Key Takeaways

1. Steady decline in fund size for KRBN, with $436 mn outflow in the last year.
2. KCCA had an inflow of $26 mn and WisdomTree launched a new California Carbon-focused ETN.
3. Single-market ETFs fared well when compared to multi-market focused carbon funds.
4. Carbon ETFs are evolving as a specific risk-hedging asset class.

The investment case for buying a fund linked to the price of carbon is that it is expected to go up. They have a low level of correlation with other asset classes as KraneShares highlighted in their whitepaper, which may appeal to investors looking to balance their portfolio.

The case for the sustainability for a physically-backed fund is that it actually holds the emission allowances, taking it off the market and restricting supply for polluters. Whereas a fund holding futures provides investors with return exposure to carbon futures, introducing more liquidity into the market which might lead to better, more efficient prices.

KraneShares carbon indexes are passive, open-ended ETFs which is benchmarked to IHS Markit’s Carbon Indexes. Their ETFs provide physical exposure as the ETFs hold allowances directly. HanETF’s SparkChange Physical Carbon ETC is backed by physical EUAs and therefore tracks the price of EUAs. WisdomTree Carbon ETC and its recently launched WisdomTree California Carbon ETP are carbon futures linked funds that track Solactive indexes.

Carbon ETFs and AuM

Carbon ETFs and AuM; Source: etfcentral, HanETF and WisdomTree

Carbon ETFs like KRBN are still quite niche. Volatility is high — EUAs touched a high of €100 in February of 2023 and almost no change in Y-o-Y allowance price but volatility is high at 44.7 %. For some wealth managers, these swings take the products off the table for retail investors.

EUA Spot and Benchmark, Source: cCarbon Data Partners

KraneShares Carbon ETFs fund flow, Source: eftcentral

Over the last one-year KRBN has seen a massive outflow of $436 mn. This is in contrast with KEUA and KCCA which have seen net inflow of funds. Barclay’s iPath Series B carbon ETN which holds only EUAs fared well with $3 mn inflow YTD.

Net assets of an ETF can decrease for several reasons including ETF redemption, and the decline in the value of underlying assets. If investors sell their shares of the ETF, it can lead to a decrease in net assets. This could happen if investors have a negative outlook on the underlying assets or if they need to liquidate their investments for other reasons. If the underlying assets of the ETF experience a decline in value, it can result in a decrease in net assets.

An ETF that holds a diverse range of carbon credits may be exposed to volatility arising from regulatory changes in any of those markets. Fund managers might prefer market-specific ETFs like KCCA and KEUA because they offer a more targeted exposure to the carbon market making the case for Carbon ETFs evolving as a specific asset class. These ETFs could be used to hedge region or portfolio-specific risks or to take advantage of opportunities in a particular market.

Conclusion

Washington’s Cap and Invest saw strong investor participation in the latest auction even triggering the APCR auction. Single-market ETFs have gained significant traction among carbon market investors as they are seen as a purer play on a particular market. These are attractive owing to their ability to provide targeted exposure, enabling investors to capitalize on the potential growth and value creation within that carbon market. However, investors considering single-market ETFs should carefully assess their risk tolerance and ensure they have a well-diversified portfolio to manage potential risks as well.