I got an email soliciting a litigation financing fund. It's some sort of private fund that seems like an interval fund. The fees are high, there are liquidity restrictions and all the other reasons why I am not a fan of the wrapper but the underlying asset might be interesting in case it ever makes its way to some sort of wrapper that has daily liquidity.
I dug in with Copilot to start trying to learn. Litigation financing is a $20 billion market and growing. There are estimates for it to get close to $30 billion by the end of the decade. In terms of return expectations, for lower risk deals expect 8-12% returns, for average risk 12%-20% and for higher risk, 20%-30%. I'm not yet sure what makes some financing relatively more or less risky. Those numbers seem in line with the sales literature.
The correlation numbers are interesting. It also has zero correlation to managed futures and gold and a 0-0.10 correlation to merger arbitrage. Copilot was unable to find any hard data on failure rates for this type of financing but it pieced together that 65-80% of deals are successful.
Like we discussed the other day with prediction markets, outcomes in the space have nothing to do with the economy or geopolitical events, the outcomes depend on "legal merit."
The time horizons can be several years which Copilot says would make them difficult to package into an open ended fund (mutual fund or ETF), Copilot suggested a CEF or interval fund instead. The suggestion makes sense but the segment can evolve to where maybe it could fit into a mutual fund. Mutual funds can close to new buyers whereas ETFs can't.
At first glance, and that is where I am trying to learn, I don't think this would be subject to volatility laundering, a specific deal doesn't fail until it fails. There's no market pricing in the odds of failure for specific financing deals. If the fund above has those types of returns then I take that to mean the interest on each deal is much higher and the return nets out the failures from the successes.
I have no idea if litigation finance will evolve into something that will be packaged to have daily liquidity but it might. Catastrophe bonds can be had with daily liquidity. Autocallables can be had with daily liquidity. So maybe litigation finance can be too. The bigger idea is to continue seeking out assets/strategies that behave in the manner that I think people want their fixed income to behave but without the volatility of plain vanilla bonds if yields go up.
The blue line is the benchmark iShares Aggregate Bond ETF (AGG) and the other four lines are fixed income substitutes that we talk about regularly here. Putting 40% into AGG or a intermediate or longer treasury fund is a very big bet that doesn't make for great diversification. The four non-AGG strategies, aside from being much less volatile take different kinds of risks that aren't related to each other. Buying those four instead, greatly dilutes the risk versus 40% into AGG or something similar.
If someone is trying to figure out what to do with the 40, in a 60/40 context, it makes far more sense to me to spread the 40 across a half dozen that look like the above, not put it all into AGG or treasury funds. Maybe, litigation finance ends up as an accessible tool for what we're talking about and so it is worth learning about now.
The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.
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