Old Game, New Players
Investing in litigation is not a novel phenomenon. "What's new is the existence of pure-play, professionally managed investment funds," Bogart says.

There are currently three pure plays that trade.  IMF Australia, which operates primarily in the Australian legal market and invests in both commercial and non-commercial lawsuits, was the first to go public in 2000, followed by Juridica Investments in 2007 and Burford Capital in 2009, both of which invest exclusively in business-to-business lawsuits.  
Although Juridica and Burford are both domiciled in Guernsey and trade on the London AIM, they invest primarily in U.S. corporate litigation and in international arbitration involving Fortune 1000 companies and the law firms that represent them.  Their investors are mostly large, high-profile U.K. institutions.

Both funds aim to provide investors with capital appreciation and dividend returns. "Burford's dividend policy is to pay out 90% of realized gains until we get to a 5% yield.  If we're going to be above a 5% yield, we switch to a 50%-of-realized-gain payout.  The purpose of that is to craft a security that's appealing both to income-oriented investors and to people looking for capital appreciation," Bogart says.

Managing Risk
"The most significant risk lies in the valuation of the individual claims by the management team," Alpert notes.  Simply put, litigation fund managers need specialized expertise in choosing the right lawsuits, just like equity managers must have stock-picking skills.

Because they're assuming a client's litigation risk, well-run commercial lawsuit funders conduct extensive due diligence before agreeing to finance a matter. Managers seek potentially high-value/low-risk cases that vary by type of underlying legal matter, to provide portfolio diversification, and by expected completion date, to provide a steady flow of funds.  

Limiting risk starts with accepting only cases where the legal merits are strong.  Liability must also be relatively clear.  Most of the high-profile funders have in-house underwriting departments staffed by experienced attorneys and accountants who try to determine probable case outcomes and estimate financial risk.  Many funds also employ outside legal and non-legal experts to assess particularly complicated or risky matters.

The probable payoff should be large enough to compensate the fund adequately for the risk as well as for the time spent on initial and ongoing due diligence. Collection or counter party risk must also be low. That is, if the party backed by the fund wins, the loser or its insurance carrier must be able to satisfy any settlement or judgment.

Many funders avoid cases that will likely end up before a jury, which adds to the uncertainty of the outcome.  They also bypass cases that could take a long time to resolve because that could diminish IRR, if it's not properly priced into the investment.  Other factors managers consider include the quality of the attorneys and expert witnesses, as well as the jurisdiction.  Well-managed funds also conduct legal and ethics compliance reviews before accepting cases.

To screen for the dizzying array of variables that could affect the outcome of a case, funds develop complex proprietary models. "We use decision tree modeling, scenario modeling and Monte Carlo simulations to value assets for our accounts," Fields says.

After all this scrutiny, few cases pass muster.  Juris Capital's Desser says the firm probably takes a "hard look" at one of every ten cases presented to the fund.  "Of the cases we review, we probably invest in less than 5%," he says.