Until recently, I only knew of the existence of cat(astrophe) bonds — financial instruments used to raise money for insurance against catastrophic events where investors profit when no disaster happens.
I had no idea, until reading this Bloomberg article about the success of Fermat Capital Management, how large the space had gotten ($45 billion!!) or how it was one of the most profitable hedge fund strategies of 2023!
This is becoming an increasingly important intersection between climate change and finance as insurance companies and property owners struggle with the rising risk of rising damage from extreme climate events. Given how young much of the science of evaluating these types of risks is, it’s no surprise that quantitative minds and modelers are able to profit here.
The entire piece reminded me of Richard Zeckhauser’s famous 2006 article Investing in the Unknown and Unknowable which covers how massive investment returns can be realized by tackling problems that seem too difficult for other investors to understand.
Investing in cat bonds was the most profitable hedge fund strategy of 2023. Fermat delivered a 20% return, beating the average 8% achieved by hedge funds as a whole. While other cat bond funds did well too, Fermat’s $10 billion portfolio — capturing a quarter of the market — made it by far the most prolific investor to take advantage of a bumper year.
Cat bonds investors are gambling on nature. If a disaster they’ve bet on occurs, their money is used to settle insurance claims. If it doesn’t, they get handsome returns. For decades, the instruments were a last resort reserved for super-rare events, such as a cataclysmic storm on the scale of Hurricane Katrina. But multibillion-dollar calamities have become alarmingly frequent on a warmer planet.
“The insurance market is on edge,” says Seo. “It’s freaked out about risk and wants as little as possible.”
How a Physics Whiz Made a Fortune Betting on Nature’s Catastrophes
Gautam Naik | Bloomberg
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