The Rise of Legal Funding
Legal funding has enjoyed a meteoric rise over the past two years, spurred by ever-increasing interest from institutional investors. So what is it about legal funding as an asset class that attracts largescale investment from the likes of George Soros, Burford Capital and Harvard, the world’s wealthiest university? Here we take a closer look.
The main attraction of legal funding for institutional investors lies in the fact that it generates uncorrelated returns. This is because when you finance litigation, you’re investing in a legal claim and whether that claim pays out generally bears little or no relation to how the overall equity market is doing.
This makes litigation funding an attractive asset class for investors looking to hedge some of the risk they are exposed to elsewhere in their portfolio. The asset class also offers considerable protection against recession. In the eventuality of stock and property markets ever taking a hit, institutional interest in legal funding will only increase on the back of cases connected to resulting bankruptcy or failed deals.
Uncorrelated and Robust Returns
Legal funding is disrupting the existing business model of law firms, showing them to be ill-equipped to deal with rapidly increasing volumes of consumer claims. In terms of correlation, demand for legal services remains constant, even increasing in times of financial and economic uncertainty. This means institutions can put their capital into a sector that will remain robust even when all other markets are failing.
Legal funding is currently expanding the number of claims that can be handled by legal professionals. With financing from institutional investment, corporations without the cash to float a lawsuit that could last for years and law firms that wouldn’t traditionally take on a contingency fee case can work together, providing access to a much wider range of legal options.
In the UK, the legal funding sector is more established than in America, largely due to the huge increase in consumer claims relating to PPI, mis-sold pensions, personal injury, etc. seen in recent years. As the sector has expanded, institutional investment has been focused on tech solutions that allow small to mid-sized law firms to process high-volumes of consumer claims.
How Institutional Investors Expect to Gain
Because the level of due diligence in litigation financing is so high, the likelihood that approved claims aren’t settled is rather low. Also, the actual amount of money on the line tends to be fairly small, and the potential reward to the investor relatively large. When these loans, or advances, are bundled together, institutional investors can use these types of investments, which are not linked to the major markets, to diversify their portfolios.
In terms of where institutional investors are looking at the current time, focus is shifting towards legaltech. The meteoric rise of fintech as an asset class paved the way for startups with a specific legal focus to attract institutional investment, boosted by rapidly rising demand for consumer litigation. As a consequence, firms such as Lawthority have enjoyed considerable growth as providers of legaltech solutions in the UK.
UK Legal Funding Sector Maturing Faster than in US
Legal funding among institutional investors is nothing new in the UK, while it is still taking root over the pond. This means all eyes are on the UK market for an idea of growth potential for similar legal funding models elsewhere in the world. And the future looks extremely bright.
Whereas the US is still getting to grips with the legal aspects of investment in the sector, investor interest in the UK has moved on to emerging technologies. For example, Lawthority is developing bespoke software solutions set to dramatically increase the capacity of smaller operations to process high-volume caseloads.
As the legal funding sector continues to mature and expand so will the array of opportunities for investors. Despite the sector being dominated by institutional investors in recent years, this landscape is also changing, with more opportunities available for retail investors to achieve diversification through this uniquely robust asset class.