When exploring the realm of alternative investments, many Canadians instinctively gravitate towards familiar territories: precious metals, commodity futures, liquid alternative funds, and covered call ETFs, to name a few.
Yet, as the global economic landscape evolves and environmental concerns rise to the forefront, there emerges a novel opportunity for sustainability-conscious investors - carbon credits. But what exactly are carbon credits and how does one invest in them?
Here's all you need to know about this burgeoning asset class, plus an ETF to put it into play.
A brief intro to carbon credits
To put it simply, a carbon credit is a permit or certificate that grants the holder the right to emit one tonne of carbon dioxide or an equivalent amount of a different greenhouse gas (GHG).
Conceptually, carbon credits were created as an economic tool aimed at reducing the overall emissions of harmful gases into the atmosphere. By placing a tangible value on the 'right to pollute,' carbon credits aim to incentivize organizations to limit their emissions and engage in eco-friendly practices.
How does this work? Well, broadly speaking, a governing body decides the total amount of emissions allowed in an area, called a "cap-and-trade" system. This total limit is then divided into smaller credits.
Companies can get these credits either directly from the governing body, buy them from others, or earn them by cutting down their emissions.
Each year, businesses have to show they have enough credits to match their emissions or they face big fines. Over time, the governing body offers fewer credits, pushing companies to pollute less.
But what influences the price of the carbon credit market? Well, like the equity markets, there are numerous factors at play, including:
- Regulatory Frameworks: As governments around the world implement stricter environmental policies, the demand for carbon credits rises, pushing prices up.
- Economic Activity: An upsurge in industrial activities generally leads to higher emissions, increasing the demand for credits.
- Technological Advancements: The development and adoption of clean technologies can reduce the demand for credits, potentially lowering prices.
- Market Sentiment: Like other markets, speculation and investor sentiment can sway carbon credit prices. News related to climate change, for example, can impact investor behavior.
It's important to note that carbon credits are commodities. They can be traded between market participants in a variety of ways. For instance, there are established carbon exchanges and trading platforms where credits are bought and sold, much like stocks in financial markets.
Firms can buy credits directly from eco-friendly projects or initiatives that generate these credits. Specialized brokers assist companies in purchasing carbon credits, ensuring they get the best deals and comply with all regulatory requirements.
Finally, like most commodities, carbon credits have an active derivatives market. Enter carbon credit futures, which are financial instruments that allow individuals or institutions to buy or sell carbon credits at a predetermined price to be delivered at a specified future date.
Essentially, they are standardized contracts that facilitate the trading of carbon credits at future prices, much like existing energy and agricultural futures contracts. They offer companies a tool to manage the price risk associated with their environmental obligations and also provide a mechanism for price discovery.
How to invest in carbon credits
Investing in the intricate world of carbon credits can be a daunting venture for retail investors. Fortunately, there's a more accessible approach via a Cboe listed ETF that professionally manages these intricate investments on your behalf.
The Ninepoint Carbon Credits ETF (CBON) is the ETF share class version of the first carbon credit mutual fund launched in Canada. CBON primarily invests in futures linked to global carbon emissions allowances, covering the following geographies:
- European Union ETS (EUA): Represents 40% of the European Union's total emissions.
- California/Quebec (CCA): Accounts for 75% of their combined total emissions.
- US Eastern States (RGGI): Makes up 10% of the Eastern US total emissions.
- United Kingdom (UKA): Constitutes 31% of the UK's total emissions.
According to Ninepoint, investing in CBON could provide both diversification and growth potential. The former stems from the low or even negative correlation of carbon credits with traditional investments like stocks or bonds. The latter cites the US$851 billion carbon credits market, which has grown by 18 times since 2017.
As an alternative commodities ETF, CBON's portfolio is primarily held in US Treasury bills, which are used as collateral for a variety of carbon credit futures contracts spread out more or less equally over the aforementioned markets. The ETF charges a 0.75% management fee.
This content was originally published by our partners at the Canadian ETF Marketplace.