A diversifying investment in the low-carbon future

Alternative investment manager lets Canadians share in potential growth of carbon trading markets

A diversifying investment in the low-carbon future

Given the developments of the past few weeks, investors might be quick to blame the surging price of oil on the conflict between Russia and Ukraine, and they’d be right. But many might forget about the driving force that was pushing oil up even before – and is set to fuel another generational opportunity.

“Over the past five to seven years, asset management flows have been heavily dominated by ESG,” said John Wilson, Co-CEO and Managing Partner at Ninepoint Partners. “Investors are increasingly saying they want to be environmentally friendly, which has led to traditional energy companies choosing not to invest in new production.”

Like others at the firm, Wilson takes the view that as members of this planet, a carbon-neutral future – and beyond that, a carbon-zero one – is in their interest as much as anyone else’s. But he also maintains that the world can’t be expected to just shut down hundreds of trillions of dollars’ worth of carbon-based energy infrastructure “on a dime.”

“We have to invest in new infrastructure and new energy generation for sure, but we need a way to transition,” he says. “The carbon credit market is going to be the key tool developed countries will use to get there.”

To push high-emission companies to shrink their carbon footprint, a number of jurisdictions around the world have instituted systems of carbon regulation. Under those systems, governments allow companies to produce a certain amount of emissions per year which they pare back over time.

Those that are able to operate and keep their emissions beneath that threshold can go to the open market and sell their excess carbon allowances (which are measured in metric tonnes of carbon dioxide equivalent) to other companies that may be unable to stay within their own emissions thresholds.

Recognizing that developing market, Ninepoint recently unveiled Canada’s first mutual fund that gives exposure to carbon credits.

The Ninepoint Carbon Credit ETF, a liquid alterative mutual fund with ETF Series listed as CBON, invests in three markets – the European Union ETS (EUA), California/Quebec (CCA), and the US Eastern States (RGGI) – indirectly through the use of carbon allowance futures. It does not invest in carbon offsets, which are another type of carbon credit that is generated from projects with positive environmental impacts.

“From an investor standpoint, it’s easier to access carbon futures that are publicly traded on exchanges. They’re liquid, and they’re publicly traded on exchanges, so you understand what the value is at the end of every trading day,” Wilson says. “And the allowances have to be certified to be included on those exchanges.”

According to Wilson, there are three major reasons why investors may want to consider having exposure to carbon credits. First, carbon credits as an asset class are expected to exhibit low to negative correlation to traditional stocks and bonds, which means they have tremendous potential as a portfolio diversifier.

Perhaps more compelling is the potential for returns. The global carbon credit market is estimated to be worth $22 trillion by 2050, several orders of magnitude larger than the roughly $800 billion it’s sitting at today in its early stages. Many more jurisdictions are expected to introduce their own carbon trading markets, and carbon credits are expecting to grow even further in price as both companies and investors get better at appraising the true environmental impact of carbon emissions.

“It’s had compelling historical returns as an asset class,” Wilson says. “Certainly, last year was an incredible year. And I challenge anybody to step back and look at the next five, 10 years and tell me there’s not going to be more industries put under tough regulation and paying higher costs of carbon in the future.

Finally, he says investors who invest in carbon allowances effectively push up the price as they bid for them. By increasing the costs of each allowance, they make it less economically viable for companies to produce carbon, creating an incentive for them to change. For an investor with equity investments in carbon-producing industries, Wilson argues, owning carbon allowances is like having their own personal system of carbon regulation.

“By owning these, you're effectively allowing some of your other holdings to produce carbon,” Wilson says. “For people that are very environmentally aware and thinking that way, that's a way to feel better about their portfolio.”