On Thursday April 4th, 2024, Litigation Finance Journal hosted a special digital event titled “Litigation Finance: Investor Perspectives.” The panel discussion featured Bobby Curtis (BC), Principal at Cloverlay, Cesar Bello (CB), Partner at Corbin Capital, and Zachary Krug (ZK), Managing Director at NorthWall Capital. The event was moderated by Ed Truant, Founder of Slingshot Capital.
Below are some key takeaways from the event:
If you were to pinpoint some factors that you pay particular attention to when analyzing managers & their track records, what would those be?
BC: It’s a similar setup to any strategy that you’re looking at–you want to slice and dice a track record as much as possible, to try to get to the answer of what’s driving returns. Within litigation finance, that could be what sub-sectors are they focused on, is it intellectual property? Is it ex-US deals? What’s the sourcing been? How has deployment been historically relative to the capital they’re looking to raise now?
It’s an industry that is starting to become data rich. You have publicly-listed companies that have some pretty interesting track record that’s available. I’m constantly consuming track record data and we’re building our internal database to be able to comp against. Within PE broadly, a lot of people are talking about DPI is the new IRR, and I think that’s particularly true in litigation finance. If I’m opening a new investment with a fund I’ve never partnered with before, my eyes are going to ‘how long have they been at it, and what’s the realization activity?’ There is also a qualitative aspect to this–has the team been together for a while, do they have a nice mix of legal acumen, investment and structuring acumen, what’s the overall firm look like? It’s a little bit art and science, but not too dissimilar from any track record analysis with alternative investment opportunities.
Zach, you’ve got a bit more of a credit-focus. What are you looking for in your opportunities?
ZK: We want to understand where the realizations are coming from. So if I’m looking at a track record, I want to understand if these realizations are coming through settlements or late-stage trial events. From my perspective as an investor, I’d be more attracted to those late-stage settlements, even if the returns were a little bit lower than a track record that had several large trial wins. And I say that because when you’re looking at the types of cases that you’ll be investing in, you want to invest in cases that will resolve before trial and get away from that binary risk. You want cases that have good merit, make economic sense, and have alignment between claimant and law firm, and ultimately are settleable by defendants. That type of track record is much more replicable than if you have a few outsized trial wins.
What are things that managers generally do particularly well in this asset class, and particularly poorly?
CB: I don’t want to paint with a broad brush here. With managers it can be idiosyncratic, but there can be structuring mistakes – not getting paid for extension risks, not putting in IRR provisions. Portfolio construction mistakes like not deploying enough and being undercommitted, which is a killer.
Conversely, on the good side, we’ve seen a ton of activity around insurance, which seems to be a bigger part of the landscape. We also welcome risk management optionality with secondaries. Some folks are clearly skating to where the puck is going and doing more innovative things, so it really depends who you’re dealing with. But on the fundamental underwriting, you rarely see a consistent train wreck – it’s more on the other stuff where people get tripped up.
How do you approach valuation of litigation finance portfolios? What I’m more specifically interested in is (i) do you rely on manager portfolio valuations, (ii) do you apply rules of thumb to determine valuations, (iii) do you focus your diligence efforts on a few meaningful cases or review & value the entire portfolio, and (iv) do you use third parties to assist in valuations?
CB: If you’re in a fund, you’re relying on the manager’s marks. What we do is not that – we own the assets directly or make co-investments. We see a lot of people approach this differently. Sometimes we have the same underlying exposure as partners and they’re marking it differently. Not to say that one party is rational and the other is not, it’s just hard to do. So this is one we struggle with. I don’t love mark-to-motion. I know there’s a tug toward trying to fair value things more, but as we’ve experienced in the venture space, you can put a lot of valuations in DPI, but I like to keep it at cost unless there is a material event.
Check out the full 1-hour discussion here.
