Lead-Lag Live

Carbon Markets as Alternative Investments with Luke Oliver

• Michael A. Gayed, CFA

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The quest for true portfolio diversification often feels impossible in today's market environment. When volatility strikes, traditional "alternatives" tend to move in lockstep with equities, undermining their diversification benefits. But what if there existed an asset class with genuine structural independence from equity markets?

Enter the carbon credit market – perhaps the ultimate alternative investment. With a remarkably low 0.3 correlation to US equities, carbon markets offer double the potential returns of the S&P 500 while operating on completely different cycles. Unlike most investments vulnerable to economic downturns, carbon markets feature government-mandated demand, steadily decreasing supply, and in California's case, a floor price that increases by inflation plus 5% annually – approximately 8% in today's environment.

This trillion-dollar market remains largely unknown to mainstream investors despite covering 25% of the global economy. Companies across Europe, California, the UK, and other regions must purchase carbon permits corresponding to their emissions by law. As governments tighten these markets to meet climate goals through 2050, the structural pressure on prices creates a compelling investment case completely disconnected from traditional market dynamics.

Luke Oliver of KraneShares explains how carbon investments like KRBN (global carbon), KCCA (California carbon), and KEUA (European carbon) can transform portfolio construction. Typically allocated at 2-4% of portfolios (though some institutions go up to 8%), carbon exposure provides diversification previously available only to endowments and family offices. For investors searching for alternatives that actually behave differently from stocks during market stress, carbon credits offer a unique opportunity backed by regulatory frameworks rather than sentiment.

Ready to diversify beyond the traditional 60/40 portfolio? Explore how carbon markets might be the missing piece in your investment strategy – offering genuine diversification with substantial return potential in a world where true alternatives have become increasingly scarce.

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Speaker 1:

So when we think about constructing a portfolio of alternatives, I got to assume that correlation as a metric alone is not enough to really kind of figure out how to mix and match things.

Speaker 2:

Well, yeah, and there's also. There's a big drawback, which is you can show things. I'm going to show you something with a very low correlation to equities that I really like, but there's no escaping the reality that, unless you found an economy on Mars that you could invest in then which would have no correlation to US equities, but that doesn't exist, presumably, something is more likely to be alternative if there are mandates for what those investment strategies are designed to take advantage of, and with that I'm obviously segueing to the carbon market.

Speaker 1:

So let's talk about that.

Speaker 2:

So why do I really like carbon? Well, you know it's got a 0.3 correlation, global carbon 0.3 correlation to US equities incredibly low, and when you look at the forecasts and the demand supply for compliance carbon, you've got a very high potential upside and it looks something like double the risk of equities but double the returns with a 0.3 correlation. And that is a very magical blend of characteristics for something to put into a portfolio with your gold, with your bonds, with your equities.

Speaker 1:

My name is Michael Guyette, publisher of the Lead Lag Report. This is a sponsor conversation sponsored by Crane Shares, one of my clients and, of course, the man of the hour, mr Luke Oliver. Luke, I don't know how many people are familiar with your name, but your name is a very strong one. I will say Luke Oliver is a very strong name. I just got to say that up front. I got to get you excited about that at least. So introduce yourself to the audience. Who are you? What's your background? What audience? Who are you? What's your background? What have you done throughout?

Speaker 2:

your career? What are you doing at Craneshares? Yeah, so I started my career in London, always been in finance and I joined Deutsche Bank and I was on the sales side in foreign exchange and I loved that, got very involved in derivatives over there but then sort of migrated through Deutsche Bank into commodities, then started running commodity portfolios and then sort of backed into being an asset manager while still being on the sales side of Deutsche Bank and we ran some successful commodity ETFs that we sold through another ETF issuer and then we decided that we should get into the ETF game ourselves and launched the X-Trackers ETF. So ended up running that business out of the US and we had some big, big products over there the first A-Shares, first CurrencyHedge, dts and I wanted to come and join a really truly innovative firm and kind of take that innovation and creativity and new ideas for alternative allocations and go somewhere that can really execute well on that. And that's what took me to CraneShares somewhere that can really execute well on that. And that's what took me to CraneShares.

Speaker 2:

And CraneShares, as you may know, are absolute top draw China asset manager and our flagship product, kweb, is perhaps the most well-known China ETF in the world, so very prominent in that China and emerging market space and what I do is wear a couple of hats. I'm sort of the strategist for the firm, but I also am, you know, have my own pet suite of products that that's very near and dear, because they are fantastic products and we focus on sort of the alternatives or like the carbon ETS that we have a KRBN, kcca, so they're my babies, if you like. That I really love to talk about. But I think that the biggest sort of pivot that I've had in the last couple of years is through being in these more exotic alternatives. Is you actually start to is a very sort of endowment, family office, long-term thinking, long-term community capital type investor space, and it's fascinating because I think that is what we're seeing other portfolios migrate to. So I think it's a lot going on.

Speaker 1:

All right. So let's do table stakes definitions, because I think a lot of people when they hear the word alternative, they think alternative to making money, because alternative is not really made that much money. It's been a beta, cheap beta type of world for yeah, let's call it a decade, roughly a decade plus.

Speaker 2:

But let's define what an alternative is first. Yeah, Well, alternative is and it's a funny definition because there's so many things that you do or have done that is different to holding the S&P 500. And historically it hasn't served us well and we would have just been better off being long the S&P 500. But when you think about alternatives really not to be too rudimentary in our conversation but you've got equities and you've got bonds, and for the longest time they were the two main building blocks Most portfolio, or a lot of portfolios, still only really hold those two things. Some portfolios don't even hold any bonds.

Speaker 2:

But if you think about why you want alternatives, it's about having different risk return, the idea being that if you invest in assets that all go up over time, but they all go up over time at different levels, different rates and at different times, you can really smooth out the experience.

Speaker 2:

And so your ideal portfolio is made up of lots of things that all perform well, but they're all performing well at different times and are in different cycles and have a low correlation to one another. So when I say what is an alternative, or I want to define an alternative, the very easy way to define. That is something that we think has positive growth story but also has a very low correlation, or the lowest correlation we can get, to large cap US equities. So think of large cap US equities as your core. And then what do you add to that to improve the overall risk return?

Speaker 2:

Because this is another key thing about alternatives they're often not always, but lots of them, lots of the interesting ones are very volatile, and so how does putting something more volatile in your portfolio improve it? Well, if the correlation is low enough and its volatility is happening to the upside when stocks are going down and to the downside when stocks are going up, you actually reduce that overall volatility. So actually, maybe even a better definition is something that reduces your volatility of your portfolio without detracting from its return.

Speaker 1:

Correlation's a funny term because, as you know, most people confuse correlation with causation. Things can have spurious correlations which are not based on anything except randomness, and then they can have changing correlations based on market volatility picks up, like the safety dynamics, for example, and gold and other types of asset classes. So when we think about constructing a portfolio of alternatives, I got to assume that correlation as a metric alone is not enough to really kind of figure out how to mix and match things.

Speaker 2:

Well, yeah, and there's also. There's a big drawback, which is you can show things. I'm going to show you something with a very low correlation to equities that I really like, but there's no escaping the reality that you found an economy on Mars that you could invest in which would have no correlation to US equities, but that doesn't exist. And so even when you take things like China, which we think is a fantastic place to diversify, or the carbon markets, or commodities, or Bitcoin, or you name something that has a different relationship, there is the susceptibility of that correlation. While historically might be under 0.5, or call it 0.5, as soon as you get some massive global macro event, these correlations can all spike. Bonds and equities can both go down. If there's a big risk event in the market, or if you have an economy that has had low correlations, well, if there's a big economic situation in the US, that will affect all sorts of economies negatively. And then you also get these kind of contagions where, if the US equities are down, people are getting margin calls, so it means they have to trim positions elsewhere, which can then pull down those markets. And then you know and I always, I think, I think Bitcoin is an example of this, bitcoin should behave like gold. If it behaved like gold, it would do incredibly well. It's obviously done well, but because when there's risk off, bitcoin sells off as well, it's not really doing its job as a diversifier. So what to be wary of with that correlation point is that something with statistically low correlation is probably a good diversifier, but it's not a get out of jail free card.

Speaker 2:

The likelihood is that there are certain events that happen To your point. Things don't have a low correlation necessarily because of some relationship between them. They just happen to not correlate most of the time. But when some bad things happen, they can both move together. Or good things happen, they can both move together. So you do have to kind of take a little bit of a pinch of salt with that correlation number. It's important, though, but you're right, it can be, it can. People can be left feeling disappointed when, when, when things suddenly correlate just when they didn't want it to correlate.

Speaker 1:

Well, I think it's sort of the big point, right? It's like that's the joke about diversification, right, it looks like it's diversified until you know the event happens. Everything correlates to one, and then what's the point of the diversification? So I do think there's something to the idea that in general, there aren't that many in quotes true alternatives, right it's certainly at the extreme it's difficult to find and you have to find things that you know.

Speaker 2:

What's nice is the sorts of flight to safety assets or if you take something with you know where I started my asset management career was in commodities, and something we do very well at CraneShares. We have a managed futures product. Do in that product is not just be long commodities which is what I used to do and find efficient ways to be long. We actually will be long and short and we'll be long and short commodities, currencies and rates, and so you're taking something that we're not just long and we're looking at momentum to decide when we want to be longer or shorter in each of those commodities, each of those currencies.

Speaker 2:

So when you package that up, you do start to get something that has very low correlations and will not really correlate necessarily with some of those big macro events. So there are ways of doing it and you have to really sort of try and find something very unique about the structure of the particular market. That will mean that even in those events where correlations are spiking, these shouldn't spike too much and of course, if something becomes very popular and becomes more mainstream, it starts to become more susceptible to being correlated again because of those people getting margin calls and having to rebalance and things like that. So it's very hard and that's why it's not easy and that's why we have a whole industry that we're all in providing the tools for investors to try and find those diversifying allocations in their portfolio.

Speaker 1:

And going back to the causation points, presumably something that is more likely to be alternative if there are mandates for what those investment strategies are designed to take advantage of, and with that I'm obviously segwaying to the carbon market Exactly. Let's talk about that, because I think you and I have talked about this in the past. It's a growing part of the marketplace, right? The correlation dynamics I think are fascinating, but I want you to kind of first of all explore with the audience that point about if you're going to go for something that's alternative, it has to be something that almost has a structural reason for it to be different, exactly, exactly.

Speaker 2:

So thanks for teeing me up there, because that's exactly where I wanted to go, which is that, if you said so, let's take something like Bitcoin right when and you're long gold. Now, when people want to sell equities because they're getting nervous about the performance of equities or they think equities are too expensive, they will say, well, where else can we put our money? Maybe we want to put it into fixed income, but then, if you're worried about the economy and stock price, maybe you're worried about getting paid back on those bonds. You don't want that either. And so you say, well, I need something else, and that something else historically was gold. So you would buy gold, you would see stocks coming down, you see gold going up.

Speaker 2:

Now you've got Bitcoin, which is like a digital gold. I mean, everyone's got a different view. My view is just simply, it's a store of value. It's now big enough and established enough and liquid enough that it does have that characteristic. So it's a little bit like holding gold in a digital format, and so you should start to see Bitcoin going up when stocks go off. But, of course, when people get nervous about stocks and they feel like they need to trim their risk. They also look at Bitcoin as risk and trim that as well, and so we're not seeing the real benefits. It's still.

Speaker 2:

I own some. It's a good thing to have as part of a diversified portfolio, but it's not really doing that diversification thing that we want it to do, because there's no structural reason to really hold it. Same goes for gold. So why do I really like carbon? Well, high level, it's got a 0.3 correlation, global carbon, 0.3 correlation to US equities incredibly low. And when you look at the forecasts and the demand supply for compliance carbon, you've got a very high potential upside and it looks something like double the risk of equities but double the returns with a 0.3 correlation, and that is a very magical blend of characteristics for something to put into a portfolio with your goal, with your bonds, with your equities. But your question was about what structurally makes carbon interesting. Now this is a new asset class, so I could go in a few directions explaining it, but let me take the California carbon market as an example to show you just why the structure is likely to maintain very low correlations to equities. How can they be similar? Well, if the economy is doing badly, stocks will do badly, and just so you understand what carbon is in the simplest way. About 25% of the global economy has a carbon market. We're not talking about ESG, we're not talking about planting trees.

Speaker 2:

There is a traded commodity, essentially a permit that companies have to buy that relates to the amount of CO2 or methane that they're putting into the atmosphere. This is a trillion dollar industry. Not everybody's heard of it. It's massive and it's a huge part of the economies of the state of California, of the Canadian economy, the European economy. They are selling hundreds of millions of these credits to big household name companies that must buy them by law. So and please jump in if you want me to pull back or speed up or because it's a little bit of a complicated space but essentially they are selling these permits, which are kind of like a commodity themselves, and the law backs that for every ton of pollution that company emits, they must buy one of these credits and return it back to the government. So the demand is mandated by law.

Speaker 2:

The supply of these credits. They're auctioned by the European Union, by the state of California, by the UK. The Chinese have a program, the Japanese have a program, australia and New Zealand, they all have the same mechanisms. In the Northeast. Here in New York we have a program that covers energy production on the whole Northeast and corridor there, and so you have supply, which is kind of managed in the same way as, say, the Fed manages liquidity, in that they can tighten and ease, but we are on one tightening cycle until 2050. So you have a mandated demand, you have a mandated supply. The government policy has a tightening supply mechanism that reduces the amount of credits being sold into the future.

Speaker 2:

And then in California there is a floor price that steps up every year by whatever inflation is plus 5%.

Speaker 2:

So if we have 3% inflation, like we're estimating now, that means every year the floor price goes up by 8%. And so you have a market with a floor that goes up 8%. It has a ceiling price that is also going up by 8%, and then you have a tightening of this market every year out beyond 2030, out to 2045 is where they have their targets beyond 2030. And that is designed to push that price higher. And as the price pushes higher, what it does is catalyze more capital into switches from high carbon intensity to low carbon intensity. So you get this massive multiplier effect in the economy, in investment, in lower carbon industry, whether that be shipping, transportation, energy production, steel glass you name it natural gas, both the usage and manufacturer. So that's why this is different, because even in a bad economy, when you might think risk assets are selling off, we have a floor price and we have a floor price that ratchets up by 8%.

Speaker 2:

So when you enter something into the market that can't be hedged is a structural finger on the scale for a price of an asset, that's something that's worth looking at. And when the prices align so for instance, when California is trading near the floor like it is right now, you have this very asymmetric opportunity where your downside is the floor that goes up by 8% and your upside is up to the ceiling, which is a couple of hundred percent higher. So, yeah, does that make sense? You need to find something that has a market structure that you know, almost you know I mentioned if you found an economy on Mars, you want to find something that looks the most like an economy on Mars. So what's the furthest away economy? What's a commodity that people are going to need regardless of economic cycle? What's a? What's a commodity that is going to be in more demand versus its supply structurally over the next 10 years.

Speaker 1:

Those are the things you want to align with, and carbon is one of those it's interesting I'm looking at on my other screen the krbn etf in the midst of the tariff tantrum and yeah, it's true, for the most part it didn't really respond the way broader equities did, so clearly did act like a diverse fire during that period yeah, it did, it did and then.

Speaker 2:

But then you've always got, um, you know that curveball that comes in, which is okay, so it's not responding to tariffs. Because of its structural design the way Europe is designed it has a market stability reserve that is always pulling down. Essentially, it's like the opposite of quantitative easing for this market that the European government will take in more of these credits if the surplus is too high and keep upward pressure on that price. But then you kind of go around the block again and you think, well, okay, but if the tariffs cause economic slowdown, then that may cause less purchasing of credits in the future. So it's important to note that when you diversify, you're sort of reducing the likelihood of of, you're reducing your risk in theory and often it works very well, but you can always have um exposure to risks and new risk, and, and certainly any investment always comes with its own risks. And so if you buy a diversifier that performs terribly, um, it may have diversified you, but maybe that wasn't, it wasn't, it wasn't such a good thing. So you sort of need to you know, I do like to people often think you're trying to convince them there's this riskless thing that they can do. But diversifying with true assets, with assets with truly sort of different return drivers, exposure to different factors, are going to be beneficial.

Speaker 2:

And then, when you come to an environment that we're in now and I think this is why we're seeing this shift to alternatives because another definition I think is incorrect on alternatives is people think, well, it's just their private assets, so you've got public equities and then you've got private equity is a diversifier, and I think the cat's out of the bag a little bit. Everyone's realizing now that private equity is not really the diversifier you think it is. It's just the way it's marked makes it seem like it has a different sort of experience. But that's really just down to how they're valued, and I think we're seeing in the public markets more and more of these private type assets. So what I like to look for?

Speaker 2:

So we're seeing private equity and private credit getting into ETFs now very interesting. But I find things like carbon even more interesting, because these are assets that the so-called you know the smart money, you know the family offices, the endowments, the folks that have a long timeline, they're comfortable committing money to a long-term strategy and their portfolios can be, you know, 40% or more alternative assets, and so when you see that what those folks are doing and the mainstream tends to follow them on a bit of a lag then I think it's quite exciting that we're able to package things like carbon into an ETF so that your audience, the traditional financial advisor, can actually put their smaller clients into the sorts of allocations that the big family offices and endowments have been doing for the last 10 years.

Speaker 1:

And mechanically it's doing it through the futures side, right, Talk to me about that.

Speaker 2:

Yeah, yeah, I mean for our institutional clients, we have a private fund that we buy the futures and take delivery of the actual credits themselves. But for our public offerings, krbn take delivery of the actual credits themselves, but for our public offerings KRBN, kcca, keua we're in the futures market. So, yeah, so our global fund, and I see that as your core allocation. When I tell people about the 5% plus inflation adjustment every year, everyone thinks, well, california sounds that, sounds fantastic. That's the thing I want. It's great we have a fund that does just that. Kcca Gets you along those California carbon credits. But KRBN, our global, is 60% Europe, about 25% 30% California, 5% UK, 5% state of Washington, 5% the northeast of the US. So it's a diversified basket and that's where you really get the correlation benefits in that global fund. But of course and I always say this that the European market is the biggest carbon market, it's the most stable, it's already the tightest market, and so I think it's interesting to be long the global, because being long just one gives you the idiosyncratic risk of that one market versus the most established market. Europe is a great backbone. So I love the KRBN, but so many of our investors are interested in KCCA right now.

Speaker 2:

So how do we do it? We basically take in. If we get $100 into the fund, we will go and put on $100 of futures exposure in those markets. We'll only have to put about 20% of our capital with the exchange. So the other 80% of the capital we then get to invest in sort of ultra short duration, ultra high quality fixed income, and so we can earn another yield on that money as well. It's not leverage, we're just down in very high quality collateral and then we're getting that exposure in the futures market.

Speaker 2:

And that is worth noting, because when people try and invest in oil or natural gas it's incredibly expensive. You pay a management fee, but the shape of the futures curve is pricing in future prices. It's called contango. A lot of you know the term, but it just means that when the prices in the future are much more expensive than the prices in the front or the spot market, and so that's a challenge, because if you think something's going up but you're already paying 20% more for it, then it's a lot harder to make a positive return. So it's worth noting that when you subtract the risk-free rate that we're earning on our collateral, we're only talking about a percent or so of curve shape, so very effective to hold futures here and that's why we do it, because it's the most liquid way to access this market. And it's worth noting that the futures traded close to a trillion dollars last year. About 70% of that is out of Europe, california, uk, other big chunks of that market. But, yeah, it's a highly liquid institutional asset class, so futures have been very efficient.

Speaker 1:

Is there something to the idea of there being like an active management component to it, as opposed to sort of an indexation approach?

Speaker 2:

Yeah, and this is the bit we haven't touched is what do we think the performance has been? So it's interesting. We had, you know, California had a 30% year a couple of years ago and Europe had 100% year or the Global Fund had 100% year back in 2021. The challenge is that, because of the invasion of Ukraine, which completely disrupted natural gas supplies in Europe, of the invasion of Ukraine, which completely disrupted natural gas supplies in Europe, exploded, the price of natural gas took. A lot of European industry came down on that energy crisis we actually had really, you know it hurt the price of carbon and we're only now so 2022 through 2024, we had a pretty rough time in European carbon. Likewise, in California, we had a delay in rulemaking where they were going to implement an extension from 2030 to 2045 and also implement a 20% increase in their ambition, and that got delayed for a year. So we've actually had a couple of tough years in carbon, and where we are today is this sort of inflection point where California is at its floor. So its kind of base case, or even, I should dare say, the bear case, is this 8%, which any of us would take 8% a year return if there's very little downside risk to that. Because of the floor Europe we're trading around 70 euros a ton, we're on our way back into the 100 euro a ton range and all the forecasts have these markets returning, especially if you take our global basket. We think there's something like a 20% a year return, as these markets kind of find their not just the floor prices but their sort of true upside potential 20% a year through 2030 and beyond. So the return that the market's forecasting here is very attractive, and so to have that positive upside, I would almost never say to someone you should diversify for the sake of diversifying. You want to find things that are really going to perform, but also do it in a way that isn't just a levered version of the regular stock market. So that's what I think this is. This is something with some risk. It's also got great return expectations and it has that low correlation. So what's exciting about this isn't just that it's got a low correlation, it's that it has a very high expected return. That also comes with a reasonable amount of risk, and so that's why I call this.

Speaker 2:

I think this is the ultimate alternative. When you stack it up against how you define an alternative. Does it have independent return, Does it have a structure that will support it through various cycles? Does it have an entirely different cycle to it through various cycles? Does it have an entirely different cycle to everything else and does it have a low correlation? You start putting those things together. You get something. You almost um, you make that venn diagram of all those things. I think that you have krbn right there in that, in that little, in that very small overlap that can do all of those things.

Speaker 1:

Is there anything that could fundamentally alter the carbon market politically? I mean, obviously, with Trump and him getting the EPA and kind of a general sort of distaste for this sort of way of thinking about the world?

Speaker 2:

Yeah, well, definitely when people ask me, what creates vol here? What is the risk involved in an investment? When I say risk, I don't mean what makes this go away, but what creates volatility. What will reduce these upside numbers that we're talking about? Driven market, and that's part of why it's got a low correlation, because you're correlating to policy rather than you know GDP growth or earnings per share or whatever whatever other metric you're using to to analyze the stock market. And so when you have a so, for instance, trump put out an executive order and that talked about states' climate plans and how that shouldn't be allowed to get in the way of US energy independence. Now, on one hand, of course, this is very important. On the other hand, the federal government doesn't have a right to interfere with certain states' policies, and the California market has some vol around this exact period because that is disconcerting for investors. If you've got lack of clarity on policy, then that's going to drive volatility in the market. So that's exactly where the vol comes from in this market is will they extend? Will they tighten? Will they get delayed in courts with the federal government? Will there be a reduction in emissions due to technological advances? That's going to reduce the demand for carbon credits. All of these things are feeding into the price of carbon. But here's why a lot of this is noise and is causing unnecessary vol. But I almost sort of half joke that if we didn't have this vol, this investment wouldn't the returns. The only reason we're not capturing these returns is because of this uncertainty. It's almost as if the you know portfolio gods have said look, this is designed to give you a 20% a year return. You can't have that for free, you have to have vol with it. And somehow, through policy and politics and shifts in sentiment around things like environment, things like climate, things like energy transition, you're getting all this volatility. So if you can stomach the volatility, the end outcome is actually a low of all outcome, which is these programs are designed to be significantly higher by 2030 and beyond, to 2045, 2050, and so on. So those are risks, but why? I also don't think one.

Speaker 2:

Legally, these programs are all part of law European law, california law, quebec I've mentioned a lot of the other countries have them. These are ingrained in law and you need law again to reverse out of them. But this is not. This is pure capitalism. This is the capitalist solution to creating a price mechanism that shifts people into greener energy, and so the way it does that is it's they sell these credits and they make so much money. So Gavin Newsom just put out the California budget, and to balance California's budget, they need the revenues they get from selling these permits, and so the California state government is bipartisan support for this. This is a revenue source for the state, and this revenue source is what pays for our state, and so it's too big to fail. This is not a nice-to-have ESG initiative that people don't like. This is a core part of where California raises revenue burning coal, which makes this program expensive for them, because they'd rather keep burning cheap coal and not have to pay for the permits the extra permits they need because they're burning coal.

Speaker 2:

But Europe, those countries when they look at the alternative, which is we keep burning cheap coal, but then we don't get all these revenues from selling these credits, then how are we going to continue, continue to thrive, and so these programs are almost the perfect solution, and just to recap how they work the governments sell a permit for every ton of pollution that comes out of an industrial company, those companies, and these aren't egregious prices, it's it's not, it's not like massively inflationary, but it is inflationary, but it's a friction point. You have to buy permits. That cost money. And any smart industrialist is going to say how many people do we need to hire? Do we need this many people? Do we need this many factories? Do we need this many trucks? And now they're saying do we need this many carbon credits? Are there ways to more efficiently run our business where we can save money on these credits?

Speaker 2:

And then what they start to realize is well, why don't we stop burning coal and start burning natural gas? Because then we'll have to buy way fewer Natural gas. When you burn, it has only half the emissions of coal. Then they start to say well, actually it's cheaper to invest in solar. Or in fact we should start looking at building nuclear reactors instead of coal-fired plants, because it will be cheaper.

Speaker 2:

And what happens is the governments make a revenue, the companies start to innovate and invest in better technology so that they don't have to pollute. And on the margins, where some people start to see more expensive energy bills because we're switching up the food chain. Of course, as you switch up the food chain and then you grow and you scale, the cost comes back down again. But in the interim there might be some friction points where people will see higher energy prices. But then what you do is you take the revenues earned by the program and you feed that back down on those margins and you subsidize energy at that end to those people that need it subsidized, and you actually have an almost perfect solution. And that's why these programs are growing Not so much in the US, california and the Northeast here are the only, and Washington are the only programs that are here now.

Speaker 2:

But when you realize that we do need to make these changes, it's inevitable. This is the only way to do it. You can't give subsidies to people to go green or to switch to EVs. There's not enough money in the world to do that. But if you put a pain point, a friction point, then humans, we're great engineers, we are great innovators. You make something expensive for us, we'll innovate our way out of it, and so these programs are designed to rise and create this massive flywheel of innovation and scaling, of better technology. And by design, they need that price to go up and we as investors get to buy this asset and participate in its growth in price. So it's so unique that we get to be on this ride and up till now, it's mainly the big institutions and big family offices that have the access to these markets that have been able to participate in this. But we've put it in an ETF form and you can get access to this today in the same place you buy the S&P 500.

Speaker 1:

Speaking of that, let's talk about pairing it with the S&P 500 or just in general, core satellite. Not investment advice, but typically what do you see in terms of the allocations, weightings, things like that?

Speaker 2:

Yeah, I mean you'd be surprised, and maybe not so surprised On the high end. We've seen people up to about 8% in this asset class and then you really start to see the efficient frontier shifting out to the left. But of course that's quite a big, that's a big allocation. So I think I mean we've certainly seen institutions that have accounts or portfolios where they are up to 8% in our global carbon fund or similar exposures, which I think is quite surprising. But that actually makes a lot of sense.

Speaker 2:

If you've already allocated to stocks, bonds and then traditional real estate, gold, all the traditional things, this is a very interesting way to allocate. But generally we see this as sort of a 2% to 4% allocation in the portfolios that use it. And you might say, well, what's a classic portfolio that uses it? We're seeing this in some of those sort of longer-term, forward-thinking portfolios. It's just in the completely standard portfolios. What we've also seen is people saying, well, long-term, we like commodities, but we don't see oil and gas in the future and we're looking for that commodity replacement. So we found ourselves in any sort of impact or sustainability aware portfolios. We've seen people just replacing commodities. People don't want to buy, um, you know, necessarily metals, industrials, um uh, agriculture, things that are expensive to hold, commodities. Commodities are expensive to hold, carbon is not, and so we've seen people replacing commodities with carbon. And that's when you start to realize, that's when a 6% actually starts to make a lot of sense.

Speaker 1:

I think the case is definitely compelling and the alternative arguments obviously are very strong. Strong, especially if we're going to be in a volatile environment anyway. You want to diversify your volatility sources as much as possible. Um, maybe a stupid question, but then you know, volatility aside, why not, just if somebody's very aggressive, why not just take a lever better on it? I mean, why not just, you know, really make a long-term play and it's like all right. Well, if this is as close to that dreaded word from a compliance perspective, current, guaranteed as possible, why not just go very aggressive?

Speaker 2:

yeah then. But that's people, can people, that's uh, you know you can. Uh, you can get at least two times leverage on on uh, on an etf, and there's also options out there. We have, uh, fairly liquid options on the global fund and our California. In fact we know some investors do get long our California through buying calls. So leverage is there. But again, that's when.

Speaker 2:

Yeah, asset allocating to low correlating diversified assets is one thing. Taking a levered bet on and being very concentrated is a different, is a different thing. So, um, certainly, I know in my personal account I've got I'm probably overweight um, you know I've got both the global and the california products that I hold and I'm probably overweight the sort of standard um allocations. But yeah, that's a. That's a different um. I'll leave the leverage for the people that want to. If, if you want to trade something like the California that, like I say, is trading near its structural floor and therefore has arguably a lot of very heavy support and then a free upside, that's potentially a great levered bet. But again, be very careful with leverage and I tend to prefer to not be levered and just size my position right. So if you're very positive on this, have a bigger weight to it. But yeah, leverage is usually where things unravel for people.

Speaker 1:

Other than the carbon market, since I know Craneshares obviously is very big on the China side. Is there an argument to me that maybe Chinese equity markets in some way shape or form are alternative?

Speaker 2:

Oh, for sure, For sure they are.

Speaker 2:

Yeah, I mean it's interesting because when you've got Chinese companies that make most of their money in China like a lot of the names that we have in KWeb joking aside, that is as close to when I was joking about could you invest in the Martian economy it starts to feel like that.

Speaker 2:

If you've got 1.4 billion people that have their own money, spending their own money with these companies that make most of their money from these people, and it's all inside China, that is very isolated from other drivers that are driving the other economies, and so I think that's, I think looking at China as a diversifier is is exactly as makes complete sense, and I think I think even us seeking to have to become experts in carbon in managed futures. We've got an inflation hedge product as we diversify. I think that's where it comes from, from our China DNA, that that is also arguably the ultimate alternative, and you've got an economy that's growing faster than most of the rest of the world, is second behind the US, and valuations in China are so much lower than the valuations on US stock. If we have any sort of you know and we're sort of seeing, we're going through the process, but as we see improvements in the geopolitical space, I think this will be exactly where a lot of alternative dollars will end up, and so they should.

Speaker 1:

Luke, for those who want to learn more about the carbon funds and green shares in general, what would you recommend and maybe talk through a little bit about the broader suite?

Speaker 2:

Yeah, yeah. So as a firm, craneshares. Cranesharescom is where you'll find everything, and we kind of characterize ourselves, as you know and and you've probably all seen brendan ahern either here or he was on fox business yesterday and or last week and uh, constantly on bloomberg and cnbc we're everything for china, we, we, we've got the the deepest bench of china experts here and we have a a daily newsletter that goes out on investing in China, called China Last Night, and then sort of as the carbon equivalent. So we've got China, we've got alternatives, and then, within the alternatives, we have a real focus on climate and we have climate markets now, which is a weekly that we put out that focuses on these markets. You can sign up for any of these. You'll see them. You go to cranesharescom, you'll see our blogs that you can sign up for at the top and you'll see all of our products. But that's really what we do. We're second to none on China, second to none in this carbon space, and we then have a really healthy alternatives lineup and there's some great, great products in there, and you'll see that we've got some great partner sub-advisors as well that we work on to give us that diverse lineup. So we've got a lot of in-house capabilities, and then we've got some excellent sub-advisors that are always very happy to get on and talk to clients about these strategies.

Speaker 2:

But that's what people are looking for now. You've got to start to think about being diversified At some point. Just being along the S&P 500 isn't going to cut it. You're going to need some allocations that are getting their upward momentum from something else and with low correlations those US equities and you start to see that playing out. I saw that the flows are starting to point towards bigger holdings that look more like cash than they do equities. But of course, you still need some return and you still want to see. If you start to see rates come back down. Then is that good for equities? Is it good for fixed income? You've got to have those alternatives in there as well.

Speaker 1:

From your lips to God's ears, because I think everybody's waiting for an environment where it's not just about the S&P, but certainly the carbon market is an utility of its own Everybody. Please learn more about Craneshares on their website. Make sure you follow Luke Oliver also on X, and I'll see you all in the next episode of Lead Lag Live.

Speaker 2:

Thank you, luke, appreciate it.

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Michael A. Gayed, CFA

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