The prospect of the strongest El Nino cycle in history is driving a growing number of money managers to race to prepare their portfolios for what they describe as an imminent shock.
This climate phenomenon, linked to warming waters in the equatorial Pacific, is intensifying droughts and floods that destroy crops. Food commodity prices are rising, and economists are revising their forecasts for inflation and deficits. These effects are transmitting to markets already under pressure from high debt levels and rising borrowing costs.
Pictet Asset Management portfolio manager Katie Self said no corner of the global asset market is completely immune to the current El Nino cycle. "It has almost become a completely certain judgment: this will be the most extreme El Nino phenomenon in history," Self said in an interview, adding that figuring out how to deal with the disruptions ahead is now "absolutely" a priority.
Man Group, the world's largest listed hedge fund company, warned in July that everything from power grid infrastructure to metals and fertilizers could become targets of El Nino. T. Rowe Price said it has turned to custom models to protect its $165 billion emerging market bond and equity portfolios from El Nino shocks. Earlier reports said that as El Nino intensifies, several boutique hedge funds are building complete investment theses around this weather cycle.
A major concern is that El Nino will hit markets already under multiple pressures, including growing reliance on debt, rising interest rates and sudden investor sell-offs. Anthropocene Fixed Income Institute analysts Kamesh Korangi and Rose Choy wrote in a report this week that compared with previous El Nino phases, "the current macro backdrop is different," with "higher rates, higher debt and more volatility." The two identified Indonesia, Brazil and Colombia as the most vulnerable sovereign nations, and said "global spillover effects" are likely to be the ultimate outcome.
Although El Nino is associated with the Pacific, investors need to understand that "its ripple effects are completely globalized," Self said. She co-manages the $5.1 billion Pictet Global Environmental Opportunities Fund with her team. "There is no place in the world that will not feel some kind of ripple effect from El Nino."
Strategies to deal with the shocks ahead include betting on interest rates linked to El Nino-driven inflation. The weather phenomenon's impact on energy markets is also becoming a key trade for the coming months. "Winter is the season when these forces — climate, geopolitics and structural — are most likely to converge intensively," ZAMS Asset Management founder and chief investment officer Zulfiqar Ali said in an interview last month. This creates an "exceptionally rich alpha environment" for managers "with analytical advantages and risk discipline to navigate it."
At Pictet, Self said she and her team are looking for companies that design technologies to help cope with extreme weather patterns triggered by El Nino. Examples include smart irrigation equipment suppliers, solutions that help plant roots extend under drought conditions, and rainwater drainage and flood control systems. "El Nino is a compounding factor," Self said. The weather cycle itself is not new, but "it is now occurring on top of a warmer baseline." These two forces "will interact and influence each other, making the situation significantly worse."
The physical effects of El Nino have already made headlines. Southeast Asian countries have been dealing with extreme air pollution from forest fires, India experienced its weakest monsoon in more than a decade, and people across South America now face severe flooding and water shortages at the same time, upending their ability to farm.
Self said the type of resilience or adaptation needed is "very broad." "This is a truly comprehensive global phenomenon."
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