In a market rife with risk, advisors and investors could be missing one of the most fundamental risks that will impact portfolios in the years and decades to come: climate. I recently sat down with Luke Oliver, managing director, head of climate investments, and head of strategy at KraneShares, to talk climate investing and had a chance to discuss some of the lesser-known ETFs within the suite.
You can find the first part of my conversation with Oliver about carbon allowances here.
Carbon Offset Structure and Investing With KSET
Gordon: Let’s start off with carbon offsets, which are very different from carbon allowances. What’s the difference between allowance and offset markets that advisors need to understand?
Oliver: Carbon offsets are in the news even more than the compliance markets, even though they’re much smaller. They’re less liquid and more of a frontier type of exposure to carbon. With carbon allowances, I feel confident saying it’s something that should be in every portfolio: yes, it’s volatile but it’s a diversifier, and it’s a mainstream investment that had $800 billion in trading last year.
When you look at offsets, it’s more frontier. Companies that are reducing emissions to meet decarbonization goals want to reduce avoidable pollution to the environment, so they buy offsets, which means they pay someone else to capture that carbon somewhere else in the global economy. Conceptually that makes a lot of sense.
The thesis is that there aren’t enough plots of land to grow enough quality environmental projects to deliver enough carbon offsets that all these corporations are going to need to meet their decarbonizing targets. We should see a massive imbalance between the demand and the actual supply that can come to market.
Gordon: KraneShares was the first issuer to launch an ETF with exposure to the carbon offsets markets through the KraneShares Global Carbon Offset Strategy ETF (KSET). Walk me through how KSET is investing and the nuances of carbon offset investing.
Oliver: Offsets fall into two general buckets: removals, and mitigation or avoidance. Mitigation and avoidance is good, saving a forest is very valid and important, but it’s not that hard and it’s not that expensive to do. Carbon removal through growing a new forest is very hard and very expensive, but they both end up being compared side by side. It will be increasingly important to distinguish between these different categories..
Investing in carbon offsets and carbon offset projects can be complex — more like private equities. KSET will get you a basket of offset projects, which gives investors access to a broad beta to the market. When you buy KSET, you’re buying across two baskets of offsets, a Corsia definition and a CBL Xpansiv one.
Tonal Shift for Transitioning Energy Companies
Gordon: While we’re on the subject of the direction that markets are moving, let’s talk about the KraneShares Global Carbon Transformation ETF (KGHG), which invests in companies transitioning their business models to decarbonize. When you take a look at the holdings, it doesn’t necessarily look like a climate fund — it’s a mix of oil companies and energy providers, some of the dirtiest industries when it comes to emissions. Why this strategy and what tailwinds do you see for KGHG?
Oliver: There’s something big happening here, and it’s all powered by the Inflation Reduction Act passed last year, because energy transition equities have a tailwind from it. If we have a recession this year, energy consumption goes down, which isn’t good for energy companies, but there is also this spending tailwind from the Inflation Reduction Act that these companies are positioned to pick up. We have always said that there is going to be money spent on this energy transition and KGHG is our way of capturing that.
The shift in attitude of oil and gas companies just in the last year alone has been noteworthy: we just had CERAWeek [S&P Global’s energy conference] and last year was fairly subdued. This year fossil fuel businesses were open about their continued fossil investments, because they are now using them to also fuel their investments in renewables and their energy transitions. These oil companies aren’t ashamed anymore to be oil companies, and they’re actively hiring, and they’re actively transitioning. It’s a new golden era for energy, clean energy.
There are the companies that are innovating, and the “clean little secret” is that green energy is already cheaper than fossil fuel. This isn’t about being “woke” or being climate sensitive, it’s just the best way to produce energy, and it’s happening now. It’s interesting because it aligns with what we’re doing with our climate suite.
Investing in Climate Commodities With KMET
Gordon: Crossing over from equities to commodities, you’ve got the KraneShares Electrification Metals Strategy ETF (KMET) launched last year , which invests in six different metals vital to electrification and the energy transition. Why these metals and this strategy?
Oliver: There’s going to be a massive shift in the demand for certain metals — even the basic metals like copper, nickel, and zinc — but especially cobalt and lithium, and we’ll throw aluminum in there as well.
If you’ve got a commodity allocation, transition it more towards the EV metals and the battery metals. Most investors are carrying these allocations anyway, so why not tilt more towards the metals that may be more defensive over time?
See also: “Why These 6 Metals are the Ones to Watch in 2023”
Gordon: Luke, I appreciate your time and you elucidating these potentially lesser-known funds in the KraneShares climate suite. Any last words on the overall strategy to leave advisors with?
Oliver: These ETFs are all about a material repricing of three markets — critical resources, transition equities, and carbon pricing — and that’s where we’re positioned. It isn’t about ESG: we’re actually trying to make money — oh, and also we’re going to save the planet in the meantime.
For more news, information, and analysis, visit the Climate Insights Channel.