Hedge Fund Strategy Built on Catastrophes Taps a Hot New Trend

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(Bloomberg) — One of the most successful hedge fund strategies of recent years — insurance-linked securities — is latching on to an old idea whose popularity is suddenly soaring.

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Parametric insurance, where policyholders get quick payouts if weather-related metrics are met, used to be the preserve of small businesses and farmers in developing countries. Now, it’s a rapidly growing market luring large corporations across the rich world. 

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Sebastien Piguet, co-founder and chief insurance officer at Descartes Underwriting, says parametric models are filling a gap left by other types of insurance policies. That’s as climate change and more frequent extreme weather events challenge standard coverage models.

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“It’s much more challenging to find capacity for this kind of coverage with traditional insurance,” he said.

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Companies using parametrics now include French pharmaceutical firm Sanofi SA, telecommunications company Liberty Latin America, and renewable energy investor Greenbacker Capital Management. The market for such products is estimated to almost double to $34 billion in the decade through 2033.

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It’s a shift that’s caught the attention of ILS investment managers. Insurance-linked securities, which a Preqin ranking listed as the best-performing hedge fund strategy of 2023, have long focused on catastrophe bonds. Typically issued by insurers and reinsurers, investors in the bonds make money if predefined triggers like wind speed or insured losses aren’t met, and lose money if they are.

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In recent years, that model has generated market-beating returns.

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Investment funds based on parametric insurance have the potential to beat cat bond returns, according to Rhodri Morris, a portfolio manager at Twelve Securis. The Zurich-based $8.6 billion alternative investment manager, which specializes in catastrophe bonds, launched the Lumyna-Twelve Capital Parametric ILS Fund together with Lumyna Investments in February. 

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“We aim to return a couple of percentage points above the cat bond market,” Morris said in an interview. 

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The fund, which is the first of its kind, has so far attracted about €85 million ($99 million) of capital. Morris says the expectation is that it will draw as much as €200 million next year.

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A key attraction for investors is they can avoid so-called trapped capital, according to Morris. Investors in cat bonds sometimes wait for months — or even years — before loss rates are assessed and payouts settled. Investors in a parametric fund will generally know within days whether an underlying insurance contract has paid out or not.

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The Lumyna-Twelve parametric fund has drawn “genuine interest” from investors, Morris said. But they’ve also had questions, and there’s a number of important factors to consider, he said.