Hedge Funds Need to Be Wary of Push Into Catastrophe Risks: XL Group

McGavick joins Franklin Montross, the CEO of Berkshire Hathaway Inc.’s General Re, and Ace Ltd.’s Evan Greenberg in saying that new sources of capital may not appreciate how much can go wrong in weather-related bets, even with historical data that is used to model the chance of storms.

Catastrophe bonds, which provide primary carriers an alternative to reinsurance, offer above-market yields to investors who accept the risk that natural disasters could wipe out their principal.

“I’m not sure they do” understand all the risks of the business, McGavick, whose Dublin-based company sells insurance and reinsurance, said in a Bloomberg Television interview today. Managers of hedge funds and pensions “are saying, ‘We kind of trust these models and we’re willing to come in and take a bit of the risk.’ Of course, if you’ve been in the business, you’re going, ‘You know, these models aren’t that good.'”

Hedge fund managers like David Einhorn and Dan Loeb have established reinsurers, which give them access to more cash to invest. Loeb’s Third Point Reinsurance Ltd., based in Bermuda, has dropped 17 percent this year in New York trading. XL advanced 6.4 percent. Einhorn’s Greenlight Capital Re Ltd, based in the Cayman Islands, slipped 3.7 percent.

McGavick said hedge funds were pushed to find new opportunities by fixed-income yields that were near record lows.

“Consider their alternative investment scenario,” McGavick told Bloomberg Television’s Scarlet Fu, Brendan Greeley and Tom Keene. “What? One-percent bonds? They just don’t have the room to play anywhere else right now.”

See related article: Hedge Funds Move Into Catastrophe Reinsurance