High-net-worth investors who are on a quest for absolute, uncorrelated returns may want to consider an investment vehicle that can truly be called an "alternative": commercial lawsuits.
The idea is fairly simple. A fund provides capital-either a lump sum or periodic payments-to one side in a business dispute, or its lawyers. In exchange, the financier receives a percentage of the settlement or judgment, or a multiple of the capital employed or drawn. Much commercial-litigation financing is non-recourse-it's an investment in the litigation, not a loan to be paid back-so the profit depends on whether the party the investor backed wins the suit or receives a settlement.
Some of the more frequently funded types of legal disputes are intellectual property, contract, antitrust, bankruptcy and insurance matters. Plaintiffs receive most of the financing, but defense funding is becoming increasingly common.
While defendants typically don't win an award if they prevail, there are circumstances where they could. For example, if a plaintiff brought a claim that was unsuccessful and the defendant prevailed on a counter-claim against the plaintiff, the plaintiff could end up owing the defendant money. After evaluating all the likely claims and counter-claims in a particular lawsuit, a litigation financier might well choose to back the defendant if the financier thought the defendant would prevail overall and "net" more in damages.
Finding cases to invest in isn't difficult. The longer litigation drags on, the more costly it can become to pursue legitimate claims. Litigation financing also frees up capital, allowing companies to focus their financial resources on core business activities that generate revenue. So many companies and their attorneys are seeking to shift the risk of litigation from themselves to investors. The top commercial litigation funders say they don't have to advertise. Many funds employ former practicing attorneys with extensive contacts. The industry has also received a fair amount of media attention, which has boosted its profile with companies and their attorneys.
There's not much competition from banks, which are generally risk averse and lack the ability to properly assess lawsuits as investments, let alone price them.
"Because the industry is so nascent, we can price our capital very strongly and get really good returns. There are not a lot of funds competing for these investments," notes David Desser, managing director of Chicago-based Juris Capital, a private fund that invests exclusively in business-to-business lawsuits and reports returns exceeding 25% annually on a portfolio basis.
Bye-Bye Beta
As investments, lawsuits are assets that are virtually uncorrelated with the broad economy, according to Morningstar research analyst Benjamin N. Alpert. There's effectively zero beta because the value of the investments rises or falls based on the outcome of the underlying legal claims, not what happens in the stock, bond or property markets. The cases are not even correlated with each other since they involve different parties, different attorneys and different legal issues and thus will have different outcomes.
The returns are "absolute" in the sense that litigation is not cyclical. Ken Bradt, the CEO of private New York-based litigation-financing provider JD Capital Advisors, characterizes his fund's returns as "stable and consistent."
Cash-on-cash returns have been 15% to 18% for the last five years.