The high price of certainty

I am currently doing some consulting projects for AxiaFunder , which is a litigation finance platform that connects High Net Worth Individuals and sophisticated investors with pre-vetted court cases.  As an early investor in Burford Capital, I’ve long been fascinated by litigation finance, and the value of uncertain, intangible assets with asymetric returns.

Below is something I’ve written on the high price of certainty:

Roughly a quarter of all debt issued by governments and companies around the world, $15 trillion in absolute terms, is trading at negative yields.* If investors hold the debt to maturity they are certain to receive less than they have paid in the market for the debt. Government bonds are seen as “low risk” because you are almost certain to receive the principal; certainty comes with a high price (zero or negative real returns).

Not only are investors paying a high price for certain assets, returns after a 10 year bull market may have become increasingly correlated. Momentum shares have a nasty habit of selling off at the same time. While within sectors, if investors worry about Deutsche Bank shares, it’s highly likely that Commerzbank and other European banks’ share prices will also suffer. Large quoted oil and gas companies, or global mining companies, may be geographically spread, but are likely to lose value in an economic slowdown.

But there are alternative investment opportunities, uncorrelated with other asset types and, whilst they do carry higher risks, also offer potentially high returns. For example, investing in litigation assets. Funding court cases is highly uncertain, with the possibility of losing your capital. But if the upside is great enough, and the portfolio is well diversified, investors can earn high rewards (20-30% potential returns) for risking their capital. Moreover these litigation finance assets should be uncorrelated with the stockmarket and bonds. But also, unlike most listed investments, uncorrelated with each other.

AxiaFunder is a technology platform that offers High Net Worth Individuals and sophisticated retail investors the opportunity to invest in commercial litigation matters. The logic behind litigation funding is straightforward: the claimant is willing to pay back a multiple on capital of around 3.5x if the case wins, in exchange for no liability if the case loses. Data from Solomonic shows that over 80% of cases settle before trial, which means the funder generally gets paid their principal and return in full. In the 20% or so of cases where the case goes to trial the results are more mixed with the claimant winning c.55-60% of the time (court cases are uncertain etc). Add it all together and the claimant and funder are likely to win more than 75% of the time. On that basis, it’s realistic to expect that investors will earn potential portfolio returns of c.30% per annum net of fees and other expenses. Capital is at risk and returns are not guaranteed.

Funding litigation is not for everyone, some cases will fail. Investors are also reliant on AxiaFunder managing the considerable operational risk. The platform is an appointed representative of FCA regulated ShareIn and uses ShareIn’s tried and tested technology solution which helps in this respect. In addition, investors face adverse cost risk if a case fails. That is, investors are liable for not only the claimant’s costs who they are backing, but also the defendant’s costs, if the case fails. AxiaFunder ensures that A-rated ATE insurance is in place to mitigate the remote risk that investors could lose more than their original investment.

AxiaFunder’s model has the advantage that investors can chose which claimants to back and capital is only raised when needed for a particular case and is then returned immediately (with profit) if a case is resolved favourably. This means cash is not tied up, waiting to be committed and deployed. Unlike Private Equity investments, a court settlement creates a natural exit after typically two to three years. Some of the cases on the AxiaFunder platform can also be made IFISA eligible.

Every case presented to investors on the platform has already been aggressively filtered: vetted by the engaged solicitor (often working on a partially or fully contingent basis); independently reviewed by a barrister; assessed and approved by an adverse cost insurer and also been approved by AxiaFunder’s own experienced case assessment team. This rigorously selective process means that only 1 out of 20 cases that the team reviews is presented to investors. Cases must have strong legal and moral merits; enforceability; a sufficiently large claim value and a strong legal team running the case.

Howard Marks of Oaktree Capital** recently suggested that in a world of negative interest rates, investors should think about the trade-off between accepting reduced certainty which by definition accompanies pursuit of higher rewards. Investing in litigation finance, recognising some risk of loss may turn out to be more thoughtful way to invest money than demanding certainty of return – especially when that return is certain to be negative.

* FT article on negative yields 3rd October 2019


**Howard Marks, Oaktree Capital Management, email 17 October 2019


Image from Sasha Freemind