Can Asset Management Disrupt Itself? | Chief Investment Officer

For all the talk of new entrants to asset management, real disruption in the sector is set to come from within, according to Fitch Ratings.

Several reports this year have highlighted the need for asset managers to adapt to survive—but Fitch Ratings Analysts Manuel Arrive and Alastair Sewell argued many firms had already made significant changes to their business models.

Groups have variously begun to adopt data and new technologies as “strategic assets,” the authors said, in response to competitive and regulatory pressures as well as a potential “inflection point” for industry asset growth in 2016. Such tools “have the potential to provide new sources of alpha and asset raising,” they added.

“Asset managers that shifted early their business positioning in anticipation of the next investment cycle or emergence of long-term, sustainable growth areas have developed a key competitive advantage,” Arrive and Sewell wrote.

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The report also highlighted the importance of “client-centric” and “outcome-oriented” approaches. Segregated mandates “should continue to be recipients of sustained inflows,” the authors said.

“Long-term institutional investors are moving down the liquidity spectrum, increasing allocations to real assets,” they added. “Private-market exposures [will] gain in popularity, as the benefits of incremental yield and diversification outweigh the obstacles of low accessibility, illiquidity, and regulatory restrictions.”

In addition, the authors reported that active managers have begun to “fight back” against performance and competition pressures. Despite room for passive strategies and products to further grow their market share, the Fitch analysts claimed a recent improvement in performance from active managers could help make the case for this under-fire section of the industry.

“Lower systematic returns, higher idiosyncratic risk, and global desynchronization may support active management performance, which has improved over the past 12 months,” Arrive and Sewell wrote. “Asset managers have been encouraged to demonstrate their active management skills, as European regulators and groups of investors increase scrutiny on value for money.”

Strategic initiatives in 2016

In May, PayPal Co-Founder and venture capitalist Peter Thiel revealed he has financed wrestler Hulk Hogan lawsuit against Gawker.

Hogan, who sued Gawker for invasion of privacy after the media firm posted a sex tape of him and a friend’s wife, was awarded $140 million. Thiel had bankrolled $10 million for the lawsuit, The New York Times reported.

“Even someone like [Hulk Hogan] who is a millionaire and famous and a successful person didn’t quite have the resources to do this alone,” Thiel told the newspaper.

This practice of third-party investors backing plaintiffs for a portion of the damages—litigation financing—is becoming a trend, even creating a dedicated market, according to Cornell Law School’s David Russell.

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Previously, financing firms offered capital to law firms to pursue expensive litigations that would result in high damages. Now, Russell argued in a paper, there are firms dedicating their entire assets under management to litigation financing, even going public on the London Stock Exchange.

“Let’s say you invest in a bunch of different lawsuits in a multitude of claim types… [creating] a diversified portfolio of lawsuits,” the paper said. “You’ve protected yourself from the risk of any one lawsuit failing and you’ve protected yourself from any statutory or jurisprudential changes that may affect one of your lawsuits in a particular area of law.”

After diversifying the portfolio by claim or fact types, financing firms should also capitalize on the “macro factors to produce a high return on the portfolio,” Russell said.

For example, financing firms should strongly consider the location of the lawsuit. If the venue can negatively impact the plaintiff’s chances of winning the suit, the investor can finance other cases in which plaintiffs have been already assigned to favorable locations—thereby decreasing risk.

Despite growth and sophistication in the legal market, litigation finance is not yet securitized for a number of reasons, Russell said.

There exists a problem of scale in creating lawsuit-backed securities (LBS), the paper continued, with only a few hundred lawsuits currently ongoing in the market.

Furthermore, financing firms—especially ones with high-profile litigations and equally high payoff—are not likely to transfer their interest to issuers to create LBSs.

It would also be nearly impossible to accurately rate LBSs due to their opacity and lack of information about the individual lawsuits.

“A layperson cannot simply read a lawsuit and divine its probability of prevailing let alone its possible value in damages,” Russell concluded. “Thus, ratings agencies may resist giving their imprimatur, via a credit rating, on a security that they clearly do not fully understand.”

Read the full paper “Litigation Financing and the Birth of a Legal Market”.