The calculus surrounding natural disasters, such as hurricanes and cyclones, fueled exceptional gains at funds managed by firms like Tenax Capital, Tangency Capital, and Fermat Capital Management. All three delivered results that exceeded double an industry benchmark, as per public filings, external estimates, and insiders.
Behind these record returns were daring investments in catastrophe bonds and other insurance-linked securities. These bonds are employed by the insurance industry to mitigate losses beyond their capacity. Investors, accepting the risk of potential capital loss, stand to gain outsized profits if the predefined catastrophe doesn’t occur.
In 2023, insurance-linked securities, particularly catastrophe bonds, emerged as the best hedge fund strategy, yielding over 14%, surpassing Preqin’s industry benchmark of 8%. The surge in cat bond issuance was driven by concerns about extreme weather events due to climate change and elevated reconstruction costs after natural disasters amid high inflation.
The turning point came in 2022 when Hurricane Ian struck Florida, causing significant uninsured losses. This prompted insurers to offload more risk to the capital markets, setting the stage for a resurgence in the cat bond market.
The cat bond market reached unprecedented heights in 2023, with issuances totaling $16.4 billion, bringing the outstanding market to a record $45 billion. Investors demanded higher returns to absorb the influx of newly-issued risk, and favorable conditions, including a mild US hurricane season, amplified returns.
While hedge fund interest in insurance-linked securities has grown, uncertainties persist, especially regarding secondary perils influenced by climate change. Karen Clark notes increasing market interest in severe convective storms, winter storms, and wildfires, areas where the cat bond market can expand.
Despite the impressive performance in 2023, caution prevails for 2024, with tightening spreads affecting returns. Tangency Capital suggests a potential return of 10% to 12% for the year, contingent on avoiding significant natural disasters triggering bond payment clauses. In a market characterized by historical highs in spreads, investors are perceived to be well-compensated for the associated risks.
