A week ago I covered Burford Capital (OTC:BRFRF) (OTC:BRFRY), a litigation funding company (link: "Burford Capital: Litigation Funding And Self-Disruption"). Burford is very interesting, but valuation concerns or idiosyncratic business risk might make Burford Capital unattractive to certain investors.
In this article, I outline why the litigation finance market is interesting and two opportunities to invest in alternative ways. One opportunity for return-focused accredited investors and a small esoteric company for retail investors.
Why is Litigation Funding Special?
There are several ways of evaluating returns. How much of any under/overperformance was related to the amount of risk taken? How much volatility does any given strategy imply? What is the correlation of the strategy to the broader market? How consistent are the investment returns?
In this article, I will present what I believe to be the most uncorrelated returns to broader market moves available today. Litigation funding. The majority of my readers are not lawyers by trade (though some certainly are). In this article, I will outline when you should invest in litigation funding, how to go about it depending on your aptitude, and what to expect.
What is Litigation Finance?
Litigation funding, or litigation finance, is the act of providing economic relief and support to plaintiffs in legal cases in exchange for a portion of the case proceeds. The traditional example is a small 50 million dollar revenue business that sees their IP stolen by a large corporation.
Going to court for a large settlement would be preferred, but implies a protracted legal battle at expenses far above what the business is willing to risk. The ability for the larger corporation to simply wage a war of attrition dissuades any smaller business from even attempting litigation.
Enter litigation finance. An entity that sponsors litigation offers the small business 5 million in litigation support for half the proceeds of the case. The litigation proceeds and ends 3 years later and the proceeds reward both business and sponsorship entity.
Two Reasons to Invest in Litigation Finance
There are two simple reasons to invest in litigation finance.
Completely uncorrelated returns: Market swings have little effect on the proceeds of a trial case. Origination of cases may be affected by market swings, but any case started in 2018 is not going to be affected by trade wars or recessions. The payoff is, logically, completely unrelated to the broader market indice price levels.
The advantage is that volatility is reduced, consistent returns are provided (no fear of dividend cuts), and reinvestments can be made at opportune moments. The means of investing which I will provide have distinct levels of “uncorrelated” price risk. A pure sell-off will affect every price on the market, but some of the methods avoid this entirely.
High Returns: In a blog post from a year ago, linked here, Logan Hensley documented that the ROI on case financing is 36%. Other sources, annual reports, show the same level of profitability (often in excess). The high returns are a result of several distinct barriers to entry, ranging from expertise to single-case risk, that have encapsulated the sector. Returns may contract considerably over time, but the returns for the next several years are a result of investments in 2016, 2017, and this year. The market environment has been (broadly) similar to previous years.
A brief word of warning. In my thesis on Burford Capital, linked above, I expect that ROEs are set to contract materially over a 10-year period. I still expect return to provide above-market ROEs.
The primary worries are regulatory changes that disallow litigation funding and new capital lowering forward returns.
The regulatory risk is fairly idiosyncratic by country and should be carefully considered given the choice of investment geography.
New capital reducing returns would be a "material" risk if the remaining barriers to entry didn't seem to imply higher-than-market ROIC. Given the circumstances, the case can be understood as an extremely opportune environment transitioning towards a more "average" state of affairs.
The 3 Unique Paths to Uncorrelated Returns
There are three ways to invest in litigation funding to the best of my knowledge:
1. For the adventurous small-time investors, Juricida offers a highly illiquid closed-end opportunity with a predetermined time horizon.
Juridica is a small closed-end fund listed on the AIM. The fund is in the process of closing down and a return of capital is therefore likely. The board has agreed to monetize all investments by the 31st of December 2018. As of the 31st of December 2017, the company had book value of £0.15 while the stock sells at a discount, £0.9. A total of seven investments remain active. Post their 13th of April dividend of 4 cents, the stock has a book value of $0.11 and therefore a discount of ~20%.
I would not recommend Juridica to most investors due to extreme illiquidity and low return on time invested along with potential PFIC-issues relating to dividends paid to US investors.
2. For the mainstream investor, Burford Capital offers the safest and easiest choice.
Burford is a multi-billion giant listed on the AIM, but the only mainstream listed entity for litigation investing. Burford Capital is a complex entity and is in a unique position. I have an upcoming article to be released within a few days on the entirety of the company.
For non-accredited investors and the general public, Burford Capital provides the best entry into the litigation funding market.
3. For the accredited investor, several sites exist that allow direct access to cases.
For investors that dislike the substantial valuation premium in Burford Capital, direct access platforms allow access at "~1x book value".
Much like AngelList for litigation, LexShares and TrialFunder offer a means for accredited investors to participate in the market.
TrialFunder is the less advanced site, but is good for individuals knowledgeable within related law. LexShares would be my recommendation. LexShares is the most recognized within the litigation funding community and offers the broadest range of possibilities. LexShares also offer marketplace funds and the ability for multiple investors to participate on single cases, making diversification more easily attainable for smaller accredited investors.
Read my article on Burford Capital: “Burford Capital: Litigation Funding And Self-Disruption ”.
If you insist on a discount to intrinsic value, use a direct investment platform to invest. If you are looking for uncorrelated returns, simply use Burford Capital. For smaller investors, I would recommend expediency when looking at Juridica.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.