2023-03-06 00:30:47 ET
Summary
- The KRBN ETF offers investors exposure to carbon credit futures.
- Carbon credits is a fast-growing market that may act as a portfolio diversifier and portfolio hedge.
- Historical returns have been good for KRBN as governments across the world attempt to put a price on carbon pollution.
Fund Overview
The KraneShares Global Carbon Strategy ETF (KRBN) provides investors with exposure to carbon credits. The KRBN ETF is benchmarked to IHS Markit’s Global Carbon Index ("Index"), an index which tracks the most traded carbon credit futures contracts across the major European and North American cap-and-trade programs: European Union Allowances ("EUA"), California Carbon Allowances ("CCA"), the Regional Greenhouse Gas Initiative ("RGGI"), and the United Kingdom Allowances ("UKA").
The KRBN ETF has $659 million in assets and charges a 0.78% expense ratio.
Why Carbon Credits
There are multiple reasons why investors may wish to invest in carbon credits. First, carbon credits is a novel and fast growing market that can be suitable for investors seeking alternative investments. According to IHS Markit, a market research firm, the four largest global carbon futures markets (EUA, CCA, RGGI, and UKA) had a combined trading volume of $684 billion in 2021, with 165% annual growth rate in trading volume (Figure 1).
Transactions in the carbon credits market is typically reserved for regulated entities so KBRN is one of the few ways investors can access this rapidly growing market.
Another reason investors may be interested in the KRBN ETF is because carbon credits has historically exhibited low correlations to other asset classes such as equities and bonds (Figure 2).
Therefore, a portfolio allocation to carbon credits may act as a portfolio diversifier and enhance the overall portfolio risk/return profile.
Thirdly, going long the price of carbon may incentivize pollution reduction and support responsible investing. This is because a higher carbon price will incentivize businesses to invest in emission reduction technologies so they can sell the excess carbon credits for a potential profit. On the other hand, higher carbon credit prices will penalize heavily polluting companies, pushing them to reduce their emissions to avoid the high cost of carbon credits (Figure 3).
Finally, for investors who have exposure to companies that may be negatively affected by carbon credit programs (i.e. heavy industrial companies), investing in carbon credits can act as a portfolio hedge.
Portfolio Holdings
Figure 4 shows the current holdings of the KRBN ETF. It has 60% exposure to EUA futures, 26% exposure to CCA futures, 5% exposure to UKA futures, and 4% exposure to RGGI futures.
KRBN Will Suffer From Some Futures Decay
Investors interested in the KRBN ETF should note carbon credit future curves are generally in contango , with future contracts further out in time trading at higher prices (Figure 5).
For an investment fund that holds these futures, what this means is that there is a natural futures roll decay, i.e., the KRBN ETF holds the 2023 EUA futures, and as that future nears maturity, KRBN must sell the expiring future and 'roll' onto the more expensive 2024 future. For some short-term futures-based funds like the United States Natural Gas ETF ( UNG ), futures roll decay can be very significant.
Returns
Figure 6 shows KRBN's historical returns. The KRBN ETF does not have a long operating history since its inception date was July 2020. However, the fund did have a very strong return in 2021, returning 108.8%. However, 2022 was a negative year, as the KRBN ETF returned -10.5%.
Distribution & Yield
The KRBN ETF does not pay a periodic distribution (since it is futures-based). However, it does pay out realized gains on an annual basis. In 2022, the ETF distributed $8.36 / share or a 21.2% trailing yield (Figure 7).
KRBN As A Portfolio Diversifier
As mentioned above, there are many reasons why one may want to invest in carbon credits. For me personally, I like the uncorrelated aspect of the asset class.
Using KRBN as a portfolio diversifier, we can see that KRBN has low monthly correlations relative to equities as modeled by the SPDR S&P 500 Trust ETF ( SPY ) and the iShares 20+ Year Treasury Bond ETF ( TLT ) in the period August 2020 to January 2023 (Figure 8).
A 10% allocation in KRBN vs. a traditional 60/40 Equity/Bond portfolio may significantly enhance portfolio returns (Figure 9).
In figure 10 below, Portfolio 1 has a 10% allocation to KRBN, 54% allocation to SPY, and 36% allocation to TLT. Portfolio 2 is 60% SPY and 40% TLT. In the analysis time period (August 2020 to January 2023), Portfolio 1 had a much higher CAGR return of 4.6% vs. 0.2% for Portfolio 2, while portfolio volatilities were comparable. This leads to far higher Sharpe Ratios for Portfolio 1.
However, investors should note that with limited operating history, this analysis may be biased in favour of KRBN's strong 2021 performance.
Conclusion
In conclusion, I think the KraneShares Global Carbon Strategy ETF is an interesting portfolio diversifier that investors should consider. Investing in the fast growing carbon credits market may offer investors an asset class with low correlations to existing asset classes like equities and bonds while serving a social good. It can also help investors hedge their portfolios against the rising price of carbon that governments across the world are rapidly trying to reduce.
For further details see:
KRBN: Carbon Credits As A Portfolio Diversifier