A growing number of money managers are racing to prepare their portfolios for the disruption they expect from what is shaping up as the strongest El Niño cycle ever recorded.

The climate phenomenon, which is tied to warming across the equatorial Pacific Ocean, is fanning droughts and floods that damage crops. El Niño is the warm phase of the El Niño–Southern Oscillation, a natural climate cycle that typically recurs every two to seven years. Food commodity prices are rising, and economists are revising their estimates for inflation and deficits. Those impacts are now feeding into markets already stressed by high debt levels and rising borrowing costs.

Katie Self, a portfolio manager at Pictet Asset Management, said no corner of global asset markets will be fully shielded from the current El Niño cycle.

“It’s become almost a full-on certainty that this is going to be the most extreme El Niño we’ve had in history,” Self said in an interview, adding that working out how to navigate the disruptions ahead is now “definitely” a priority.

The urgency extends across the industry. Man Group, the world’s largest publicly traded hedge fund firm, warned in July that everything from grid infrastructure to and fertilizer could be in El Niño’s crosshairs. T. Rowe Price says it has turned to custom-made models to protect its $165 billion portfolio of emerging-market debt and equities from the phenomenon. A number of boutique hedge funds are now building entire investment cases around the weather cycle as it intensifies, Bloomberg has previously reported.

A major concern is that El Niño will hit markets already struggling with growing debt reliance, rising interest rates and sudden investor selloffs.

“The current macro backdrop differs” from previous El Niño phases, “with higher rates, debt and volatility,” analysts Kamesh Korangi and Rose Choy wrote this week in a note from the Anthropocene Fixed Income Institute, a research group focused on climate-related risks in bond markets. The pair identified Indonesia, Brazil and Colombia as the most vulnerable sovereigns — large agricultural and commodity producers directly exposed to the droughts and floods the cycle fans — and highlighted the possibility of “spillover effects globally.”

Though El Niño originates in the Pacific, investors need to understand that “the knock-on effects are fully global,” said Self, who co-manages the $5.1 billion Pictet Global Environmental Opportunities fund.

“There is not a single place in the world that will not feel some kind of a knock-on effect from El Niño.”

Strategies to navigate the coming shocks include bets on interest rates tied to an El Niño-fueled bump in inflation — a link that runs through the food and energy components of the consumer price baskets central banks watch when setting policy — while the weather phenomenon’s impact on energy markets is emerging as a key trade for the months ahead.

The winter timing tracks the phenomenon’s usual arc: El Niño events historically build to peak strength in the Northern Hemisphere winter. “Winter is the season when these forces — climatic, geopolitical, and structural — are likely to converge most intensely,” Zulfiqar Ali, founder and chief investment officer of energy commodities trading hedge fund ZAMS Asset Management, said in an interview last month. That creates an “unusually alpha-rich 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 designing technologies that help cope with the extreme weather patterns fanned by El Niño. Examples include providers of smart-irrigation equipment, solutions that lengthen the roots of plants to help them endure drought conditions, and storm-water drainage and flood protection systems.

“El Niño is a compounding factor,” Self said. The weather cycle itself is not new, but “it’s now happening on this much warmer baseline.” Those two forces “are going to interact, interplay and make things substantially worse.”

The physical fallout is already dominating headlines. Southeast Asian countries have been battling extreme air pollution from forest fires, India faced its weakest monsoon in more than a decade, and communities across South America are contending with both severe floods and a lack of rain, upending their ability to farm. How those conditions evolve into the coming planting seasons will help shape harvest outlooks — and with them the inflation and deficit revisions economists are weighing.

For investors whose strategies are exposed to land, agriculture or forests in developing countries, the risks are particularly pronounced.

Jonathan Dean, who leads the natural capital strategy at BNP Paribas Asset Management’s alternatives unit — a strategy built around nature-based assets such as forests and land — said he is closely monitoring carbon-credit projects as El Niño fans forest fires such as those raging in Indonesia.

El Niño-triggered forest fire risk “has put the attention” on mal-adaptation of carbon credit projects, Dean said.

“It’s always been a fundamental part of our underwriting to understand the potential loss rates from a project, doing the climate research before to be able to identify risk factors within a project region,” he said.

The private equity strategy Dean oversees, which has more than $560 million in commitments from the International Finance Corporation and other development finance institutions, has been working with a project developer in Indonesia to “maximize the opportunity,” he said. Insurance and remote-sensing technologies are part of a package of tools fund managers can consider to help assess risks in nature-based projects, he added.

The types of resilience or adaptation needed “are very broad ranging,” Pictet’s Self said. “It’s a really full, global phenomenon.”

Bloomberg, via BusinessWorld. Original report: Money managers say there’s nowhere to hide as Super El Niño forms.