Legal Finance Strategy for Compelling Risk-Adjusted Returns
Explore the unique world of legal financing with Andrea Hoch, Senior Director of Investor Relations at AIR Asset Management, and Joe Siprut, CEO & CIO of Kerberos Capital Management. This exclusive interview uncovers how our innovative private credit strategy delivers specialized capital solutions to law firms and seeks attractive risk-adjusted returns. Find out how investing in legal finance may diversify your portfolio and buffer your investment portfolios from market volatility.
TRANSCRIPT
Andrea Hoch, Senior Director of Investor Relations, AIR Asset Management.
Joe Siprut, Chief Executive Officer & Chief Investor Officer, Kerberos Capital Management.
Andrea Hoch: Hi, I'm Andrea Hoch, Senior Director of Investor Relations at AIR Asset Management. I'm here with Joe Siprut CEO and CIO of Kerberos Capital Management, our esteemed sub-advisor on law firm lending. Joe, thank you for being here with us today.
Joe Siprut: Thanks for having me.
Andrea Hoch: Joe, we take a unique approach to law firm lending. Can you please explain how we're innovating in this space?
Joe Siprut: The key premise to understand is that the law firms we're trying to partner with and help solve problems for are law firms that have a specific type of model. They take large amounts of cases on contingency. The effect is that there's very episodic and lumpy cash flow and there isn't necessarily a strong base of recurring revenues, which is the model for most traditional law firms.
So, the question is, if you're a law firm that operates on contingency, how do you manage cash flow and how do you scale your platform? And that's what Kerberos does. We specialize in providing capital solutions to firms that have that type of business model. In effect, by doing so, we're getting a complexity premium that is disproportionate to the actual risk being taken because you have to be a specialist to underwrite that type of collateral. So, that's really what we do. Get a good risk-adjusted return for our investors by using our specialized underwriting abilities.
Andrea Hoch: That's fascinating. Can you dive into what sets this approach apart from the traditional litigation finance strategies?
Joe Siprut: I think the traditional litigation finance strategies are technically or literally stated “financing litigation”, meaning a single piece of litigation, a particular case where company “A” is suing company “B” and there's a financier who provides capital to assist in the prosecution of the case, and they might be seeking a multiple-of-money-type return. What we do in a very technical sense is not litigation financing at all. Instead, what we're doing is providing a credit product to the firms who are bringing those cases on contingency. So, the difference turns out to be quite important because we're not taking single case risk. We are cross-collateralized on the whole law firm's portfolio of cases. So, for any particular loan we do, hundreds of thousands even, of cases, just for one single loan as opposed to single case equity-type risk.
Andrea Hoch: Switching gears a bit, let's talk about performance. AIR Asset Management’s strategy has nearly achieved a 16% net return since its inception in January of 2022. Joe, what do you attribute this success to and how does it fit with investors’ strategies for noncorrelated investment products?
Joe Siprut: The key to executing the strategy is to retain underwriting discipline and to do the right things to position yourself as a lender in the marketplace to get the “pick of the litter” when it comes to deal flow. Kerberos, for example, has been around quite a long time now. I mean, by the standards of this asset class anyway, which is, which is fairly nascent, we're considered veterans, and we were among the first to have a dedicated law firm lending strategy.
Over time, we built up a brand as an industry leader for lending against legal assets. That gives us a good variety of transactions to choose from. We're not typically under stress to get money out because we always have good deals available and when you can choose among good risk-adjusted opportunities, the effect is that you get into some really good deals that you ride for a couple of years and make an excellent risk-adjusted return. If you have a bad investment or a bad loan, maximizing the recovery value becomes of paramount importance, and that can really have an impact on returns. So, I think the key to our success is good deal flow, which we've earned over time, staying very disciplined with our underwriting and our buy box, and then knowing how to service and navigate these loans so that we have optimal performance.
Andrea Hoch: Absolutely. Investors are increasingly looking for ways to diversify their portfolios. How does this law firm lending strategy reduce correlation and volatility compared to traditional asset classes?
Joe Siprut: It's an interesting question because I would argue that not only is this strategy completely uncorrelated to traditional U.S. equities, for example. In a way, it's actually inversely correlated. When the global macroeconomic environment is trending south and things are going poorly out there, the effect of that is that deals will fall apart and when deals fall apart, people will sue each other, and that drives demand for litigation and therefore for, litigation finance specifically. As a broad statement, I could make a case that it's inversely correlated. You could think of it though, as just being generally uncorrelated and that's really important because no matter what the stock market is doing, an investor can look at an allocation to this strategy as something that is untethered to those types of considerations. That provides very, very nice diversification that is really important to institutional LP’s and high net worth.
Andrea Hoch: So, Joe, you were a nationally recognized attorney before founding Kerberos. Will you tell us a little bit about the transition, the background of your team members, and what drove you to start an asset management firm?
Joe Siprut: Sure. The origins of Kerberos initially grew out of what I was doing as a lawyer. I spent probably half of my career as a traditional corporate litigator. Second half of my career, I started doing plaintiff-side work. It was during that time that, the litigation finance asset class, I mean, it wasn't even really an asset class back then, but that was when it started to take hold initially. I had a vision for the kind of product that I thought would be successful under those circumstances. We launched the company with litigation finance, growing out of the legal practice, but very quickly through luck or whatever else, we were able to raise some capital, put it out, develop a great track record and we just kept on going. Within a matter of months, I had transitioned out of the law altogether. We've built up Kerberos into the franchise that it now is over the last six years. So, it's been great. I like to think that I've kept many of the things that I liked about practicing law like solving problems for people and navigating complex situations. That's all still there. Not only is it still there, but that's why we're good at our jobs. Most of our investment team has that same background from the legal side, and it's that specialized skill set that gives us the edge when it comes to underwriting and servicing these assets. That being said, we do also believe in the marriage between the collateral underwriting with the traditional credit focus. One of our differentiating factors among managers in this asset class is that we really bring a credit-focused perspective to what we do, even though we're lending against legal assets. We're very focused on liquidity and cash flow, the operations of our counterparties, and all the other usual belt-and-suspenders-type questions. We have credit specialists who are part of our investment team for that reason, and I think that figuring out how to get those two silos to work well together is an important part of our secret sauce.
Andrea Hoch: Thank you for sharing that. Here at AIR, leveraging your track record, leadership, and deep expertise in law firm lending has been successful. We believe that our partnership aligns with our mission to deliver attractive risk-adjusted returns through resilient noncorrelated investment products. How do you see our collaboration continuing to enhance value for our investors?
Joe Siprut: I think the partnership has been great. In particular, the pairing of AIR’s offering with some of Kerberos’s traditional vehicles has given investors some great options. For example, Kerberos manages closed-end vehicles which can be appropriate or desirable for certain types of investors. Others, on the other hand, place a premium on liquidity flexibility.
And so, the way that AIR’s fund is structured certainly provides wonderful options on all those points. I think ultimately, that's what the partnership is all about. Coming together and creating something that has even more value for our stakeholders and investors.
Andrea Hoch: Looking ahead, what's your outlook on the future for law firm lending and litigation finance? Are there any particular trends or growth potential that you're excited about?
Joe Siprut: Yeah, I think it's an exciting time to be doing what we do because the caliber of the counterparties keeps getting better and better. When this asset class started, law firms began to slowly take on litigation financing as an addition to their business model. But we've now reached a point where there are new law firms that are being launched with litigation finance in their DNA. The very business model of the firm itself relies on the use of litigation financing to scale. That's a really interesting development and it's led to some new and interesting structural opportunities for us. Ultimately, it's just the pursuit of great risk-adjusted returns but having more tools in the toolbox allows us to execute even better.
Andrea Hoch: As we conclude, I like to remind our viewers that investing through AIR Asset Management can allow for enhanced liquidity options while accessing innovative strategies like law firm lending. To learn more, please reach out to us at info at airassetmanagement.com. Joe, Thank you for a great discussion.
Joe Siprut: You're welcome. Thanks for having me.