the industry for several years as well, he hasn’t seen an appreciable difference in competition, suggesting that the demand for litigation finance is increasing at an equal if not greater pace than the supply. (Still, it behooves a fund to develop proprietary channels for finding new cases, which Drucker identified as a focus for him and his colleagues at Lake Whillans.)
Of course, institutional investors have concerns that go beyond financial returns. Kelly recounted one situation where an educational institution’s endowment was interested in investing, but then a board member asked: what if we end up indirectly financing a lawsuit against one of the university’s big donors? This endowment decided not to go forward with an investment.
Roth acknowledged this sometimes happens, but observed that there’s a certain amount of self-selection at work: now that investors understand litigation funding better, investors with these types of concerns tend not to look at the industry at all. And many institutional investors are getting over such qualms, as they see both the attractiveness of the asset class and the value of helping to back meritorious litigation (because that’s the type of litigation that pays out). Spiegel said that he’s now hearing from investors who wouldn’t have taken his firm’s calls just a few years ago.
What do institutional investors look for when deciding to invest in a fund? In addition to the fund’s historical track record, they seek a strong team of legal and financial experts with experience in the space. Some investors also ask about whether or how the fund uses data for modeling and simulations when deciding which cases to back (but there is a debate in litigation finance about the utility of analytics, given the nature and size of the data set).
Investors also look for funds that are focused, as opposed to ones that are trying to be everything to everyone. Lee Drucker noted that Lake Whillans doesn’t invest in patent cases — and investors generally find this appealing, as a sign that the fund is being strategic in its growth and focusing on sectors where it has deep expertise.
On the whole, the institutional investors who are interested in litigation finance sound quite savvy. So does this mean, as Steve Huttler put it, that there’s no “dumb money” in the space — at least not yet?
“There’s dumb money in everything, including litigation finance — I just don’t know if it’s me or the other guy,” quipped Lee Drucker, to audience laughter. “But this is still a very inefficient market, so the tailwind is at our back.”
David Lat, the founding editor of Above the Law, is a writer, speaker, and legal recruiter at Lateral Link, where he is a managing director in the New York office. David’s book, Supreme Ambitions: A Novel (2014), was described by the New York Times as “the most buzzed-about novel of the year” among legal elites. David previously worked as a federal prosecutor, a litigation associate at Wachtell Lipton, and a law clerk to Judge Diarmuid F. O’Scannlain of the U.S. Court of Appeals for the Ninth Circuit. You can connect with David on Twitter (@DavidLat), LinkedIn, and Facebook, and you can reach him by email at dlat@laterallink.com.
