𝗖𝗮𝗿𝗯𝗼𝗻 𝗖𝗿𝗲𝗱𝗶𝘁𝘀: 𝗔𝗻 𝗘𝗺𝗲𝗿𝗴𝗶𝗻𝗴 𝗜𝗻𝘃𝗲𝘀𝘁𝗺𝗲𝗻𝘁 𝗢𝗽𝗽𝗼𝗿𝘁𝘂𝗻𝗶𝘁𝘆
As climate change issues take center stage, carbon credits have emerged as a unique investment product. These credits act as a type of permit that allows the holder to emit a certain amount of CO2. The most noteworthy is the European Emission Allowances (EUA), but the market's growing interest in the $KRBN ETF is also worth mentioning, making it an attractive addition to risk parity portfolios.
A carbon credit represents the right to emit one tonne of carbon dioxide and functions as a key tool in the fight against global warming. Governments and international bodies issue these credits, creating a carbon market. Entities exceeding their emission allowances can buy credits from those who pollute less, incentivizing emission reductions.
𝗧𝗵𝗲 𝗥𝗶𝘀𝗶𝗻𝗴 𝗗𝗲𝗺𝗮𝗻𝗱
As governments tighten regulations to meet their Paris Agreement commitments, the demand for carbon credits is set to increase, which will likely increase the demand and price of EUAs.
The European Union has been at the forefront of addressing climate change, with emissions trading as a key policy tool. The EU Emissions Trading System (EU ETS), the world's first and largest international emissions trading system, has positioned the EU as a major player in the carbon credits market.
As part of its ambitious European Green Deal, the EU has pledged to become climate-neutral by 2050. To achieve this, the bloc has proposed an interim target of reducing greenhouse gas emissions by at least 55% by 2030 compared to 1990 levels. This ambitious target could significantly ramp up demand for carbon credits within the EU.
Moreover, the EU's "Fit for 55" package, aimed at aligning EU policies with the 2030 climate target, includes plans to expand the scope of the EU ETS. Sectors such as maritime, road transport, and buildings could soon come under its ambit. This expansion will likely lead to an increased need for carbon credits, as more sectors will have to comply with emissions limits.
In addition, the proposed Carbon Border Adjustment Mechanism (CBAM) is another factor that could spur demand. The CBAM requires importers of certain goods to buy carbon credits equivalent to the carbon emissions produced in the manufacturing of those goods. This mechanism is designed to prevent 'carbon leakage' — when companies transfer production to countries with less stringent emissions regulations.
The combination of these three factors paints a picture of growing demand for carbon credits in the EU. This trend, coupled with increased emission consciousness among businesses and individuals across the bloc, could drive the price of carbon credits higher, presenting a compelling investment opportunity.
𝗧𝗵𝗲 𝗜𝗻𝘃𝗲𝘀𝘁𝗺𝗲𝗻𝘁 𝗖𝗮𝘀𝗲 𝗪𝗶𝘁𝗵 𝗔 𝗥𝗶𝘀𝗸 𝗣𝗮𝗿𝗶𝘁𝘆 𝗟𝗲𝗻𝘀
The KraneShares Global Carbon ETF ($KRBN) provides exposure to the carbon credits market. It gives investors access to the world's three main carbon allowances markets: the EU, California, and the Regional Greenhouse Gas Initiative.
In the context of a risk parity strategy, where we aim to achieve portfolio balance by allocating risk, rather than capital, carbon credits present a compelling opportunity.
The beauty of carbon credits lies in their low correlation with traditional asset classes like equities, bonds, or commodities. This unique characteristic enables them to act as an effective diversifier. In volatile market conditions, carbon credits can provide a stabilizing force, potentially reducing portfolio drawdowns.
This is particularly essential in a risk parity approach. By including carbon credits in the mix, the portfolio's overall risk profile can be better managed. The innate volatility of traditional asset classes can be counterbalanced by the relatively stable and predictable behaviour of carbon credits. As a result, even during periods of market stress, the portfolio can maintain a balanced risk profile.
Further, the regulatory and societal shifts toward a low carbon economy are likely to fuel demand for carbon credits. As the 'polluter pays' principle takes hold and as stricter emissions targets come into play, the price of carbon credits could see a significant uptick. This scenario provides an attractive risk-return trade-off, a key component of any risk parity strategy.
𝗖𝗼𝗻𝗰𝗹𝘂𝘀𝗶𝗼𝗻
In conclusion, in a risk parity strategy, carbon credits can provide much-needed balance and stability, while also offering the potential for attractive returns from the positively skewed future demand profile.
Carbon credits offer a unique investment opportunity. Their lack of correlation with traditional asset classes makes them a valuable addition to a diversified portfolio, such as the All Seasons Portfolio. Their demand is likely to rise due to regulatory and societal pressure, making them a compelling investment for the years to come.
Sincerely
Nicholas / All Seasons Portfolio... Show More
