Risk Models Behind World’s Best Hedge Fund Strategy Are Getting a Lot Harder to Crack

As the best-performing hedge fund strategy of 2023 draws growing interest from mainstream investors, the risk models it depends on are becoming more difficult to examine, according to a Bloomberg exclusive published February 25, 2024 and updated February 26, 2024. The strategy is tied to insurance-linked securities, a market dominated by catastrophe bonds, commonly known as cat bonds. In 2023, no other asset class produced a better-performing bet for hedge funds, and firms including Fermat Capital Management and Tenax Capital posted their largest returns in their histories.

The article frames the rising profile of the strategy as a source of tension. Cat bonds transfer catastrophe risk from insurers and reinsurers to capital market investors, and their pricing relies on modeling of the probability and severity of events such as hurricanes and earthquakes. As more mainstream capital enters the space, the opacity of those underlying models presents a growing challenge for investors seeking to assess the risk they are taking on.

The primary source is limited in length, so this summary reflects its core findings. Readers seeking the full analysis of model risk and fund-level performance data should consult the original Bloomberg report.