Opportunities Amid Uncertainty: Legal Finance

January 30, 20234 min read
Opportunities Amid Uncertainty: Legal Finance
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In this challenging market environment, where stocks and bonds have been largely underperforming, investors may be looking to allocate their capital to assets with little correlation to public markets. One of the most, if not the most, uncorrelated alternative asset class is legal finance. 

Yieldstreet is one of the few platforms that offers legal finance investment options. We’ve offered 80 deals to investors, which have covered roughly $500 million of investment commitments. To date, investors in the space have a net annualized return of 13% and we’ve recovered approximately $350 million in proceeds.

Legal finance is an investment strategy that monetizes the contingent assets inherent in litigation. 

Legal finance is based on the concept of investing in or lending against lawsuits and the litigating firm’s contingency fees. The amount a plaintiff ultimately receives, and the law firm’s fee is based on the outcome of litigation. The strategy involves providing investment capital to pursue those cases or seeking to borrow against these lawsuits. Litigation often takes years and is capital-intensive.

Does legal finance correlate to the broader markets at all?

Unlike most assets, legal finance outcomes aren’t materially impacted by typical economic indicators like by interest rates, inflation, corporate revenues, or consumer spending. Its performance is strictly tied to the outcome of the case. Therefore, investors can use legal finance to hedge against some of the current market headwinds. 

What are some ways Yieldstreet aims to mitigate the risk with investing in legal finance?

Even if legal finance doesn’t correlate to public markets, investors should be aware of the drivers of legal finance risk. Certain legal finance investments are non-recourse, meaning repayment is tied solely to the case and investors’ principal may be lost if the lawsuit is unsuccessful. Investors are compensated by the potential to generate high returns. 

We try to mitigate the risk associated with investing in legal finance by looking at a specific set of factors when deciding our case profile: 

1. Liability 

When evaluating our case portfolios, we ask ourselves questions such as: Does the fact pattern establish clear wrong doing? Is there established legal precedent for similar cases? Does the law firm have a strong track record?

2. Damages

It’s important to know whether the amount expected to be recovered from the defendant will be high enough to support attractive investment returns. A verdict is only worth the amount that can be recovered. However, our investments typically aren’t dependent on the credit worthiness of our borrowers. Typically, investment grade insurance companies contribute to settlement payments, which means that even in times of high market volatility, payouts should remain insulated from external market pressures. 

3. Timing

Some litigation can take years to resolve, so we’re mindful of these timelines when doing a cost benefit analysis of specific cases. Timing also affects the pricing of our investments – longer term offerings often require a higher rate of return. 

4. Diversification

And last, to minimize dependency on a single litigation’s outcome, we create portfolios that aim to include a variety of strong cases, the outcomes of which are independent of one another. The intent is for winning cases to offset underperforming cases. This form of diversification is another way we help to mitigate risk.

What is the legal finance team’s due diligence process?

Yieldstreet’s due diligence for legal finance is broadly a three-part process — it consists of a law firm analysis, a case/legal merits analysis, and an analysis of the investment’s structure and suitability within a broader portfolio. 

For the law firm analysis, we look at the track record of the lawyers to both win cases and achieve high settlements. When looking at the case, we employ the services of third-party experts in the field to review case filings and measure the merits and weaknesses of the case. When constructing portfolios, we focus on assembling a diversified set of cases with different risk and duration profiles.

All securities involve risk and may result in significant losses. Alternative investments involve specific risks that may be greater than those associated with traditional investments; are not suitable for all clients; and intended for experienced and sophisticated investors who meet specific suitability requirements and are willing to bear the high economic risks of the investment. Investments of this type may engage in speculative investment practices; carry additional risk of loss, including possibility of partial or total loss of invested capital, due to the nature and volatility of the underlying investments; and are generally considered to be illiquid due to restrictive repurchase procedures. These investments may also involve different regulatory and reporting requirements, complex tax structures, and delays in distributing important tax information.