In the first of a two part series on unconventional alternatives, Marianne Scordel (pictured), Founder of Bougeville Consulting, looks at litigation funding.
One of the questions many of us working in financial services ask ourselves at one point or another is: “How does my work add value to society?”
Some readily find an answer to that question. However, for others, including investors facing a choice on how to deploy their assets, making sense and creating value may be the result of a quest: for the job, the product, or the approach that will fulfil a wider purpose, alongside the objective of generating financial returns.
In the following paragraphs and in our next article, we will explore two different ways in which some of our clients have raised – and at times answered – the question of ‘values’, understood as ‘acting responsibly’, to coincide with monetary targets, taking into account the broader stakeholders’ community and with sustainability in mind.
The first of these two ways we will be talking about has to do with a specific product, rather than with an unconventional approach to a more traditional offering.
Litigation funding is not widely thought of as an asset class in itself, however this section of alternative investments has similarities with hedge funds and private equity funds. While the purpose is to generate a return, it has, at times, been encouraged as promoting a sense of justice.
Eve Ellis, a Partner at Mishcon de Reye, explains that Litigation Funding often takes the form of a self-managed offshore company, the purpose of which is to pay out the legal fees for the cases the fund, on advice from a litigation adviser, decides to back (or to “invest in”). Unlike hedge funds or private equity, these products are not financial instruments – and hence litigation advisers do not generally need to be regulated by the FCA. However one can easily draw a parallel between their risk profiles and investment strategies and those of “traditional” fund portfolios:
• Liquidity profile: these funds are typically illiquid, in the sense that one invests in a case and keeps funding it until the end, in the same way as a private equity manager might invest in a company they wish to turn around, knowing this might take a few years. In terms of hedge funds, this would be similar to a value, or an activist, investor, whose strategy is to extract the value of a company based on fundamentals, which, again, may take some time and does, at times, require having resort to court cases for the purpose of uncovering what’s right, or fair (as in ‘fair value’).
• Unlike value investors though, those involved in choosing legal cases to invest in, will not have control over the cases “during the life of the investment”, for obvious reasons of independence. One could argue that this is healthy in terms of the relationship between this type of activity and civil society, in the sense that it supports rather than perverts its functioning and balance of powers. The flipside of this though is that as in distressed asset investing, the result of each case is dependent on ‘the J factor’, or the take a given judge may have on each given case. This is, to some extent, imponderable.
• Ellis also points out the fact that, as in venture capital, “a few cases do well, while others may not” – hence the need to take this into account when constructing a portfolio of cases. The payouts on a given case can be interesting. However, this is indeed a risky business, which may lead to some choices in terms of diversification or level of concentration.
• Finally, when asked the question – obvious for someone with experience in hedge funds – of whether the ‘manager’ of a litigation funding operation can sell his cases short, Rowena Herdman-Smith, also a Partner at Mishcon, says that this would effectively consist of funding the defence, and unless they have a counterclaim, defendants are not due any payment, other than probably their legal costs, if they succeed in defending the claim. No arbitrage between the two parties then (similar to what happens to the stock of two companies involved in an M&A, for instance), and no betting on a loser, which, in a hedge fund context, some might deem value creating rather than destroying. The latter point is controversial of course, but some ‘faith based approaches’, such as Islamic finance, incorporate those concerns when it comes to considering long/short strategies. This is the topic we will discuss next time: how religious endowments make their investment decisions to remain in line with the principles they advocate and values they believe in.
Litigation funding happens more or less formally – which is why total AuMs can’t be easily quantified – and its development as a substantial and structural part of our industry may take a while. Herdman-Smith insists that she has seen cases where individuals could win cases against large companies. Some of these cases would never have been brought to justice, or would have lasted too long and been too intricate to have been sustained financially if it had not been for litigation funding. To paraphrase Keynes, the judiciary, as well as the market, can remain irrational longer than one can remain solvent. This is how long-sighted fund managers, as well as litigation “fund managers”, can come in handy. n
Marianne Scordel is the Founder of Bougeville Consulting, which provides customised assistance to hedge fund managers setting up or effecting changes to their businesses. Over time, she has dealt with a variety of structures and strategies. Prior to setting up Bougeville, she worked for Nomura and Barclays Capital. She is an Alumna of St Antony’s College, Oxford.