Most alternative asset classes go through a predictable process of ‘democratisation’.
This cycle of investment goes something like this in our connected, technologically driven world:
- Someone somewhere has the germ of a good idea which usually consists of a form of finance involving a niche (frequently in the netherworld of shadow banking)
- The investment is first institutionalised usually via an investment bank that is willing to structure up the product and flog it on via its sales teams
- Hedge funds jump on board. As the market opens up, other providers of this niche investment opportunity come out of the woodwork and start getting involved, increasing the size of the overall market
- Slowly but surely traditional institutional investors such as pension funds get involved, helped by the fact that they can take long term views on fundamentally illiquid asset classes
- Wealth advisers start to get interested and sniff around the opportunity set. This prompts some asset managers to set up closed-end investment trusts – increasingly in the UK – which opens access
- ETF issuers also start sniffing around the space although most of the time they’re put off because of the fundamental illiquidity of the asset class
- Sophisticated high net worth individuals start knocking on the door for direct access which in turns spawns some form of ‘market place’ approach – usually an electronic gateway where opportunities are ‘carefully selected’
- The asset class by this time has expanded hugely, with returns usually depressed. Poor decisions get made, bad investments crop up.
- Confidence begins to drain away from the ‘peak’ sector amongst institutions as everyone including your mum starts saying “Did you hear about the opportunity in….[fill in blank for the alternative]”. Too much money is raised and then badly invested.
- The inevitable Blow up occurs and the regulator’s ‘demand action’. Headlines appear such as “79yearsr old loses all their pension money on exotic investments in …[fill in blank]”.
- After a period of calm reflection, contrarians start to return to the space, and the good money managers win out. The asset class becomes established.
This process of risk normalisation, price discovery and marketisation are all essential and obvious. I’m sure back in the dim and distant past boring stuff such as gilts and equities went through the same process. “Make money by lending to the government and never worry about being repaid – buy a Treasury Consul.”
I’ve already bored my readers with my views on litigation funding, and I suspect that we are fast approaching Stage Seven in my Process of Normalisation for Alternatives. I am, I freely admit, a tad cynical but I also believe that litigation funding is going to turn into a great force for good. It equalises the playing field, causes huge corporations great discomfort, can make investors decent money and helps keep lawyers overpaid – sorry scrub that last point, maybe that’s not a big advantage.
Anyway, my point is that although I think we are peak litigation funding, that doesn’t mean there’s not still good investments to be had. The only problem for most mainstream, wealthy investors is that beyond shares (and retail bonds) in Burford they’ll struggle to access it.
But there is some good news for those looking for a novel way into the asset class. I’ve just stumbled across a new online platform called Lexshares.com.
Put simply this is a market place for litigation claims. A plaintiff needs investors, and they approach the advisors behind Lexshares. They run due diligence on the case, and if accepted it goes on the platform. Currently for instance there appears to be an opportunity based around a professional athlete suing a financial advisory firm looking to raise $750,000. The advisors are apparently accused of defrauding the plaintiff of tens of millions of dollars. You’ll also see a trademark infringement case.
One colleague who’s already registered on the platform says that most ‘actions’ sell out fairly quickly. He also suggests that of the 50 cases exhibited on the platform, 6 have won so far and just 1 lost. IRRs run at 88% apparently and the Boston based platform looks like its expanding fast, with $15m raised recently to grow the business and there’s also talk of a fund that will sit alongside the individual investors. In terms of practicalities the website reports that there “are no upfront or management fees for investors on LexShares. LexShares takes a carried interest in each case successfully funded “. As for minimum investment stakes Lexshares says “the minimum may vary from offering to offering, but can be as low as $2,500. The maximum investment is the lesser of the offering size remaining for investment or 5% of an investor’s liquid net worth. “
Crucially Lexshares also reports that it will accept international investors.
One last observation from the website. It hosts an excellent education resource with one of the best guides to litigation finance I’ve ever seen – it’s at https://www.lexshares.com/litigation_finance_101.
Now, I have absolutely no idea whether the investments on the platform make sense. Logically I can see the opportunity, especially as the sweet spot for these ‘actions’ seems to be in the hundreds of thousands of dollars. My guess is that these small sums are a bit below the radar for the likes of Burford and I’d also guess that that small size might also imply higher returns. The risks are obvious – that your action fails. And I suppose there’s another obvious problem – if the platform goes down, and you sit tight with your investment, you’re in a fairly illiquid asset class. But that goes with the asset class – it is illiquid and terribly niche. The whole sector could of course get pole axed by regulatory changes – as I’ve already hinted at in previous blogs – but for now it seems like a fascinating source of uncorrelated, high returns. Until, of course, it isn’t!