As advisors look for ways to diversify client portfolios, carbon ETFs may be a solution.
Carbon ETFs provide potential portfolio diversification due to the global carbon futures markets’ historically low correlation to other asset classes. Changing market dynamics and the start of a new year makes right now an ideal time to evaluate portfolio allocations and make necessary changes.
It’s important to make sure portfolios are diversified at large, but it’s also important to make sure each sleeve is well-diversified in itself.
While many investors may currently have exposure to either European Union Allowances (EUAs) or California Carbon Allowances (CCAs), balanced exposure to both can offer better risk/return fundamentals.
Exposure to both CCAs and EUAs delivers superior risk/reward ratios versus concentrated regions while offering an attractive level of returns, according to Oktay Kurbanov, partner at Climate Finance Partners.
Why Pair Carbon ETFs Together?
EUAs have generated strong returns in recent years as prices more than tripled between 2019 and 2022. However, EUAs come with much higher volatility risk than CCAs, which have seen more modest returns.
EUAs realized three times higher volatility of 43% compared to CCAs, with a worst 12-month return of -47%, during the period (November 2016), according to Kurbanov. In comparison, CCAs saw more tolerable volatility of 14%, with a worst 12-month return of -19% (November 2022).
The KraneShares European Carbon Allowance Strategy ETF (KEUA ) offers exposure to the EUAs program. The program is the world’s oldest and most liquid carbon allowance market.
Meanwhile, the KraneShares California Carbon Allowance ETF (KCCA ) offers targeted exposure to the CCA scap-and-trade carbon allowance program.
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