Carbon Credits: The Newest Investment for the Environmentally Conscious Investor

Embracing Environmentally Friendly Investments with Carbon Credits

Increasing numbers of investors are embracing financial opportunities that reflect their values, with a focus on environmental sustainability. Among these new opportunities, carbon credits stand out. These are permits certifying that a specific amount of carbon emissions has been reduced – equivalent to one metric ton of carbon dioxide.

Carbon credits come under the umbrella of "cap-and-trade" schemes. The cap denotes the maximum allowable carbon emissions by a particular company, usually on a decreasing scale over time. The trade refers to the company's right to buy and sell carbon credits to adjust their permissible emission levels. While not as prevalent in the U.S. as elsewhere, a number of states are collaborating in regional initiatives to introduce such systems.

Companies can monetize their carbon emission reduction through carbon credits. Moreover, investors too can reap financial benefits from these credits. Continue reading to discover how you can invest in carbon credits and why you should consider it.

The Path to Carbon Credit Investments

In the U.S., carbon emission reduction programs are primarily voluntary, and absent in many states. Therefore, opportunities to invest in carbon credits are somewhat limited, though expected to expand in the future. Here are some ways to get started.

Carbon Credit ETFs

Exchange-traded funds (ETFs), as an aggregate investment vehicle, mirror the performance of a selection of underlying assets. A carbon-credit ETF follows the carbon market's fluctuations.

The KraneShares Global Carbon Strategy ETF (KRBN) is an example, anchored to the IHS Markit Global Carbon Index, tracking carbon-credit futures contracts (more on these later). Established in 2020, the fund witnessed a remarkable 154% rise in net asset value (NAV) by the end of 2021.

Similar offerings include the KraneShares European Carbon Allowance Strategy ETF (KEUA) and the KraneShares California Carbon Allowance Strategy ETF (KCCA).

Carbon Credit Futures

Investing in carbon credits can also be done through carbon-credit futures, a form of derivative where two parties agree to transact an underlying asset at a pre-agreed price on a specific future date. In this scenario, carbon credits serve as the underlying assets.

Note that futures contracts are considered an advanced trading strategy and potentially complex. They underpin the ETFs we discussed earlier, as these ETFs follow the performance of carbon-credit futures. However, for most individual investors, carbon-credit ETFs are more straightforward.

Investing in Companies Trading Carbon Credits

An indirect way to invest in carbon credits is by acquiring shares in companies dealing with them. Microsoft, aiming to be "carbon negative" by 2030, secured 1.3 million carbon offset credits for 2021. Shell also operates in the carbon credit industry, trading credits with other companies and using the revenue to support its environmental product portfolio.

Carbon Credits: What You Need To Know Before Investing

As with all investments, understanding what you're investing in is crucial. Carbon credits, being relatively new, have limited information available and fewer investment options.

On the upside, carbon credits are easily accessible through ETFs and can be added to any portfolio. However, understanding the associated risks with carbon credit investments is essential.

Carbon Credits: Understanding the Risks

Investing in carbon credits can be lucrative, but it's not without risks. Carbon-credit ETFs do not provide extensive market exposure like some other ETFs. For instance, the KraneShares Global Carbon Strategy ETF primarily covers companies in Europe, California, and parts of the eastern U.S.

Therefore, maintaining a well-diversified portfolio may necessitate investing in a broad range of assets beyond carbon-credit ETFs, futures, or related companies.

It's also worth noting that while ETFs aren't inherently risky, carbon-credit ETFs typically track benchmarks that monitor the performance of carbon-credit futures. These futures contracts are a type of derivative, considered volatile and speculative.

Weighing the Pros and Cons of Carbon Credit Investments

Delving into the world of carbon credit investments can be a roller coaster ride. Let's break it down, starting with the advantages, to give you a clearer perspective:

The Upside of Carbon Credit Investments

• Potential for Profitable Returns: When investing, the first thing that probably springs to your mind is profit. Carbon credits are no exception. Take, for example, the KraneShares Global Carbon Strategy ETF, which has more than doubled its value since its inception in mid-2020, posting a whopping 154% return by the close of 2021.

• Supporting the Environment: In addition to the financial benefits, carbon credits are a beacon of hope for the environment. They limit the volume of carbon emissions companies can release each year. Investors with a strong ethical and environmental conscience might see carbon credits as an opportunity to make their money work for the planet.

• Ease of Investment: Carbon credits are more accessible than they might initially seem. Thanks to carbon-credit ETFs, investors can tap into the market without having to sift through individual companies or juggle the complexities of carbon futures.

Despite these potential upsides, investing in carbon credits is not without its pitfalls:

The Downside of Carbon Credit Investments

• Risk Level: As is the case with any type of investment, risks lurk in the shadows. Carbon-credit ETFs monitor the movement of carbon futures, which can be extremely volatile. Also, given that carbon-credit investments are relatively recent, they don't offer a lot of historical data for analysis, making predictions about their performance a bit like shooting in the dark.

• Limited Diversification: ETFs are typically admired for their ability to diversify a portfolio. However, carbon-credit ETFs don't share this broad-scope advantage. Concentrating too much of your portfolio on carbon credits can tip the balance of your investment strategy and inadvertently increase your risk exposure.

• Environmental Impact Questions: Although carbon credits are designed to limit a company's carbon emissions, their actual impact on the environment is under scrutiny. Critics point out that the reach of such programs is limited in the U.S., as cap-and-trade programs only exist in a few regions. Moreover, rather than reducing their emissions, companies can opt to purchase additional carbon credits, raising doubts about the true environmental benefit.

How to Begin Your Carbon Credit Investment Journey

Direct investment in carbon credits by individuals isn't feasible. Instead, the easiest and most accessible method for retail investors is through carbon-credit ETFs.

Open a Trading Account

To begin trading ETFs and other securities, you must first open a brokerage account. You can trade carbon ETFs from an existing account or open a new one if you don’t already have one. Most popular investment apps also allow trading in these ETFs.

Decide on a Carbon Credit ETF

Once your brokerage account is ready, decide which ETF to purchase. Given the nascent stage of these ETFs, your choices are limited. Currently, funds are available for global, European, and California carbon futures.

Make Your Initial Purchase

Once you've decided which carbon-credit ETF to buy, you can proceed with your purchase. Log into your brokerage account, look for the ETF’s ticker symbol, and buy. Just like stocks, ETFs trade as shares on stock exchanges throughout the trading day, with purchases possible for as little as the price of a single share.

After Investing in Carbon Credits: What to Watch Out For

Having purchased your carbon-credit ETF share, observe its performance over time. Despite the price volatility of many carbon-credit ETFs, patient and strategic investing can prove rewarding. Be wary of impulsive decisions and understand the tax implications when selling your investment.

Is Investing in Carbon Credits Right for You?

Investing in carbon credits allows you to potentially profit while promoting environmental sustainability. But are carbon credits a suitable investment for you?

There are several factors to consider when investing in carbon credits. While carbon-credit ETFs are the most accessible, they come with their share of volatility, limited diversification, and unresolved questions regarding their environmental impact.

Despite positive returns since inception, carbon-credit ETFs may experience price fluctuations due to the volatile nature of futures contracts.

In deciding whether carbon-credit ETFs are the right fit, assess your portfolio and see how these investments complement it, ensuring portfolio diversification.

How can novices invest in carbon credits?

Investing in carbon credits is made easy through carbon ETFs such as the KraneShares Global Carbon Strategy ETF. Investors can open a brokerage account, search for this fund or another carbon-credit fund, and make their purchase.

Is a large investment necessary to start investing in carbon credits?

No, you can begin investing in carbon credits with a relatively modest amount. If you're investing in a carbon-credit ETF, you can start with just a single share.

What is the optimal way to invest in carbon credits?

While there is no universally best method to invest in carbon credits, carbon ETFs are the most accessible for most investors. Alternatively, you could invest in individual companies dealing in carbon credits or trade carbon-credit ETFs.