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I’m always interested in investments that don’t correlate to beta, and which can serve as unique diversifiers in a portfolio. To that end, the thriving carbon credits market fits the bill. And the good thing is that there are products like the KraneShares California Carbon Allowance ETF (NYSEARCA:KCCA) which can provide easy access to the space.
KCCA offers investors a unique opportunity to participate in the California Carbon Allowances cap-and-trade carbon allowance program. This ETF is benchmarked to the IHS Markit Carbon CCA Index, tracking the most frequently traded CCA futures contracts. As an integral component of KraneShares’ suite of carbon ETFs, KCCA presents an innovative vehicle to engage with the carbon pricing market, hedge potential risks, and support responsible investing.
Understanding the Fund’s Structure
KCCA is traded on the NYSE and has a total annual fund operating expense of 0.81%. Since its inception on October 5th, 2021, it has accumulated net assets worth $277 million. The ETF provides quarterly distributions and is primarily invested in CCA futures, with excess cash invested in treasuries.
The fund has done particularly well this year.
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An in-depth look at the fund’s holdings reveals that it is entirely invested in CCA Vintage 2023 Future contracts. The identifier for these futures contracts is LUDZ23 Comdty, with a position of 7,180, and a current exposure of $277,291,600.
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Portfolio Diversification: The Role of Carbon Credits
Carbon credits have emerged as a rapidly growing asset class, with the four largest global carbon futures markets transacting over $700 billion in 2022. However, trading in carbon credits is primarily reserved for emitters and other regulated entities. Hence, KraneShares’ ETFs, including KCCA, offer one of the few gateways for retail investors to gain access to this market.
Beyond their growth potential, carbon credits have historically exhibited low correlations with other asset classes like equities and bonds, making them an effective portfolio diversifier. For investors exposed to companies that could be adversely affected by stricter carbon credit programs, investing in carbon credits can serve as a valuable hedge.
The Driving Force Behind KCCA’s Outperformance
The primary factor behind KCCA’s recent outperformance is the regulatory developments in California’s carbon market. The California Air Resources Board is considering reducing excess allowances and implementing a scoping study targeting a 48% reduction in emissions below 1990 levels by 2030, up from the current 40% target. These potential changes, expected to take effect by 2025, could increase the demand and price for CCA credits, providing a boost to KCCA.
The Pros and Cons of Investing in KCCA
Investing in KCCA offers the potential for significant returns, given the rising demand for carbon credits and the tightening of emission standards in California. Additionally, the fund’s low correlation with traditional asset classes offers excellent portfolio diversification benefits.
However, investing in KCCA is not without its risks. The fund invests in derivatives, which can be more volatile than other investments and may magnify the fund’s gains or losses. The fund is also exposed to liquidity and counterparty risk. Furthermore, the fund’s dependence on the existence of cap and trade regimes can be a potential risk factor, as there is no guarantee that these regimes will continue to exist or prove effective in reducing GHG emissions.
Conclusion: Is KCCA a Worthy Investment?
Given the robust growth potential, portfolio diversification benefits, and the ability to hedge against carbon-intensive investments, KCCA presents a compelling investment opportunity. As an interesting diversifier, KCCA has demonstrated impressive performance so far. Investing in KCCA not only offers potential returns but also supports responsible investing, aligning with the growing global emphasis on sustainability. As the carbon credit market continues to evolve, KCCA could serve as a valuable addition to a diversified investment portfolio. I like the fund for a small allocation in a portfolio.
