"Strongest El Nio in history" approaches; Pictet Asset Management: nowhere to hide for global assets as inflation shock collides with high debt

The prospect of the strongest El Nio cycle in history is prompting a growing number of money managers to race to prepare their portfolios for what they say will be an imminent shock. The climate phenomenon, which is linked to warming of the waters in the equatorial Pacific, is exacerbating 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. Katie Self, a portfolio manager at Pictet Asset Management, said no corner of the global asset market is completely immune to the current El Nio cycle. "It has almost become a completely certain judgment: this will be the most extreme El Nio 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 Nio. T. Rowe Price said it has turned to custom models to protect its $165 billion emerging market bond and equity portfolios from El Nio shocks. It was previously reported that, as El Nio intensifies, a number of boutique hedge funds are building complete investment theses around this weather cycle. A major concern is that El Nio will hit markets already under multiple pressures, including growing reliance on debt, rising interest rates and sudden investor sell-offs. Analysts Kamesh Korangi and Rose Choy of the Anthropocene Fixed Income Institute wrote in a report this week that compared with previous El Nio 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 sovereigns, and said "global spillover effects" are likely to be the ultimate outcome. Although El Nio is linked to the Pacific, investors need to understand that "its chain reactions are completely globalized," Self said. She and her team co-manage the $5.1 billion Pictet Global Environmental Opportunities Fund. "There is no place in the world that will not feel some kind of chain reaction from El Nio." Strategies for dealing with the coming shock include betting on interest rates linked to El Nio-driven inflation. The weather phenomenon's impact on energy markets is also becoming a key trade for the months ahead. "Winter is the season when these forcesclimate, geopolitics and structuralare most likely to converge intensively," Zulfiqar Ali, founder and chief investment officer of energy commodities trading hedge fund ZAMS Asset Management, said in an interview last month. This creates an "exceptionally rich alpha environment" for managers "with the analytical edge 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 Nio. Examples include smart irrigation equipment suppliers, solutions that help plant roots extend under drought conditions, and rainwater drainage and flood control systems. "El Nio 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 reinforce each other, making the situation significantly worse." The physical effects of El Nio are already making headlines. Southeast Asian countries have been dealing with extreme air pollution caused by forest fires, India has experienced its weakest monsoon in more than a decade, and people across South America are now facing severe floods and water shortages at the same time, upending their ability to farm. Self said the type of resilience or adaptation required is "very broad." "This is a truly comprehensive global phenomenon."