While others were stockpiling water, flashlights, and board games in preparation for Hurricane Irene, the hedge fund Tudor Investment was crunching numbers.
Paul Tudor Jones’ investment firm employs a weather derivatives analyst.
Weather derivatives are fairly new, the first one traded in 1997 and the CME introduced the first exchange-traded weather futures contracts in 1999.
The main buyers aren’t hedge funds, they are insurance companies, farming conglomerates looking to insure against freezes and bad crops, electric companies, etc.
But because weather derivatives are non-correlated (the Euro crisis didn’t stop Irene) and provide a considerable amount of yield, investors in the space have grown recently to include direct investments from pension funds and hedge funds. Some hedge funds, like ~$2.5 billion Nephila Capital for example, specialize in reinsurance and weather risk.
You can go long-only in the weather derivatives space, which some liken to fixed income, or you can go long and short using weather derivatives. The types of weather derivatives you can buy vary from precipitation, rainfall and other “event” derivatives to heating and cooling products, which an electric company might use when measuring volumetric risk around how much product they might sell.
Before an event like Irene, a hedge fund like Tudor would build a position based on a prediction, which one of their analysts made about Irene on Friday.
Tudor’s weather derivatives analyst sent around a report on Friday afternoon that predicted the chances of a hurricane of disastrous proportions were 35%.
Chances that it will be less serious, costing the city a few billion dollars in damage, he said were 75%.
The worst case scenario the analyst predicted, according to a report seen by Business Insider, is a hurricane that costs the area it hits, which includes New York, $40 billion+ in damage. The power could be out for up to a week.
He compared it to the devastating hurricane that hit New York in 1821.
On Saturday he updated his prediction to say it looks like slightly less than what we expected. But “stay on guard.”
Tudor is currently up around 3% this month. We’ll have to wait to see if they made money on Irene.