Carbon Credits Etf: A Smart Investment Strategy

Carbon credits, or permissions for companies to emit carbon and other greenhouse gases, have been one of the best-performing commodities in recent years. As environmental concerns and regulations tighten, the market for carbon credits is growing, and investors are taking note. One way to invest in this market is through carbon credit exchange-traded funds (ETFs), which allow investors to bet on carbon prices while supporting action against climate change. This introduction will explore the basics of carbon credits, the emergence of carbon credit ETFs, and the potential risks and rewards of investing in this unique market.

KraneShares Global Carbon Strategy ETF (KRBN)

KRBN was developed with the help of the environmental finance boutique Climate Finance Partners. The fund offers portfolio diversification benefits because carbon futures (contracts linked to the value of emission allowances) have historically had low correlations with other asset classes like stocks or bonds. As of February 2022, around two-thirds of the ETF is invested in European Union Allowance (EUA) futures, followed by California Carbon Allowances (CCA), the Regional Greenhouse Gas Initiative (RGGI), and United Kingdom Allowances (UKA).

The ETF's backers say that investors can bet on carbon prices while supporting action against climate change. The fund is benchmarked to the S&P Global Carbon Credit Index, which offers broad coverage of cap-and-trade carbon allowances by tracking the most traded carbon credit futures contracts. Cap-and-trade programs, also known as Emissions Trading Systems (ETS), are a market-based approach to regulating a region's emissions, with mandatory participation for specified industries.

KRBN investors will benefit from increasing carbon emissions prices. The fund is designed to benefit from long-term price appreciation due to the markets' increasing supply scarcity and has a low correlation to other major asset classes.

KraneShares California Carbon Allowance Strategy ETF (KCCA)

The CCA cap-and-trade program was implemented in 2012 by the California Air Resources Board (CARB) and covers approximately 80% of the state's greenhouse gas (GHG) emissions. The program was expanded to cover Quebec in 2014. The program aims to reduce carbon levels to 60% of 1990 levels by 2030 and achieve carbon neutrality by 2045, with a 4% reduction in the cap each year to meet this objective.

California carbon allowances are among the fastest-growing, strongest-performing, and most diversifying asset classes. In 2021, CCA carbon allowance futures traded around $1.5 billion per month. KCCA provides a potential hedge against inflation through a price floor that is pegged to inflation rates, i.e., the price floor rises 5% plus the Consumer Price Index (CPI).

KCCA can be paired with other KraneShares carbon funds, allowing investors to customize their allocation to the global carbon credit market. KCCA provides 100% exposure to CCA futures, and investors can benefit from the fund's potential diversification benefits due to the historically low correlation with traditional asset classes.

KraneShares European Carbon Allowance Strategy ETF (KEUA)

KraneShares is a specialist in Chinese ETFs and offers innovative investment solutions tailored to three key pillars: China, Climate, and Alternatives. The KraneShares European Carbon Allowance Strategy ETF (KEUA) is benchmarked to the S&P Carbon Credit EUA Index (previously the IHS Markit Carbon EUA Index), which tracks the most traded European Union Allowances (EUA) futures contracts. KEUA is part of the KraneShares suite of carbon ETFs, which also includes the KraneShares Global Carbon Strategy ETF (KRBN) and the KraneShares California Carbon Allowance Strategy ETF (KCCA).

The EUA cap-and-trade program is the world's oldest and most liquid carbon allowance market, covering approximately 40% of the EU's total emissions from 27 EU Member States, as well as Iceland, Liechtenstein, and Norway. The program targets a reduction in emissions by at least 55% of 1990 levels by 2030 and climate neutrality by 2050. The "Fit for 55" package released in 2021 proposed an expansion and tightening of the program, including an increased cap reduction from 2.2% to 4.2% per year.

EUA carbon allowances are among the fastest-growing, strongest-performing, and most diversifying asset classes. In 2021, EU carbon allowance futures traded around $30 billion per month, and they can provide potential portfolio diversification due to their historically low correlation with traditional asset classes. KEUA seeks to provide a total return that tracks the performance of the S&P Carbon Credit EUA Index (previously the IHS Markit Carbon EUA Index), which includes only carbon credit futures that mature in December of the next one to two years. The fund will generally seek to obtain exposure to the same carbon credit futures that are in the index and will invest at least 80% of its net assets in instruments that provide exposure to European carbon allowances.

The KEUA ETF was launched on October 5, 2021, and has a net expense ratio of 0.79% ($79 annually on a $10,000 investment). It had already attracted $35 million in assets as of February 2022. KEUA can be purchased through brokers.

iPath Series B Carbon ETN (GRN)

The iPath Series B Carbon ETN (GRN) is an exchange-traded note (ETN) that offers exposure to carbon credits, specifically targeting the EU Emission Trading Scheme and the Kyoto Protocol's Clean Development Mechanism. ETNs are structured differently from ETFs—while ETFs are exchange-traded funds that buy and hold securities, ETNs are promissory notes issued by banks that promise to pay the return of an index. In the case of GRN, the index it tracks is the Barclays Global Carbon II TR USD Index, which provides exposure to the price of carbon emissions credits from two of the world's major emissions-related mechanisms.

GRN was launched in 2019 and has delivered strong performance, with returns of over 164% in 2021. It is important to note that GRN does not own the underlying assets it tracks, unlike ETFs. Instead, the ETN's issuer, Barclays, promises to pay the return of the index. This means that while GRN can perfectly match the index's returns, it carries the credit risk of the issuer. As a result, if Barclays were to go bankrupt, investors may not get their money back.

GRN is a unique product in the carbon credit space, but it is worth noting that there are alternative investment options available, such as ETFs, which may be preferred by some investors due to their structure and the ownership of the underlying assets.

SparkChange Physical Carbon EUA ETC (CO2)

Each EUA acts as a permit for companies to pollute one tonne of carbon dioxide. The EU Commission issues fewer of these annually to decrease emissions, creating the potential for upward price pressure and driving scarcity value.

SparkChange CO2 is backed by physical EUAs and tracks the price of EUAs (excluding fees). Each CO2 is physically backed by one EUA, adjusted for accumulated management fees since its launch. The carbon EUAs held within the ETC cannot be used by polluters, ensuring a direct environmental impact.

The value of the ETC is affected by movements in the price of the underlying EUAs. The abandonment, termination, or non-renewal upon expiration of a trading scheme may cause the price of EUAs to fall (potentially to zero). Investors' capital is at risk, and investors may not get back the amount originally invested.

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