Litigation Finance: Investing in Lawsuits for Uncorrelated Alpha
Litigation Finance: Investing in Lawsuits for Uncorrelated Alpha
COACHING POINTS
- The Concept: Justice is expensive. Many smaller companies cannot afford to sue deep-pocketed corporations for valid claims (e.g., patent theft). Investors fund these legal battles. If the plaintiff wins, the investor gets their principal back plus a hefty profit share.
- The Superpower: Zero Correlation. The S&P 500 can crash 30% because of the Fed, but that won’t change the evidence in a commercial lawsuit. This asset class moves to its own rhythm.
- The Returns: Institutional litigation funds target IRRs of 20-25%. Because the risk of total loss is high on single cases, diversification across multiple cases is mandatory.
In a world where stocks, bonds, and even real estate often move in sync, finding true diversification is the Holy Grail.
Litigation Finance offers a return stream based on court verdicts, not market sentiment. It turns the legal system into an investable asset class.
Source: Westfleet Advisors Market Report
Typical structure for a $1 Million investment in a commercial claim.
- Investment: $1,000,000 to cover legal fees.
- Settlement Reached: $10,000,000.
- Investor Priority (Standard Deal):
1. Return of Capital ($1M).
2. Preferred Return or Multiple (e.g., 2.5x Capital = $2.5M total). - Net Profit: Investor gets $2.5M total ($1.5M profit).
- ROI: 150% absolute return. If the case took 3 years, IRR is ~35%.
What-If Scenario: 2022 Market Crash Environment
Comparison: Traditional 60/40 Portfolio vs. Litigation Fund.
| Asset Class | Driver of Return | 2022 Performance |
|---|---|---|
| S&P 500 | Earnings / Rates | -19.4% |
| Aggregate Bonds | Fed Policy | -13.0% |
| Litigation Fund | Case Settlements | +15.0% (Uncorrelated) |
Result: While traditional assets suffered a “double whammy,” litigation payouts continued regardless of the economy, stabilizing the total portfolio.
Visualizing the Correlation Matrix
| Asset Class | Correlation to S&P 500 |
|---|---|
| US Equities | 1.0 |
| Real Estate (REITs) | 0.75 |
| Corporate Bonds | 0.50 |
| Litigation Finance | 0.05 |
*Litigation Finance shows virtually zero correlation (0.05) to the stock market, making it an ultimate diversifier.
Execution Protocol
Retail investors cannot call a law firm directly. Use specialized platforms like LexShares, Yieldstreet, or Oasis. You generally need to be an Accredited Investor.
Never invest in a single case unless you are a legal expert. Invest in a “Multi-Case Fund” or build a portfolio of 10+ distinct cases. The loss rate on individual cases can be 30%+, so you need the winners to cover the losers.
This is highly illiquid. Money is tied up until the case settles or a judgment is paid. This can take 2 to 5+ years. There is no secondary market to sell your position early.
COACHING DIRECTIVE
- Do This: If you are an HNWI looking for an alternative asset that truly zigs when the market zags. Allocate 2-5% of your portfolio.
- Avoid This: If you need cash flow. Litigation finance is “lumpy”—you get nothing for years, then a big check. It does not pay quarterly dividends.
Frequently Asked Questions
What is Litigation Finance?
Also known as Legal Funding, it involves a third-party investor providing capital to a plaintiff or law firm to cover legal costs in exchange for a portion of the settlement or judgment. If the case is lost, the investor typically gets nothing.
Why is it considered ‘Uncorrelated’?
The outcome of a lawsuit does not depend on interest rates, inflation, or GDP growth. A judge’s ruling is independent of the stock market. This makes it a powerful diversifier during recessions.
What are the risks?
Binary Risk is the main concern. In many single-case investments, it is ‘win big or lose all.’ Case duration is also unpredictable; a case expected to settle in 2 years might drag on for 5 years, reducing the annualized return.