KraneShares recently hosted a virtual summit regarding the global carbon transformation that featured Professor Robert Engle, Nobel Laureate, professor of finance at the NYU Stern School of Business, co-director of the Volatility and Risk Institute at NYU Stern, and chair of the finance board for Climate Finance Partners (CLIFI), the subadvisor for the KraneShares Global Carbon Strategy ETF (KRBN).
Climate risk has been well documented and forecasted from a scientific perspective, but the economic impacts remain largely unknown as to the degree of risk as well as the timing. Engle explained that it’s a risk that is starting to be priced into current markets.
Including climate information when making investment choices is a best practices type of approach as advisors and investors can make the best decisions by being well informed and utilizing comprehensive data. Investing with an eye toward the climate risks could also present opportunities in the years to come by hedging for climate risk in portfolios now.
“If we think that the market does not appreciate the seriousness of this and underprices climate change then obviously you take a view and you invest in things that are going to appreciate when the market actually learns this,” Engle said.
A climate hedged portfolio should be expected to underperform current markets, which can often be a difficult sell for advisors to their clients. Engle likens it to an insurance policy for a portfolio, in which you pay for the policy if it is needed, but until it is needed, it remains a cost.
During periods of little climate news, there will be a negative risk premium in portfolios that short the companies most at risk for climate change, but when there is important news, it could lead to repricing within markets and cause the portfolio to have a positive alpha.
“The key thing here is not whether the sustainable portfolio does better than the market or worse than the market; what we would expect is that it will do better than the market when there is information that is relevant for informing the market about climate change,” Engle explained.
The Volatility Lab at NYU has created a tool for analyzing how climate-related funds have performed over the last year, looking at returns, the Sharpe ratio, their volatility, and other statistics. The KraneShares Global Carbon Strategy ETF (KRBN) has offered the best returns over the last 12 months of all 170 funds tracked, offering up a 34.48% return as of June 14, 2022. For reference, the next highest fund return was 4.73% for the First Trust EIP Carbon Impact ETF (ECLN).
Why KRBN Performs Well in an ESG Muddled Environment
Engle went on to discuss how two different ways to build climate hedged portfolios using fundamental analysis that relies on information like ESG data alongside financial data or utilizing the statistical analysis to find the assets and portfolios that are highly correlated to climate news, the needle mover for climate pricing in markets. The challenge within U.S. markets is the confusion and complexity around ESG data and reporting, but there are some specific, easily identifiable climate assets that can be invested in, such as carbon.
“That’s the thing that’s nice about carbon because the asset is futures on emissions allowances,” Engle said. “It’s the price that people are paying for carbon emissions and that’s kind of the tool for allocating emissions and restricting emissions over time.”
KRBN has gained notoriety and popularity among advisors and investors for this very reason. It doesn’t rely on any kind of ESG component, but instead is a direct climate change-linked asset, it’s an easy allocation to understand and explain to clients.
Carbon allowance limits are expected to contract over time as the world commits more heavily to a net-zero emissions future, thereby providing a predicted, sustainable price pressure on allowances forward-looking.
KRBN tracks the IHS Markit Global Carbon Index, which follows the most liquid carbon credit futures contracts in the world and includes contracts from the European Union Allowances (EUA), California Carbon Allowances (CCA), and Regional Greenhouse Gas Initiative (RGGI) markets.
KRBN carries an expense ratio of 0.78% and has over $1.17 billion in net assets.
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