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Portfolio Theory in the Context of Litigation Finance (pt. 1 of 2)

The following article is part of an ongoing column titled ‘Investor Insights.’ 

Brought to you by Ed Truant, founder and content manager of Slingshot Capital, ‘Investor Insights’ will provide thoughtful and engaging perspectives on all aspects of investing in litigation finance. 

Executive Summary

  • Modern Portfolio Theory (MPT) – a mathematical framework based on the “mean-variance” analysis – argues that it’s possible to construct an “efficient frontier” of optimal portfolios offering the maximum possible expected return for a given level of risk
  • MPT states that assets (such as stocks) face both “systematic risks” – market risks such as interest rates – as well as “unsystematic risks” – mostly uncorrelated exposures that are characteristic to each asset, including management changes or poor sales resulting from unforeseen events
  • Post-modern Portfolio Theory (PMPT) adds a layer of refinement to the definition of risk
  • Diversification of a portfolio can mitigate the impact of unsystematic risks on portfolio performance – although, it depends on its composition of assets
  • Behavioural Finance (BF) introduces a suggestion that psychological influences and biases affect the financial behaviors of investors and financial practitioners, also applicable to litigation finance

Slingshot Insights:

  • Portfolio theory is important to the commercial litigation finance asset class due to its inherently high level of unsystematic risks
  • Slingshot’s Rule of Thumb: a portfolio should contain no less than 20 investments in order to provide the benefits associated with portfolio theory
  • Diversification is critical for every fund manager
  • Specialty fund managers may play a positive role in a comprehensive litigation finance investing strategy by assisting with meeting a particular performance objective when defined in the context of acceptable “mean-variance” targets
  • Diversification provides optionality for an under-performing manager to ‘live to fight another day’ if their first fund achieved sub-par performance
  • Portfolio theory is applicable to consumer litigation finance

For those new to the commercial litigation finance sector, one aspect worth discovering from an investment perspective is the existence of unique risks attributable to this asset class.  For investment managers looking to get started in the industry, it is critical to understand the implications of the risks inherent in the asset class, especially for those with a limited track record in litigation finance.  Accordingly, significant attention should be paid to portfolio construction and diversification, in particular during the early stages of the life cycle of an industry where investments possess both idiosyncratic and binary risk, and where there is much less empirical data to guide investment decisions.  Portfolio risk is generally influenced by three main factors: volatility of results, correlation (of outcomes within a given portfolio) and the size of the portfolio.  For the purposes of this article, I have assumed that correlation within a portfolio is non-existent, as each case stands on its own and is not influenced by others in the portfolio. However, to the extent correlation does exist, it can have a significant impact on the value of portfolio theory. 

As the industry evolves so too will its data requirements

When the litigation finance industry first originated, the concept of portfolio theory was less important, given the recognition within the industry of a requisite level of experimentation (i.e. risk) to be assumed in order for a conclusion to be drawn about the attractiveness of the asset class. Therefore, the industry attracted the appropriate level of risk capital correlating to the risk/reward promise of litigation finance.  As the asset class matures and managers prove out the return profile, the early risk money is being supplemented with institutional capital, which is less inclined to assume the same level of risk as that of high net worth and family office investors.  Accordingly, in order to attract such capital, an element of data and analysis will need to be captured and compiled to assist the investor in understanding the dynamics inherent in the industry (returns, duration, volatility, correlation, etc.), which is partly why I believe the concepts in this article will grow increasingly significant in the near future.

Portfolio Theory Concepts

Before we discuss the applicability of portfolio theory to litigation finance, let’s dig into some portfolio theory concepts.

While an in-depth study into portfolio theory is beyond the scope of this article, the following will provide readers with some theoretical concepts that have been developed and refined over the last 70 years.  Multitudes of research studies and articles have been published over the years and are publicly available.

  1. Modern Portfolio Theory (“MPT”)

Modern Portfolio Theory was developed by Harry Markowitz and published under the title “Portfolio Selection” in the journal of Finance in 1952, and remains one of the most important and influential economic theories dealing with finance and investment.  In essence, the theory suggests that investors can reduce risk through diversification.  Risk, in the context of modern portfolio theory, is the concept of the standard deviation of return as compared to the average return for the markets.  The theory states that the risk for individual stock returns has two components:

Systematic Risk – These are market risks that cannot be diversified away. Interest rates, recessions and wars are examples of systematic risks in the context of public equities.

Unsystematic Risk – Also known as “specific risk,” this risk is specific to individual stocks, such as a change in management or a decline in operations. This kind of risk can be diversified away as one increase the number of stocks in one’s portfolio. It represents the component of a stock’s return that is not correlated with general market moves.

One of the limitations of MPT is the fact that it assumes a normal distribution of outcomes in the shape of a ‘normal bell curve’, which may be applicable for markets where there is perfect information, but not applicable to many private market investments where there is a meaningful information asymmetry among market participants (thereby resulting in skewed performance distributions and potentially heavy tails).  Essentially, MPT is limited by measures of risk and return that do not always represent the realities of the investment market. Nonetheless, it laid the foundation for additional theories which have served to refine the original, underlying one.

  1. Post-modern Portfolio Theory (“PMPT”)

The term ‘post-modern portfolio theory’ has its roots in research undertaken at the Pension Research Institute at San Francisco University in 1983, and was created in 1991 by software entrepreneurs Brian M. Rom and Kathleen Ferguson, in order to differentiate the portfolio-construction software developed by their company from those provided by traditional MPT.  The PMPT theory uses the standard deviation of negative returns as the measure of risk, while MPT uses the standard deviation of all returns as a measure of risk. The authors determined that the normal distribution curve which represents the basis for MPT does not accurately reflect all markets and is merely a subset of PMPT. Essentially, different than MPT which tends to focus on risk in the context of derivation from mean market returns, PMPT focuses on risk and reward relative to an expected Internal Rate of Return (“IRR”) required for a given set of risks, which is more of a risk-adjusted return philosophy.  However, a key limitation of both MPT and PMPT is that they are both premised on the assumption of efficient markets, being the theory that all participants in a market have the same access to information. Enter Behavioural Finance…

  1. Behaviour Finance (“BF”)

I think we can all agree that most financial markets are anything but rational, which means there must be something else influencing their behaviour and, hence, their performance.  Behavioural Finance is a conceptual framework to study the influence of psychology on the behavior of investors and financial analysts. It also recognizes the subsequent effects on markets. BF focuses on the fact that investors are not always rational, have limits to their self-control, and are influenced by their own biases.  BF believes that investors are subject to a variety of judgment errors or biases, which are broadly defined as Self-Deception (you think you know more than you do), Heuristic Simplification (information processing errors), Social Influence (how our decisions are influenced by others) and Emotion (your mood’s impact on rational thinking at the time of investment).  The applicability of BF cannot be overstated in the context of litigation as there is the potential for many biases to enter the decision-making process, especially by litigators who’s own experience may be impacting their decisions.

While many theories exist to explain market behaviour and how investors should position their portfolios to address risk, I have focused on the three above as they are among the most prominent.  While they serve as a guide to address risk in the context of portfolio construction, they also serve to highlight an investor’s inherent limitations, and give rise to questions litigation finance managers should be asking themselves: are my biases working their way into my portfolio construction?  Of course, much of the research on which these theories are predicated relate to the public equities marketplace, which simplifies analysis via transparency and quantum of data.  In the context of litigation finance, we have a private market which is not large and not very transparent.  In addition, it is a market that is very inefficient due to the confidential nature of litigation – because it is a private market – and due to its relative nascency.  This is, in part, one of the reasons that I am presently pursuing the Slingshot Data Project (more to come in future articles) through a “Give to Get” model, where value (in the form of analytics) will be provided to a variety of participating constituents.

Application to Commercial Litigation Finance

Before we can discuss the application of portfolio theory to commercial litigation finance, it is important to determine the risks that are inherent in the asset class.

The litigation finance asset class exhibits a significant number of unique risks, some of which are Systematic and others Unsystematic, and some which fall into both categories.  As an example of a dual risk, collectability risk is inherent in any piece of litigation where one party is suing another (i.e. a Systematic Risk). In addition, there is the specific collection risk associated with a given defendant (are they more likely to settle and pay quickly, or delay, appeal and negotiate a settlement over a protracted period of time), which may be higher or lower than the overall risk inherent in litigation (i.e. an Unsystematic Risk)).

Generally, I find the level of Unsystematic risks to be high in litigation finance given that the outcome of each case is idiosyncratic to the aspects of the case (case merits, credibility of the witnesses, the credibility of professional witnesses, the litigious nature of the defendant, legal counsel effectiveness, defense counsel effectiveness, judiciary effectiveness, jurisdiction and collectability – to name some of the more significant risks).  However, litigation finance also has a number of Systematic exposures (binary outcomes, duration, liquidity, counter-party, collectability, case precedent, regulatory, legislative, etc.) which may not be fully addressable through the application of portfolio theory.

With respect to the influence of binary risk, I would add that while each case possesses binary risk at the outset, very few cases in fact are determined by a judicial decision (as with most litigation, the vast majority of cases are settled out of court). So, while binary risk (a Systematic risk) is endemic to the asset class, its application – in particular in the context of a portfolio – should not be overstated, because it rarely influences the performance directly – unless there is a series of highly correlated cases embedded in a portfolio (although the threat of a judicial outcome is a significant factor in any settlement).  In addition, certain case types have a higher propensity to be settled via a judicial decision (e.g. International Arbitrations) as opposed to others (e.g. Breach of Contract). Having said that, if one is only looking at the tail end of a portfolio, binary risk can be disproportionately higher, as those cases within the tail likely have a higher probability of being decided by a judiciary simply because they have had longer case durations which may indicate that neither side is willing to negotiate a settlement, or that the case is heading toward a trial decision. This proves that correlations – and thereby a degree of diversification – are not constant across a spectrum of case distributions.

In the second part of this article, which can be found here, I apply the portfolio theories outlined above to the commercial litigation finance marketplace and offer some perspectives on responsible portfolio construction.

Slingshot Insights

Investing in a nascent asset class like litigation finance is mainly about investing in people.  Most managers simply don’t have the track record of a fully realized portfolio on which investors can base their investment decision.  Accordingly, much time and attention is spent on understanding how managers think about building their business and in particular their first portfolio.  In addition to the underwriting process, one of the most important considerations for investors to understand is how managers think about portfolio construction and diversification. Portfolio theory plays an integral role in terms of how managers should be thinking about constructing their portfolios from the perspective of the number of cases in the portfolio, but managers should also ensure their own personal bias is not entering into the portfolio and that they have thought about all of the systematic risks that can affect like cases. My general rule of thumb is that most first time managers should be targeting a portfolio of at least 20 equal sized commitments, appreciating that it is almost impossible to achieve equal sized deployments due to deployment risk. It is also not in the manager’s best long-term interest to take a short-cut on diversification for expediency sake (i.e. to raise the next larger fund) and to do so may be interpreted as poor judgment from an investor’s perspective!

As always, I welcome your comments and counter-points to those raised in this article.

Edward Truant is the founder of Slingshot Capital Inc. and an investor in the consumer and commercial litigation finance industry.

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£5 Billion Opt-Out Claim Brought Against Google over Anti-Competitive Behaviour

By Harry Moran |

As LFJ reported last week, Google is the target of a €900 million claim brought against the technology giant in the Netherlands over its alleged anti-competitive behaviour. However, that is not the only lawsuit being brought against the company over such allegations, with a new claim being filed at the Competition Appeal Tribunal (CAT) in the UK.

An announcement from Geradin Partners highlights the filing of a new claim brought against Google before the CAT over allegations that the company abused its market dominance to increase prices for Google Ads and harm competitors in the search advertising market. The claim, which has an estimated value of £5 billion, is being brought on behalf of UK-based advertisers who have allegedly suffered losses because of Google’s anti-competitive behaviour. The lawsuit is to represent UK businesses who purchased advertising space on Google search spaces since 1 January 2011.

The opt-out competition damages claim is being brought by Or Brook Class Representative Limited, with Dr Or Brook acting as the proposed class representative. Dr Brook is a competition law expert, currently holding the position of Associate Professor of Competition Law and Policy at the School of Law at the University of Leeds. She is supported by a legal team led by Geradin Partners, with funding for the proceedings being provided by Burford Capital.

Dr Or Brook, provided the following comment on the lawsuit: “Today, UK businesses and organisations, big or small, have almost no choice but to use Google ads to advertise their products and services. Regulators around the world have described Google as a monopoly and securing a spot on Google’s top pages is essential for visibility. Google has been leveraging its dominance in the general search and search advertising market to overcharge advertisers.”

Damien Geradin, founding partner of Geradin Partners, emphasised that “this is the first claim of its kind in the UK that seeks redress for the harm caused specifically to businesses who have been forced to pay inflated prices for advertising space on Google pages.”

The full announcement from Geradin Partners can be read here.

New Burford Capital Research Reveals Significant Opportunities for Businesses Through Patent Monetization

By Harry Moran |

Burford Capital, the leading global finance and asset management firm focused on law, today releases new research on patent monetization, a means for businesses with significant intellectual property to generate revenue from patent assets through licensing, direct enforcement and corporate divestitures. With high research and development costs, long development timelines and intense IP competition, CFOs and GCs are faced with the challenge of seeking greater value from their companies' patent portfolios without diverting capital from core business operations. Moreover, converting underutilized intellectual property into liquid assets enables companies to fuel ongoing innovation and drive future growth.

Despite substantial investments in securing and maintaining patents, many companies fall short in leveraging their intellectual property—resulting in missed financial opportunities and ongoing costs that could otherwise be offset through monetization. This research shows companies shifting to a more proactive stance toward patent monetization as they face mounting economic pressures, rising costs of maintaining large patent portfolios and headline-generating enforcements and divestitures by major brands that increase acceptance. Nearly 70% of in-house lawyers say their organizations are more likely to monetize patents today than a decade ago, and 73% report that patent monetization revenue has grown over the last 10 years.

"Patent monetization remains a significantly underutilized asset for many businesses," said Christopher Bogart, CEO of Burford Capital. "Companies frequently hold valuable patents that require substantial investment to enforce, incurring significant expense—risk we routinely finance for clients. In today's climate of intensifying global competition and rapidly evolving IP enforcement landscapes, legal finance empowers companies to strengthen their patent monetization strategies and take a more proactive, value-driven approach to IP management."

"Companies have a significant opportunity to unlock value from their intellectual property," said Katharine Wolanyk, Managing Director at Burford Capital and head of its intellectual property and patent litigation finance division. "In conversations with CFOs and general counsel across industries, we frequently hear that patent portfolios are viewed as cost centers rather than assets, and this research substantiates that assertion. Legal finance offers a powerful solution by transforming underutilized IP assets into a source of liquidity that can fuel business priorities and allow companies to continue the essential cycle of innovation."

Key findings from the study include:

  • Companies are missing revenue opportunities: Even as patent monetization is increasing, 79% of in-house lawyers say that more than a quarter of their patent portfolio is underutilized. The costs of maintaining patents without monetization include lost revenue, delayed market entry and reduced market share.
  • Revenue generated by patent monetization is growing: 73% of in-house lawyers report that revenue from patent monetization has increased over the last 10 years and 69% of in-house lawyers say their organizations have become more likely to monetize patents in the past decade.
  • Divestiture is a fast-growing monetization strategy: 71% of in-house lawyers have already divested patents or are actively exploring divestiture options.
  • Clients can de-risk direct enforcement with finance: 72% of law firm lawyers cite the high cost of litigation as a deterrent to clients pursuing meritorious patent claims.
  • Legal finance plays a growing role in patent monetization: 59% of law firm lawyers say clients use legal finance for patent monetization; 51% of in-house lawyers say they are actively planning or exploring the use of legal finance to support patent enforcement and monetization going forward.
  • Global patent monetization is active: The US remains the top market for patent monetization due to strong enforcement mechanisms. The Unified Patent Court (UPC) is driving change in Europe, with 74% of in-house lawyers expecting increased enforcement in the region.

This research, commissioned by Burford and conducted by GLG, captures insights from 300 in-house IP counsel and law firm partners involved in patent litigation in North America, Europe and Asia.

The research report can be downloaded on Burford's website.

About Burford Capital

Burford Capital is the leading global finance and asset management firm focused on law. Its businesses include litigation finance and risk management, asset recovery, and a wide range of legal finance and advisory activities. Burford is publicly traded on the New York Stock Exchange (NYSE: BUR) and the London Stock Exchange (LSE: BUR), and works with companies and law firms around the world from its global network of offices.

For more information, please visit www.burfordcapital.com.

This announcement does not constitute an offer to sell or the solicitation of an offer to buy any ordinary shares or other securities of Burford.

Court House Capital Appoints New CEO as Michelle Silvers Moves into Chairman Role

By Harry Moran |

Court House Capital is pleased to announce the appointment of Matt Hourn as its new Chief Executive Officer, effective 14 April 2025. This strategic leadership transition marks an exciting new chapter for the company as Michelle Silvers, who has served as CEO since 2020, steps into the role of Chairman of the Board. 

Michelle Silvers has been instrumental in Court House Capital’s growth, innovation, and performance since its inception. Her move into the Chairman position reflects the company's ongoing commitment to visionary leadership and long-term success. 

"Leading Court House Capital has been an incredible journey, and I am proud of what we've built. I look forward to continuing to support the company's future in a strategic capacity as Chairman." Michelle Silvers, Chairman, Court House Capital 

Incoming CEO Matt Hourn brings over 25 years of experience in commercial litigation and is cofounder of Court House Capital. His strong commercial insight and legal expertise, leadership capabilities, and innovative vision make him well-suited to drive the next phase of growth. 

"I am honoured to step into the role of CEO and build on the strong foundation Michelle has established," Matt Hourn, Chief Executive Officer, Court House Capital. 

This transition underscores the firm’s commitment to continuity and strategic evolution, positioning Court House Capital for sustained success. 

ABOUT COURT HOUSE CAPITAL 

Court House Capital is a leading litigation funder focused on cases in Australia and New Zealand. Led by industry founders, with Australian based capital, the team is renowned for expertise, agility and collaboration. courthousecapital.com.au