Adventurous Investor

November 2, 2012 6:22 pm

Perfectly legal funding opportunities

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Litigation funding has emerged from nowhere

Oiling the cogs of the legal economy may not sound appealing, but litigation funding has emerged from nowhere over the past few years to become a viable, alternative asset class for the adventurous investor.

There are two quoted litigation funds on the London Stock Exchange, plus a slew of private outfits including offerings from the likes of Harbour, City of London Group and Calunius Capital (not to mention a longer list of hedge funds that dabble in this space).

The very simple idea is to fund other people’s legal actions, whether they are simple commercial court cases over a real estate development that hasn’t gone as planned (a typical deal for Burford, one of the London-listed funds) or patent and antitrust actions (the focus of fellow listed fund Juridica).

It will come as no surprise to discover that in the core US market, the cost of litigation has been rising at around 8 per cent each year and that these actions can take anywhere between three and five years to come to fruition. As a result, a number of S&P 500 companies have long been looking for other stakeholders to help shoulder the cost.

What will the returns be?

If we take the fund manager’s assertions at face value and expect a typical investment to make 80 per cent total return over five to six years, allowing for a year of fund raising and finding investable ideas, fund investors can expect a compound annual return between 11 per cent and 13 per cent each year.

But investors then have to deduct fees and costs that can be anything between 3 per cent and 4.5 per cent each year, which probably brings returns back to 10 per cent each year net.

There are plenty of things that could go wrong, however, and some analysts are worried there may be a change in the regulatory environment in key US states.

On a positive note, litigation funding should be a classic, non-correlated investment that will probably continue to prosper even if the UK slips back into recession or the eurozone implodes.

Under historic English rules of champerty and maintenance, third parties were excluded from profiting from someone else’s legal actions. But in most of the US (though not all states) and also here in the UK, those ancient rules have been abandoned.

Yet despite these fair winds, third party litigation funding isn’t huge. One recent research report (by a firm called Execution) put the potential size of the main US market at $44bn (£27bn), but in reality the actual market is probably currently worth no more than a few billion pounds.

London stockmarket-listed funds have been at the forefront of litigation funding, and I think we’ve had just enough data from the likes of Juridica and Burford to begin to make a considered judgement about this most alternative of investment ideas.

On paper both the London-listed (but largely US-focused) funds seem fairly evenly matched with Juridica the pioneer, having listed in December 2007, and Burford coming a little later in 2009.

Burford trades at 105.3p (just below net asset value of 106p) and boasts net assets of £191m (making it the bigger outfit), while Juridica’s £120m of gross assets trades at 102.5p against net asset value of 114p (which is a discount of about 10 per cent). Yet Burford’s shares have sometimes traded at a whopping 30 per cent premium to its assets, so its recent share price weakness has put it back on (close to) level pegging with Juridica, which has had a rally from a recent low where the discount was as wide as 40 per cent.

One small aside – Burford recently bought a UK legal insurance company called FirstAssist, making it closer to an all-purpose legal financial boutique.

Both Burford and Juridica account for their investments in their balance sheet in slightly different ways, so those stated discounts can be misleading. What is obvious is that litigation funding is a classic form of long-term investing involving fundamentally illiquid assets, making it very similar to venture capital as an asset class.

Juridica has been quietly working its way through a portfolio of claims that includes 12 patent cases (total value $38m-£23m) and six antitrust claims ($180m-£111m), as well as other, smaller suits.

There have already been at least half a dozen successful resolutions and, according to one internal analysis of five claims in the autumn of 2011, the average internal rate of return was about 78 per cent, based on a timescale that varied between 185 days and 1,005 days.

Looking at Juridica and its capital fund raising cycle, it should be very close to realising its portfolio of assets (assuming an average duration of three to five years), and sure enough it has recently been handing money back to investors at a fairly decent clip.

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