updated 8/31/2005 3:32:10 PM ET 2005-08-31T19:32:10

It's not like we needed another reason to resent hedge funds.

While Gulf Coast residents are just beginning to assess the catastrophic damage and coordinate relief efforts after Hurricane Katrina, there are already signs of one set of winners -- investors in an arcane security known as catastrophe bonds.

Holders of catastrophe bonds with exposure to Atlantic hurricane risks aren't likely to see any losses, according to Eqecat, a firm that measures losses for the insurance industry, and Standard & Poor's. That's because the bonds, which are held by hedge funds, pensions and other insurance companies, are structured in a way that makes hitting the triggers for a loss all but impossible to reach.

These bonds, which began arriving after Hurricane Andrew blew through in 1992, are issued by insurance companies, which take the premiums on property and casualty policies, bundle them, then sell the products to investors at attractive interest rates. Most hurricane-related bonds are weighted to exposures in Florida and Texas,with few Gulf Coast exposures. There are also bonds that include risk from earthquakes and other potentially catastrophic events (including terrorist attacks, in some instances).

The real risk to investors is in the bond triggers. A catastrophic event such as Hurricane Katrina could in theory set them off, which could cost investors the entire principal of the bonds they'd bought.

The bonds set thresholds for claims or use factors such as wind speed at landfall to set the triggers. So, a Category 4 or 5 hurricane making a direct hit on Miami would trigger a principle loss for investors. But since 1997, none of the 59 Cat bonds issued has hit its trigger, even those covering Florida hurricane damage last year, when four storms battered the peninsula in rapid succession.

This is what has attracted increasing numbers of multi-strategy hedge funds. And, in addition to the high interest rates that reflect the extra risk they are assuming, investors also get a security that generally isn't correlated to other market moves -- the ideal investment for hedge fund managers. Cat bonds have "held up through Long-Term Capital and 9/11 and the general slow down in capital markets," said Greg Hagood, a principal at Bermuda-based Nephila Capital. "The noncorrelation continued to hold pretty strong, and that's attracted people to the space."

Hurricane Katrina was a relatively weak Category 1 when it first crossed Florida and losses there were minimal.

"We have not placed any catastrophe bond ratings on credit watch," this week, says James Doona, a credit analyst at S&P.

Indeed, market watchers said the hurricane bonds didn't even trade on Monday, a sign that holders were comfortable with their investment. That the storm gathered strength in the Gulf over the weekend and hit the coast early on Monday could also have limited trading activity--there might have been more trading had the storm gathered strength and remained headed in an uncertain direction during trading hours.

"We did see bids and offers yesterday, but we didn't actually see any trades," said Hagood.

"We have investors who want to buy, but no one on the other end that wants to sell," said Judith Klugman, a managing director at Swiss Re Capital Markets, a unit of Swiss Re, which is both a major issuer of catastrophe bonds as well as a major market maker in the bonds.

As of the end of last year, more than $4 billion of catastrophe bonds were outstanding, and about $3 billion of that was held by specialty investment funds. Demand by investors outstripped the supply of the bonds, according to reinsurance broker Guy Carpenter, a unit of Marsh & McLennan. Total issuance last year was $1.14 billion, down from the record in 2003 of $1.73 billion but up from 2002's $1.22 billion.

Bonds specializing in North Atlantic hurricanes are especially popular. There were $608 million of them issued last year, according to Guy Carpenter.

Most Cat bonds are rated double- or single-B, says S&P, but they compare favorably to corporate bonds of the same rating. Typical double-B Cat bonds have rates five points above Libor, compared to three to four for corporate bonds. Single-B bonds can be 12 points above Libor. "That's pretty fat," says Doona from S&P.

Some hedge funds that buy cat bonds even helped capitalize start-up Bermuda reinsurance firms. Chicago-based Citadel Investment Group backed CIG Re Ltd., which had $450 million in capital when it was formed last fall. Soros Fund Management and other funds backed Glacier Re AG, with $301 million in capital.

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