The Road Less Traveled: Off-The-Beaten-Path Private Assets

Differentiating Portfolios With Litigation Finance, Asset-Based Lending And Infrastructure Investment

Caught in the crossfire of escalating geopolitical tensions, inflation, elevated interest rates and lingering pandemic-induced challenges, traditional equity-bond portfolios are leaving investors wanting more. This financial tumult has driven a pivot toward alternative investments among advisors and their clients. According to data from Preqin, this is not a fleeting phase – assets under management in private market investments are predicted to skyrocket from $13.3 trillion in 2021 to a staggering $23.2 trillion by the end of 2026.

If this prediction holds, we are poised to witness a race among advisors to unearth less-correlated assets for portfolio diversification and to better cater to their high net worth (HNW) and ultra-high net worth (UHNW) clients. However, finding truly differentiated opportunities in private markets may become more difficult as demand grows. As such, advisors may need to venture off the beaten path to find opportunities more insulated from the major economic drivers influencing stocks and bonds.

We explore three niche private investments that advisors can use to diversify client portfolios and potentially decrease portfolio risk, all while distinguishing their practices from the competition.

Litigation Finance

The litigation finance opportunity stems from the disconnect between the institutional capital raised for financing litigation and the legal fees actually incurred. Traditional banks have been slow to adapt and provide support for underwriting legal cases, while many plaintiff law firms have limited credit options. Furthermore, investment returns in litigation finance are determined by case outcomes, which are entirely independent of macroeconomic factors.

Litigation finance takes two main forms – providing funding for lawsuits in exchange for a share of any potential profits, or via direct investment in law firms. The former treats a strong legal claim as an asset with potential revenue, with the investment risk tied to the outcome of individual cases. Cases can vary and may include mass torts, class actions, personal injury, antitrust, appellate financing or even intellectual property. The latter involves evaluating a firm’s docket of cases, with guarantees from partners serving as investment collateral.

Asset-Based Lending

Asset-based lending (ABL) is an intriguing asset class with attributes that weaken its correlation to the broader market, because the returns are often independent of borrower performance, tied to specific assets rather than cash flows. And during market downturns, ABL loans typically offer multiple avenues for full loan recovery, further mitigating risks associated with the strategy – though, of course, the risk of investment loss remains.

ABL involves providing a loan or credit facility to a borrower based on the underlying value of specific assets. Unlike traditional lending, which focuses on a borrower’s creditworthiness and cash flows, ABL places greater emphasis on the collateral provided by the borrower, who pledges certain assets to secure the loan.

These assets can include accounts receivable, inventory, equipment, real estate or intellectual property, among other assets. The lender assesses the value of the collateral and offers a loan amount based on a percentage of that value, known as the borrowing base.

The current opportunity within ABL for private market investment primarily stems from ongoing market volatility, which means some borrowers face unforeseen challenges accessing credit. The ability to isolate and lend against high-quality assets presents ample opportunities. This is particularly true since standards have tightened among traditional sources amid the recent banking crisis, which has created strong demand for alternative financing options.

ABL can provide capital at comparatively attractive rates while still maintaining a relatively senior position in the event of financial distress, similar to “senior secured” private credit lending.

Infrastructure

Infrastructure as a private investment also provides exposure to “tangible” assets and has an attractive profile because of its ability to provide stable cash flows, less-correlated returns and a hedge against inflation.

Infrastructure investments involve funding or buying projects or assets related to the development, operation or maintenance of physical infrastructure. This includes transportation (roads, airports and ports); utilities (water, electricity and gas); social infrastructure (hospitals, schools and government buildings); communications (telecom networks); and energy (power generation and renewable energy projects).

Infrastructure strategies potentially offer returns from capital appreciation in addition to income generation. As an infrastructure asset develops and matures, its value may increase. For example, assets like airports or shipping ports can benefit from increased economic activity in their surrounding regions.

However, infrastructure investments are relatively uncorrelated to the broader economy due to the long-term nature of projects, which typically span multiple economic cycles, and their important social and economic function, which makes them less susceptible to downturns.

An Alternate Route

The loyalty of HNW and UHNW investors in wealth management relationships is not as strong as previously assumed. A growing number are reassessing their advisor partnerships, driven by a desire for more personalized experiences and access to a wider range of investments.

The expansion of private markets continues to give rise to specialized investment niches. Given the current economic climate, advisors may need to explore prudent portfolio diversification by incorporating unique strategies that exhibit lower correlations with traditional markets. By doing so, advisors can differentiate themselves in a crowded marketplace and demonstrate to HNW and UHNW investors their ability to navigate the rapidly evolving wealth management landscape.

Matthew Malone is Head of Investment Management at Opto Investments, a technology-driven solutions provider that helps independent RIAs access private market funds.