June 14, 2025 • 47 mins
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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Transcript
Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Speaker 1 (00:00):
So when we think about constructing a portfolio
of alternatives, I got to assumethat correlation as a metric
alone is not enough to reallykind of figure out how to mix
and match things.
Speaker 2 (00:09):
Well, yeah, and there's also.
There's a big drawback, whichis you can show things.
I'm going to show you somethingwith a very low correlation to
equities that I really like, butthere's no escaping the reality
that, unless you found aneconomy on Mars that you could
invest in then which would haveno correlation to US equities,
but that doesn't exist,presumably, something is more
(00:31):
likely to be alternative ifthere are mandates for what
those investment strategies aredesigned to take advantage of,
and with that I'm obviouslysegueing to the carbon market.
Speaker 1 (00:41):
So let's talk about that.
Speaker 2 (00:43):
So why do I really like carbon?
Well, you know it's got a 0.3correlation, global carbon 0.3
correlation to US equitiesincredibly low, and when you
look at the forecasts and thedemand supply for compliance
carbon, you've got a very highpotential upside and it looks
something like double the riskof equities but double the
returns with a 0.3 correlation.
(01:05):
And that is a very magicalblend of characteristics for
something to put into aportfolio with your gold, with
your bonds, with your equities.
Speaker 1 (01:17):
My name is Michael Guyette, publisher of the Lead
Lag Report.
This is a sponsor conversationsponsored by Crane Shares, one
of my clients and, of course,the man of the hour, mr Luke
Oliver.
Luke, I don't know how manypeople are familiar with your
name, but your name is a verystrong one.
I will say Luke Oliver is avery strong name.
I just got to say that up front.
I got to get you excited aboutthat at least.
(01:38):
So introduce yourself to theaudience.
Who are you?
What's your background?
What audience?
Who are you?
What's your background?
What have you done throughout?
Speaker 2 (01:43):
your career?
What are you doing atCraneshares?
Yeah, so I started my career inLondon, always been in finance
and I joined Deutsche Bank and Iwas on the sales side in
foreign exchange and I lovedthat, got very involved in
derivatives over there but thensort of migrated through
Deutsche Bank into commodities,then started running commodity
portfolios and then sort ofbacked into being an asset
(02:06):
manager while still being on thesales side of Deutsche Bank and
we ran some successfulcommodity ETFs that we sold
through another ETF issuer andthen we decided that we should
get into the ETF game ourselvesand launched the X-Trackers ETF.
So ended up running thatbusiness out of the US and we
had some big, big products overthere the first A-Shares, first
(02:28):
CurrencyHedge, dts and I wantedto come and join a really truly
innovative firm and kind of takethat innovation and creativity
and new ideas for alternativeallocations and go somewhere
that can really execute well onthat.
And that's what took me toCraneShares somewhere that can
really execute well on that.
And that's what took me toCraneShares.
And CraneShares, as you may know, are absolute top draw China
(02:50):
asset manager and our flagshipproduct, kweb, is perhaps the
most well-known China ETF in theworld, so very prominent in
that China and emerging marketspace and what I do is wear a
couple of hats.
I'm sort of the strategist forthe firm, but I also am, you
know, have my own pet suite ofproducts that that's very near
(03:11):
and dear, because they arefantastic products and we focus
on sort of the alternatives orlike the carbon ETS that we have
a KRBN, kcca, so they're mybabies, if you like.
That I really love to talkabout.
But I think that the biggestsort of pivot that I've had in
the last couple of years isthrough being in these more
(03:34):
exotic alternatives.
Is you actually start to is avery sort of endowment, family
office, long-term thinking,long-term community capital type
investor space, and it'sfascinating because I think that
is what we're seeing otherportfolios migrate to.
(03:56):
So I think it's a lot going on.
Speaker 1 (03:58):
All right.
So let's do table stakesdefinitions, because I think a
lot of people when they hear theword alternative, they think
alternative to making money,because alternative is not
really made that much money.
It's been a beta, cheap betatype of world for yeah, let's
call it a decade, roughly adecade plus.
Speaker 2 (04:18):
But let's define what an alternative is first.
Yeah, Well, alternative is andit's a funny definition because
there's so many things that youdo or have done that is
different to holding the S&P 500.
And historically it hasn'tserved us well and we would have
just been better off being longthe S&P 500.
But when you think aboutalternatives really not to be
too rudimentary in ourconversation but you've got
(04:42):
equities and you've got bonds,and for the longest time they
were the two main buildingblocks Most portfolio, or a lot
of portfolios, still only reallyhold those two things.
Some portfolios don't even holdany bonds.
But if you think about why youwant alternatives, it's about
having different risk return,the idea being that if you
invest in assets that all go upover time, but they all go up
(05:04):
over time at different levels,different rates and at different
times, you can really smoothout the experience.
And so your ideal portfolio ismade up of lots of things that
all perform well, but they'reall performing well at different
times and are in differentcycles and have a low
correlation to one another.
So when I say what is analternative, or I want to define
(05:25):
an alternative, the very easyway to define.
That is something that we thinkhas positive growth story but
also has a very low correlation,or the lowest correlation we
can get, to large cap USequities.
So think of large cap USequities as your core.
And then what do you add tothat to improve the overall risk
(05:46):
return?
Because this is another keything about alternatives they're
often not always, but lots ofthem, lots of the interesting
ones are very volatile, and sohow does putting something more
volatile in your portfolioimprove it?
Well, if the correlation is lowenough and its volatility is
happening to the upside whenstocks are going down and to the
downside when stocks are goingup, you actually reduce that
(06:09):
overall volatility.
So actually, maybe even abetter definition is something
that reduces your volatility ofyour portfolio without
detracting from its return.
Speaker 1 (06:20):
Correlation's a funny term because, as you know, most
people confuse correlation withcausation.
Things can have spuriouscorrelations which are not based
on anything except randomness,and then they can have changing
correlations based on marketvolatility picks up, like the
safety dynamics, for example,and gold and other types of
asset classes.
So when we think aboutconstructing a portfolio of
(06:41):
alternatives, I got to assumethat correlation as a metric
alone is not enough to reallykind of figure out how to mix
and match things.
Speaker 2 (06:50):
Well, yeah, and there's also.
There's a big drawback, whichis you can show things.
I'm going to show you somethingwith a very low correlation to
equities that I really like, butthere's no escaping the reality
that you found an economy onMars that you could invest in
which would have no correlationto US equities, but that doesn't
(07:11):
exist.
And so even when you takethings like China, which we
think is a fantastic place todiversify, or the carbon markets
, or commodities, or Bitcoin, oryou name something that has a
different relationship, there isthe susceptibility of that
correlation.
While historically might beunder 0.5, or call it 0.5, as
(07:35):
soon as you get some massiveglobal macro event, these
correlations can all spike.
Bonds and equities can both godown.
If there's a big risk event inthe market, or if you have an
economy that has had lowcorrelations, well, if there's a
big economic situation in theUS, that will affect all sorts
(07:57):
of economies negatively.
And then you also get thesekind of contagions where, if the
US equities are down, peopleare getting margin calls, so it
means they have to trimpositions 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 shouldbehave like gold.
If it behaved like gold, itwould do incredibly well.
(08:20):
It's obviously done well, butbecause when there's risk off,
bitcoin sells off as well, it'snot really doing its job as a
diversifier.
So what to be wary of with thatcorrelation point is that
something with statistically lowcorrelation is probably a good
diversifier, but it's not a getout of jail free card.
(08:43):
The likelihood is that there arecertain events that happen To
your point.
Things don't have a lowcorrelation necessarily because
of some relationship betweenthem.
They just happen to notcorrelate most of the time.
But when some bad things happen, they can both move together.
Or good things happen, they canboth move together.
So you do have to kind of takea little bit of a pinch of salt
(09:05):
with that correlation number.
It's important, though, butyou're right, it can be, it can.
People can be left feelingdisappointed when, when, when
things suddenly correlate justwhen they didn't want it to
correlate.
Speaker 1 (09:19):
Well, I think it's sort of the big point, right?
It's like that's the joke aboutdiversification, right, it
looks like it's diversifieduntil you know the event happens
.
Everything correlates to one,and then what's the point of the
diversification?
So I do think there's somethingto the idea that in general,
there aren't that many in quotestrue alternatives, right it's
certainly at the extreme it'sdifficult to find and you have
(09:41):
to find things that you know.
Speaker 2 (09:44):
What's nice is the sorts of flight to safety assets
or if you take something withyou know where I started my
asset management career was incommodities, and something we do
very well at CraneShares.
We have a managed futuresproduct.
Do in that product is not justbe long commodities which is
(10:06):
what I used to do and findefficient ways to be long.
We actually will be long andshort and we'll be long and
short commodities, currenciesand rates, and so you're taking
something that we're not justlong and we're looking at
momentum to decide when we wantto be longer or shorter in each
of those commodities, each ofthose currencies.
So when you package that up, youdo start to get something that
(10:26):
has very low correlations andwill not really correlate
necessarily with some of thosebig macro events.
So there are ways of doing itand you have to really sort of
try and find something veryunique about the structure of
the particular market.
That will mean that even inthose events where correlations
(10:47):
are spiking, these shouldn'tspike too much and of course, if
something becomes very popularand becomes more mainstream, it
starts to become moresusceptible to being correlated
again because of those peoplegetting margin calls and having
to rebalance and things likethat.
So it's very hard and that'swhy it's not easy and that's why
(11:07):
we have a whole industry thatwe're all in providing the tools
for investors to try and findthose diversifying allocations
in their portfolio.
Speaker 1 (11:19):
And going back to the causation points, presumably
something that is more likely tobe alternative if there are
mandates for what thoseinvestment strategies are
designed to take advantage of,and with that I'm obviously
segwaying to the carbon marketExactly.
Let's talk about that, becauseI think you and I have talked
about this in the past.
It's a growing part of themarketplace, right?
(11:41):
The correlation dynamics Ithink are fascinating, but I
want you to kind of first of allexplore with the audience that
point about if you're going togo for something that's
alternative, it has to besomething that almost has a
structural reason for it to bedifferent, exactly, exactly.
Speaker 2 (11:54):
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 likeBitcoin right when and you're
long gold.
Now, when people want to sellequities because they're getting
(12:14):
nervous about the performanceof equities or they think
equities are too expensive, theywill say, well, where else can
we put our money?
Maybe we want to put it intofixed income, but then, if
you're worried about the economyand stock price, maybe you're
worried about getting paid backon those bonds.
You don't want that either.
And so you say, well, I needsomething else, and that
something else historically wasgold.
(12:34):
So you would buy gold, youwould see stocks coming down,
you see gold going up.
Now you've got Bitcoin, which islike a digital gold.
I mean, everyone's got adifferent view.
My view is just simply, it's astore of value.
It's now big enough andestablished enough and liquid
enough that it does have thatcharacteristic.
So it's a little bit likeholding gold in a digital format
(12:55):
, and so you should start to seeBitcoin going up when stocks go
off.
But, of course, when people getnervous about stocks and they
feel like they need to trimtheir risk.
They also look at Bitcoin asrisk and trim that as well, and
so we're not seeing the realbenefits.
It's still.
I own some.
It's a good thing to have aspart of a diversified portfolio,
(13:17):
but it's not really doing thatdiversification thing that we
want it to do, because there'sno structural reason to really
hold it.
Same goes for gold.
So why do I really like carbon?
Well, high level, it's got a0.3 correlation, global carbon,
0.3 correlation to US equitiesincredibly low.
(13:38):
And when you look at theforecasts and the demand supply
for compliance carbon, you'vegot a very high potential upside
and it looks something likedouble the risk of equities but
double the returns with a 0.3correlation, and that is a very
magical blend of characteristicsfor something to put into a
(14:01):
portfolio with your goal, withyour bonds, with your equities.
But your question was aboutwhat structurally makes carbon
interesting.
Now this is a new asset class,so I could go in a few
directions explaining it, butlet me take the California
carbon market as an example toshow you just why the structure
(14:24):
is likely to maintain very lowcorrelations to equities.
How can they be similar?
Well, if the economy is doingbadly, stocks will do badly, and
just so you understand whatcarbon is in the simplest way.
About 25% of the global economyhas a carbon market.
We're not talking about ESG,we're not talking about planting
(14:48):
trees.
There is a traded commodity,essentially a permit that
companies have to buy thatrelates to the amount of CO2 or
methane that they're puttinginto the atmosphere.
This is a trillion dollarindustry.
Not everybody's heard of it.
It's massive and it's a hugepart of the economies of the
(15:08):
state of California, of theCanadian economy, the European
economy.
They are selling hundreds ofmillions of these credits to big
household name companies thatmust buy them by law.
So and please jump in if youwant me to pull back or speed up
or because it's a little bit ofa complicated space but
(15:29):
essentially they are sellingthese permits, which are kind of
like a commodity themselves,and the law backs that for every
ton of pollution that companyemits, they must buy one of
these credits and return it backto the government.
So the demand is mandated bylaw.
The supply of these credits.
(15:50):
They're auctioned by theEuropean Union, by the state of
California, by the UK.
The Chinese have a program, theJapanese have a program,
australia and New Zealand, theyall have the same mechanisms.
In the Northeast.
Here in New York we have aprogram that covers energy
production on the wholeNortheast and corridor there,
(16:12):
and so you have supply, which iskind of managed in the same way
as, say, the Fed managesliquidity, in that they can
tighten and ease, but we are onone tightening cycle until 2050.
So you have a mandated demand,you have a mandated supply.
The government policy has atightening supply mechanism that
(16:33):
reduces the amount of creditsbeing sold into the future.
And then in California there isa floor price that steps up
every year by whatever inflationis plus 5%.
So if we have 3% inflation, likewe're estimating now, that
means every year the floor pricegoes up by 8%.
And so you have a market with afloor that goes up 8%.
(16:56):
It has a ceiling price that isalso going up by 8%, and then
you have a tightening of thismarket every year out beyond
2030, out to 2045 is where theyhave their targets beyond 2030.
And that is designed to pushthat price higher.
And as the price pushes higher,what it does is catalyze more
(17:18):
capital into switches from highcarbon intensity to low carbon
intensity.
So you get this massivemultiplier effect in the economy
, in investment, in lower carbonindustry, whether that be
shipping, transportation, energyproduction, steel glass you
(17:41):
name it natural gas, both theusage and manufacturer.
So that's why this is different, because even in a bad economy,
when you might think riskassets are selling off, we have
a floor price and we have afloor price that ratchets up by
8%.
So when you enter something intothe market that can't be hedged
(18:03):
is a structural finger on thescale for a price of an asset,
that's something that's worthlooking at.
And when the prices align sofor instance, when California is
trading near the floor like itis right now, you have this very
asymmetric opportunity whereyour downside is the floor that
goes up by 8% and your upside isup to the ceiling, which is a
(18:26):
couple of hundred percent higher.
So, yeah, does that make sense?
You need to find something thathas a market structure that you
know, almost you know Imentioned if you found an
economy on Mars, you want tofind something that looks the
most like an economy on Mars.
So what's the furthest awayeconomy?
(18:47):
What's a commodity that peopleare going to need regardless of
economic cycle?
What's a?
What's a commodity that isgoing to be in more demand
versus its supply structurallyover the next 10 years.
Speaker 1 (19:00):
Those are the things you want to align with, and
carbon is one of those it'sinteresting I'm looking at on my
other screen the krbn etf inthe midst of the tariff tantrum
and yeah, it's true, for themost part it didn't really
respond the way broader equitiesdid, so clearly did act like a
(19:21):
diverse fire during that periodyeah, it did, it did and then.
Speaker 2 (19:24):
But then you've always got, um, you know that
curveball that comes in, whichis okay, so it's not responding
to tariffs.
Because of its structuraldesign the way Europe is
designed it has a marketstability reserve that is always
pulling down.
Essentially, it's like theopposite of quantitative easing
for this market that theEuropean government will take in
(19:46):
more of these credits if thesurplus is too high and keep
upward pressure on that price.
But then you kind of go aroundthe block again and you think,
well, okay, but if the tariffscause economic slowdown, then
that may cause less purchasingof credits in the future.
So it's important to note thatwhen you diversify, you're sort
(20:10):
of reducing the likelihood of of, you're reducing your risk in
theory and often it works verywell, but you can always have um
exposure to risks and new risk,and, and certainly any
investment always comes with itsown risks.
And so if you buy a diversifierthat performs terribly, um, it
(20:31):
may have diversified you, butmaybe 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 convincethem there's this riskless thing
that they can do.
But diversifying with trueassets, with assets with truly
sort of different return drivers, exposure to different factors,
(20:55):
are going to be beneficial.
And then, when you come to anenvironment that we're in now
and I think this is why we'reseeing this shift to
alternatives because anotherdefinition I think is incorrect
on alternatives is people think,well, it's just their private
assets, so you've got publicequities and then you've got
private equity is a diversifier,and I think the cat's out of
(21:18):
the bag a little bit.
Everyone's realizing now thatprivate equity is not really the
diversifier you think it is.
It's just the way it's markedmakes it seem like it has a
different sort of experience.
But that's really just down tohow they're valued, and I think
we're seeing in the publicmarkets more and more of these
(21:39):
private type assets.
So what I like to look for?
So we're seeing private equityand private credit getting into
ETFs now very interesting.
But I find things like carboneven more interesting, because
these are assets that theso-called you know the smart
money, you know the familyoffices, the endowments, the
folks that have a long timeline,they're comfortable committing
(22:03):
money to a long-term strategyand their portfolios can be, you
know, 40% or more alternativeassets, and so when you see that
what those folks are doing andthe mainstream tends to follow
them on a bit of a lag then Ithink it's quite exciting that
we're able to package thingslike carbon into an ETF so that
(22:26):
your audience, the traditionalfinancial advisor, can actually
put their smaller clients intothe sorts of allocations that
the big family offices andendowments have been doing for
the last 10 years.
Speaker 1 (22:39):
And mechanically it's doing it through the futures
side, right, Talk to me aboutthat.
Speaker 2 (22:43):
Yeah, yeah, I mean for our institutional clients,
we have a private fund that webuy the futures and take
delivery of the actual creditsthemselves.
But for our public offerings,krbn take delivery of the actual
credits themselves, but for ourpublic 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
(23:10):
year, everyone thinks, well,california sounds that, sounds
fantastic.
That's the thing I want.
It's great we have a fund thatdoes just that.
Kcca Gets you along thoseCalifornia 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 basketand that's where you really get
(23:33):
the correlation benefits in thatglobal fund.
But of course and I always saythis that the European market is
the biggest carbon market, it'sthe most stable, it's already
the tightest market, and so Ithink it's interesting to be
long the global, because beinglong just one gives you the
idiosyncratic risk of that onemarket versus the most
(23:56):
established market.
Europe is a great backbone.
So I love the KRBN, but so manyof our investors are interested
in KCCA right now.
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 thosemarkets.
We'll only have to put about20% of our capital with the
exchange.
So the other 80% of the capitalwe then get to invest in sort
(24:19):
of ultra short duration, ultrahigh quality fixed income, and
so we can earn another yield onthat money as well.
It's not leverage, we're justdown in very high quality
collateral and then we'regetting that exposure in the
futures market.
And that is worth noting,because when people try and
(24:39):
invest in oil or natural gasit's incredibly expensive.
You pay a management fee, butthe shape of the futures curve
is pricing in future prices.
It's called contango.
A lot of you know the term, butit just means that when the
prices in the future are muchmore expensive than the prices
in the front or the spot market,and so that's a challenge,
(25:00):
because if you think something'sgoing up but you're already
paying 20% more for it, thenit's a lot harder to make a
positive return.
So it's worth noting that whenyou subtract the risk-free rate
that we're earning on ourcollateral, we're only talking
(25:22):
about a percent or so of curveshape, so very effective to hold
futures here and that's why wedo it, because it's the most
liquid way to access this market.
And it's worth noting that thefutures traded close to a
trillion dollars last year.
About 70% of that is out ofEurope, california, uk, other
big chunks of that market.
But, yeah, it's a highly liquidinstitutional asset class, so
(25:42):
futures have been very efficient.
Speaker 1 (25:43):
Is there something to the idea of there being like an
active management component toit, as opposed to sort of an
indexation approach?
Speaker 2 (25:50):
Yeah, and this is the bit we haven't touched is what
do we think the performance hasbeen?
So it's interesting.
We had, you know, Californiahad a 30% year a couple of years
ago and Europe had 100% year orthe Global Fund had 100% year
back in 2021.
The challenge is that, becauseof the invasion of Ukraine,
(26:11):
which completely disruptednatural 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 camedown on that energy crisis we
actually had really, you know ithurt the price of carbon and
we're only now so 2022 through2024, we had a pretty rough time
in European carbon.
(26:31):
Likewise, in California, we hada delay in rulemaking where
they were going to implement anextension from 2030 to 2045 and
also implement a 20% increase intheir ambition, and that got
delayed for a year.
So we've actually had a coupleof tough years in carbon, and
where we are today is this sortof inflection point where
(26:52):
California is at its floor.
So its kind of base case, oreven, I should dare say, the
bear case, is this 8%, which anyof us would take 8% a year
return if there's very littledownside risk to that.
Because of the floor Europewe're trading around 70 euros a
ton, we're on our way back intothe 100 euro a ton range and all
(27:16):
the forecasts have thesemarkets returning, especially if
you take our global basket.
We think there's something likea 20% a year return, as these
markets kind of find their notjust the floor prices but their
sort of true upside potential20% a year through 2030 and
beyond.
So the return that the market'sforecasting here is very
(27:39):
attractive, and so to have thatpositive upside, I would almost
never say to someone you shoulddiversify for the sake of
diversifying.
You want to find things thatare really going to perform, but
also do it in a way that isn'tjust a levered version of the
regular stock market.
So that's what I think this is.
This is something with somerisk.
It's also got great returnexpectations and it has that low
(28:06):
correlation.
So what's exciting about thisisn't just that it's got a low
correlation, it's that it has avery high expected return.
That also comes with areasonable amount of risk, and
so that's why I call this.
I think this is the ultimatealternative.
When you stack it up againsthow you define an alternative.
(28:26):
Does it have independent return, Does it have a structure that
will support it through variouscycles?
Does it have an entirelydifferent cycle to it through
various cycles?
Does it have an entirelydifferent cycle to everything
else and does it have a lowcorrelation?
You start putting those thingstogether.
You get something.
You almost um, you make thatvenn diagram of all those things
.
I think that you have krbnright there in that, in that
(28:48):
little, in that very smalloverlap that can do all of those
things.
Speaker 1 (28:52):
Is there anything that could fundamentally alter
the carbon market politically?
I mean, obviously, with Trumpand him getting the EPA and kind
of a general sort of distastefor this sort of way of thinking
about the world?
Speaker 2 (29:07):
Yeah, well, definitely when people ask me,
what creates vol here?
What is the risk involved in aninvestment?
When I say risk, I don't meanwhat makes this go away, but
what creates volatility.
What will reduce these upsidenumbers that we're talking about
(29:29):
?
Driven market, and that's partof why it's got a low
correlation, because you'recorrelating to policy rather
than you know GDP growth orearnings per share or whatever
whatever other metric you'reusing to to analyze the stock
market.
And so when you have a so, forinstance, trump put out an
(29:53):
executive order and that talkedabout states' climate plans and
how that shouldn't be allowed toget in the way of US energy
independence.
Now, on one hand, of course,this is very important.
On the other hand, the federalgovernment doesn't have a right
to interfere with certainstates' policies, and the
(30:17):
California market has some volaround this exact period because
that is disconcerting forinvestors.
If you've got lack of clarityon policy, then that's going to
drive volatility in the market.
So that's exactly where the volcomes from in this market is
will they extend?
Will they tighten?
Will they get delayed in courtswith the federal government?
(30:40):
Will there be a reduction inemissions due to technological
advances?
That's going to reduce thedemand for carbon credits.
All of these things are feedinginto the price of carbon.
But here's why a lot of this isnoise and is causing
unnecessary vol.
(31:01):
But I almost sort of half jokethat if we didn't have this vol,
this investment wouldn't thereturns.
The only reason we're notcapturing these returns is
because of this uncertainty.
It's almost as if the you knowportfolio gods have said look,
this is designed to give you a20% a year return.
(31:22):
You can't have that for free,you have to have vol with it.
And somehow, through policy andpolitics and shifts in
sentiment around things likeenvironment, things like climate
, things like energy transition,you're getting all this
volatility.
So if you can stomach thevolatility, the end outcome is
(31:43):
actually a low of all outcome,which is these programs are
designed to be significantlyhigher by 2030 and beyond, to
2045, 2050, and so on.
So those are risks, but why?
I also don't think one.
Legally, these programs are allpart of law European law,
california law, quebec I'vementioned a lot of the other
countries have them.
(32:03):
These are ingrained in law andyou need law again to reverse
out of them.
But this is not.
This is pure capitalism.
This is the capitalist solutionto creating a price mechanism
that shifts people into greenerenergy, and so the way it does
that is it's they sell thesecredits and they make so much
(32:25):
money.
So Gavin Newsom just put outthe California budget, and to
balance California's budget,they need the revenues they get
from selling these permits, andso the California state
government is bipartisan supportfor this.
This is a revenue source forthe state, and this revenue
source is what pays for ourstate, and so it's too big to
(33:03):
fail.
This is not a nice-to-have ESGinitiative that people don't
like.
This is a core part of whereCalifornia raises revenue
burning coal, which makes thisprogram expensive for them,
because they'd rather keepburning cheap coal and not have
to pay for the permits the extrapermits they need because
they're burning coal.
But Europe, those countries whenthey look at the alternative,
which is we keep burning cheapcoal, but then we don't get all
these revenues from sellingthese credits, then how are we
(33:27):
going to continue, continue tothrive, and so these programs
are almost the perfect solution,and just to recap how they work
the governments sell a permitfor every ton of pollution that
comes out of an industrialcompany, those companies, and
these aren't egregious prices,it's it's not, it's not like
(33:48):
massively inflationary, but itis inflationary, but it's a
friction point.
You have to buy permits.
That cost money.
And any smart industrialist isgoing 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 weneed this many carbon credits?
Are there ways to moreefficiently run our business
(34:09):
where we can save money on thesecredits?
And then what they start torealize is well, why don't we
stop burning coal and startburning natural gas?
Because then we'll have to buyway fewer Natural gas.
When you burn, it has only halfthe emissions of coal.
Then they start to say well,actually it's cheaper to invest
in solar.
Or in fact we should startlooking at building nuclear
(34:29):
reactors instead of coal-firedplants, because it will be
cheaper.
And what happens is thegovernments make a revenue, the
companies start to innovate andinvest in better technology so
that they don't have to pollute.
And on the margins, where somepeople start to see more
expensive energy bills becausewe're switching up the food
(34:51):
chain.
Of course, as you switch up thefood chain and then you grow
and you scale, the cost comesback down again.
But in the interim there mightbe some friction points where
people will see higher energyprices.
But then what you do is youtake the revenues earned by the
program and you feed that backdown on those margins and you
subsidize energy at that end tothose people that need it
(35:13):
subsidized, and you actuallyhave an almost perfect solution.
And that's why these programsare growing Not so much in the
US, california and the Northeasthere are the only, and
Washington are the only programsthat are here now.
But when you realize that we doneed to make these changes, it's
inevitable.
This is the only way to do it.
(35:33):
You can't give subsidies topeople to go green or to switch
to EVs.
There's not enough money in theworld to do that.
But if you put a pain point, afriction point, then humans,
we're great engineers, we aregreat innovators.
You make something expensivefor us, we'll innovate our way
out of it, and so these programsare designed to rise and create
(35:59):
this massive flywheel ofinnovation and scaling, of
better technology.
And by design, they need thatprice to go up and we as
investors get to buy this assetand participate in its growth in
price.
So it's so unique that we getto be on this ride and up till
now, it's mainly the biginstitutions and big family
(36:20):
offices that have the access tothese markets that have been
able to participate in this.
But we've put it in an ETF formand you can get access to this
today in the same place you buythe S&P 500.
Speaker 1 (36:31):
Speaking of that, let's talk about pairing it with
the S&P 500 or just in general,core satellite.
Not investment advice, buttypically what do you see in
terms of the allocations,weightings, things like that?
Speaker 2 (36:41):
Yeah, I mean you'd be surprised, and maybe not so
surprised On the high end.
We've seen people up to about8% in this asset class and then
you really start to see theefficient frontier shifting out
to the left.
But of course that's quite abig, that's a big allocation.
So I think I mean we'vecertainly seen institutions that
have accounts or portfolioswhere they are up to 8% in our
(37:05):
global carbon fund or similarexposures, which I think is
quite surprising.
But that actually makes a lotof sense.
If you've already allocated tostocks, bonds and then
traditional real estate, gold,all the traditional things, this
is a very interesting way toallocate.
But generally we see this assort of a 2% to 4% allocation in
(37:26):
the portfolios that use it.
And you might say, well, what'sa classic portfolio that uses
it?
We're seeing this in some ofthose sort of longer-term,
forward-thinking portfolios.
It's just in the completelystandard portfolios.
What we've also seen is peoplesaying, well, long-term, we like
commodities, but we don't seeoil and gas in the future and
(37:50):
we're looking for that commodityreplacement.
So we found ourselves in anysort of impact or sustainability
aware portfolios.
We've seen people justreplacing commodities.
People don't want to buy, um,you know, necessarily metals,
industrials, um uh, agriculture,things that are expensive to
(38:11):
hold, commodities.
Commodities are expensive tohold, carbon is not, and so
we've seen people replacingcommodities with carbon.
And that's when you start torealize, that's when a 6%
actually starts to make a lot ofsense.
Speaker 1 (38:24):
I think the case is definitely compelling and the
alternative arguments obviouslyare very strong.
Strong, especially if we'regoing to be in a volatile
environment anyway.
You want to diversify yourvolatility sources as much as
possible.
Um, maybe a stupid question,but then you know, volatility
aside, why not, just ifsomebody's very aggressive, why
not just take a lever better onit?
(38:44):
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 tothat dreaded word from a
compliance perspective, current,guaranteed as possible, why not
just go very aggressive?
Speaker 2 (38:57):
yeah then.
But that's people, can people,that's uh, you know you can.
Uh, you can get at least twotimes leverage on on uh, on an
etf, and there's also optionsout there.
We have, uh, fairly liquidoptions on the global fund and
our California.
In fact we know some investorsdo get long our California
through buying calls.
So leverage is there.
(39:19):
But again, that's when.
Yeah, asset allocating to lowcorrelating diversified assets
is one thing.
Taking a levered bet on andbeing very concentrated is a
different, is a different thing.
So, um, certainly, I know in mypersonal account I've got I'm
probably overweight um, you knowI've got both the global and
(39:40):
the california products that Ihold and I'm probably overweight
the sort of standard umallocations.
But yeah, that's a.
That's a different um.
I'll leave the leverage for thepeople that want to.
If, if you want to tradesomething like the California
that, like I say, is tradingnear its structural floor and
therefore has arguably a lot ofvery heavy support and then a
(40:03):
free upside, that's potentiallya great levered bet.
But again, be very careful withleverage and I tend to prefer
to not be levered and just sizemy position right.
So if you're very positive onthis, have a bigger weight to it
.
But yeah, leverage is usuallywhere things unravel for people.
Speaker 1 (40:24):
Other than the carbon market, since I know
Craneshares obviously is verybig on the China side.
Is there an argument to me thatmaybe Chinese equity markets in
some way shape or form arealternative?
Speaker 2 (40:34):
Oh, for sure, For sure they are.
Yeah, I mean it's interestingbecause when you've got Chinese
companies that make most oftheir money in China like a lot
of the names that we have inKWeb joking aside, that is as
close to when I was joking aboutcould you invest in the Martian
(40:57):
economy it starts to feel likethat.
If you've got 1.4 billion peoplethat have their own money,
spending their own money withthese companies that make most
of their money from these people, and it's all inside China,
that is very isolated from otherdrivers that are driving the
other economies, and so I thinkthat's, I think looking at China
(41:21):
as a diversifier is is exactlyas makes complete sense, and I
think I think even us seeking tohave to become experts in
carbon in managed futures.
We've got an inflation hedgeproduct as we diversify.
I think that's where it comesfrom, from our China DNA, that
that is also arguably theultimate alternative, and you've
(41:45):
got an economy that's growingfaster than most of the rest of
the world, is second behind theUS, and valuations in China are
so much lower than thevaluations on US stock.
If we have any sort of you knowand we're sort of seeing, we're
going through the process, butas we see improvements in the
(42:05):
geopolitical space, I think thiswill be exactly where a lot of
alternative dollars will end up,and so they should.
Speaker 1 (42:13):
Luke, for those who want to learn more about the
carbon funds and green shares ingeneral, what would you
recommend and maybe talk througha little bit about the broader
suite?
Speaker 2 (42:22):
Yeah, yeah.
So as a firm, craneshares.
Cranesharescom is where you'llfind everything, and we kind of
characterize ourselves, as youknow and and you've probably all
seen brendan ahern either hereor he was on fox business
yesterday and or last week anduh, constantly on bloomberg and
cnbc we're everything for china,we, we, we've got the the
(42:45):
deepest bench of china expertshere and we have a a daily
newsletter that goes out oninvesting in China, called China
Last Night, and then sort of asthe carbon equivalent.
So we've got China, we've gotalternatives, and then, within
the alternatives, we have a realfocus on climate and we have
climate markets now, which is aweekly that we put out that
(43:06):
focuses on these markets.
You can sign up for any ofthese.
You'll see them.
You go to cranesharescom,you'll see our blogs that you
can sign up for at the top andyou'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 reallyhealthy alternatives lineup and
there's some great, greatproducts in there, and you'll
(43:28):
see that we've got some greatpartner sub-advisors as well
that we work on to give us thatdiverse lineup.
So we've got a lot of in-housecapabilities, and then we've got
some excellent sub-advisorsthat are always very happy to
get on and talk to clients aboutthese strategies.
But that's what people arelooking for now.
You've got to start to thinkabout being diversified At some
(43:51):
point.
Just being along the S&P 500isn't going to cut it.
You're going to need someallocations that are getting
their upward momentum fromsomething else and with low
correlations those US equitiesand you start to see that
playing out.
I saw that the flows arestarting to point towards bigger
(44:17):
holdings that look more likecash than they do equities.
But of course, you still needsome return and you still want
to see.
If you start to see rates comeback down.
Then is that good for equities?
Is it good for fixed income?
You've got to have thosealternatives in there as well.
Speaker 1 (44:29):
From your lips to God's ears, because I think
everybody's waiting for anenvironment where it's not just
about the S&P, but certainly thecarbon market is an utility of
its own Everybody.
Please learn more aboutCraneshares on their website.
Make sure you follow LukeOliver also on X, and I'll see
you all in the next episode ofLead Lag Live.
Speaker 2 (44:46):
Thank you, luke, appreciate it.
So when we think about constructing a portfolio
of alternatives, I got to assumethat correlation as a metric
alone is not enough to reallykind of figure out how to mix
and match things.
Speaker 2 (00:09):
Well, yeah, and there's also.
There's a big drawback, whichis you can show things.
I'm going to show you somethingwith a very low correlation to
equities that I really like, butthere's no escaping the reality
that, unless you found aneconomy on Mars that you could
invest in then which would haveno correlation to US equities,
but that doesn't exist,presumably, something is more
(00:31):
likely to be alternative ifthere are mandates for what
those investment strategies aredesigned to take advantage of,
and with that I'm obviouslysegueing to the carbon market.
Speaker 1 (00:41):
So let's talk about that.
Speaker 2 (00:43):
So why do I really like carbon?
Well, you know it's got a 0.3correlation, global carbon 0.3
correlation to US equitiesincredibly low, and when you
look at the forecasts and thedemand supply for compliance
carbon, you've got a very highpotential upside and it looks
something like double the riskof equities but double the
returns with a 0.3 correlation.
(01:05):
And that is a very magicalblend of characteristics for
something to put into aportfolio with your gold, with
your bonds, with your equities.
Speaker 1 (01:17):
My name is Michael Guyette, publisher of the Lead
Lag Report.
This is a sponsor conversationsponsored by Crane Shares, one
of my clients and, of course,the man of the hour, mr Luke
Oliver.
Luke, I don't know how manypeople are familiar with your
name, but your name is a verystrong one.
I will say Luke Oliver is avery strong name.
I just got to say that up front.
I got to get you excited aboutthat at least.
(01:38):
So introduce yourself to theaudience.
Who are you?
What's your background?
What audience?
Who are you?
What's your background?
What have you done throughout?
Speaker 2 (01:43):
your career?
What are you doing atCraneshares?
Yeah, so I started my career inLondon, always been in finance
and I joined Deutsche Bank and Iwas on the sales side in
foreign exchange and I lovedthat, got very involved in
derivatives over there but thensort of migrated through
Deutsche Bank into commodities,then started running commodity
portfolios and then sort ofbacked into being an asset
(02:06):
manager while still being on thesales side of Deutsche Bank and
we ran some successfulcommodity ETFs that we sold
through another ETF issuer andthen we decided that we should
get into the ETF game ourselvesand launched the X-Trackers ETF.
So ended up running thatbusiness out of the US and we
had some big, big products overthere the first A-Shares, first
(02:28):
CurrencyHedge, dts and I wantedto come and join a really truly
innovative firm and kind of takethat innovation and creativity
and new ideas for alternativeallocations and go somewhere
that can really execute well onthat.
And that's what took me toCraneShares somewhere that can
really execute well on that.
And that's what took me toCraneShares.
And CraneShares, as you may know, are absolute top draw China
(02:50):
asset manager and our flagshipproduct, kweb, is perhaps the
most well-known China ETF in theworld, so very prominent in
that China and emerging marketspace and what I do is wear a
couple of hats.
I'm sort of the strategist forthe firm, but I also am, you
know, have my own pet suite ofproducts that that's very near
(03:11):
and dear, because they arefantastic products and we focus
on sort of the alternatives orlike the carbon ETS that we have
a KRBN, kcca, so they're mybabies, if you like.
That I really love to talkabout.
But I think that the biggestsort of pivot that I've had in
the last couple of years isthrough being in these more
(03:34):
exotic alternatives.
Is you actually start to is avery sort of endowment, family
office, long-term thinking,long-term community capital type
investor space, and it'sfascinating because I think that
is what we're seeing otherportfolios migrate to.
(03:56):
So I think it's a lot going on.
Speaker 1 (03:58):
All right.
So let's do table stakesdefinitions, because I think a
lot of people when they hear theword alternative, they think
alternative to making money,because alternative is not
really made that much money.
It's been a beta, cheap betatype of world for yeah, let's
call it a decade, roughly adecade plus.
Speaker 2 (04:18):
But let's define what an alternative is first.
Yeah, Well, alternative is andit's a funny definition because
there's so many things that youdo or have done that is
different to holding the S&P 500.
And historically it hasn'tserved us well and we would have
just been better off being longthe S&P 500.
But when you think aboutalternatives really not to be
too rudimentary in ourconversation but you've got
(04:42):
equities and you've got bonds,and for the longest time they
were the two main buildingblocks Most portfolio, or a lot
of portfolios, still only reallyhold those two things.
Some portfolios don't even holdany bonds.
But if you think about why youwant alternatives, it's about
having different risk return,the idea being that if you
invest in assets that all go upover time, but they all go up
(05:04):
over time at different levels,different rates and at different
times, you can really smoothout the experience.
And so your ideal portfolio ismade up of lots of things that
all perform well, but they'reall performing well at different
times and are in differentcycles and have a low
correlation to one another.
So when I say what is analternative, or I want to define
(05:25):
an alternative, the very easyway to define.
That is something that we thinkhas positive growth story but
also has a very low correlation,or the lowest correlation we
can get, to large cap USequities.
So think of large cap USequities as your core.
And then what do you add tothat to improve the overall risk
(05:46):
return?
Because this is another keything about alternatives they're
often not always, but lots ofthem, lots of the interesting
ones are very volatile, and sohow does putting something more
volatile in your portfolioimprove it?
Well, if the correlation is lowenough and its volatility is
happening to the upside whenstocks are going down and to the
downside when stocks are goingup, you actually reduce that
(06:09):
overall volatility.
So actually, maybe even abetter definition is something
that reduces your volatility ofyour portfolio without
detracting from its return.
Speaker 1 (06:20):
Correlation's a funny term because, as you know, most
people confuse correlation withcausation.
Things can have spuriouscorrelations which are not based
on anything except randomness,and then they can have changing
correlations based on marketvolatility picks up, like the
safety dynamics, for example,and gold and other types of
asset classes.
So when we think aboutconstructing a portfolio of
(06:41):
alternatives, I got to assumethat correlation as a metric
alone is not enough to reallykind of figure out how to mix
and match things.
Speaker 2 (06:50):
Well, yeah, and there's also.
There's a big drawback, whichis you can show things.
I'm going to show you somethingwith a very low correlation to
equities that I really like, butthere's no escaping the reality
that you found an economy onMars that you could invest in
which would have no correlationto US equities, but that doesn't
(07:11):
exist.
And so even when you takethings like China, which we
think is a fantastic place todiversify, or the carbon markets
, or commodities, or Bitcoin, oryou name something that has a
different relationship, there isthe susceptibility of that
correlation.
While historically might beunder 0.5, or call it 0.5, as
(07:35):
soon as you get some massiveglobal macro event, these
correlations can all spike.
Bonds and equities can both godown.
If there's a big risk event inthe market, or if you have an
economy that has had lowcorrelations, well, if there's a
big economic situation in theUS, that will affect all sorts
(07:57):
of economies negatively.
And then you also get thesekind of contagions where, if the
US equities are down, peopleare getting margin calls, so it
means they have to trimpositions 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 shouldbehave like gold.
If it behaved like gold, itwould do incredibly well.
(08:20):
It's obviously done well, butbecause when there's risk off,
bitcoin sells off as well, it'snot really doing its job as a
diversifier.
So what to be wary of with thatcorrelation point is that
something with statistically lowcorrelation is probably a good
diversifier, but it's not a getout of jail free card.
(08:43):
The likelihood is that there arecertain events that happen To
your point.
Things don't have a lowcorrelation necessarily because
of some relationship betweenthem.
They just happen to notcorrelate most of the time.
But when some bad things happen, they can both move together.
Or good things happen, they canboth move together.
So you do have to kind of takea little bit of a pinch of salt
(09:05):
with that correlation number.
It's important, though, butyou're right, it can be, it can.
People can be left feelingdisappointed when, when, when
things suddenly correlate justwhen they didn't want it to
correlate.
Speaker 1 (09:19):
Well, I think it's sort of the big point, right?
It's like that's the joke aboutdiversification, right, it
looks like it's diversifieduntil you know the event happens
.
Everything correlates to one,and then what's the point of the
diversification?
So I do think there's somethingto the idea that in general,
there aren't that many in quotestrue alternatives, right it's
certainly at the extreme it'sdifficult to find and you have
(09:41):
to find things that you know.
Speaker 2 (09:44):
What's nice is the sorts of flight to safety assets
or if you take something withyou know where I started my
asset management career was incommodities, and something we do
very well at CraneShares.
We have a managed futuresproduct.
Do in that product is not justbe long commodities which is
(10:06):
what I used to do and findefficient ways to be long.
We actually will be long andshort and we'll be long and
short commodities, currenciesand rates, and so you're taking
something that we're not justlong and we're looking at
momentum to decide when we wantto be longer or shorter in each
of those commodities, each ofthose currencies.
So when you package that up, youdo start to get something that
(10:26):
has very low correlations andwill not really correlate
necessarily with some of thosebig macro events.
So there are ways of doing itand you have to really sort of
try and find something veryunique about the structure of
the particular market.
That will mean that even inthose events where correlations
(10:47):
are spiking, these shouldn'tspike too much and of course, if
something becomes very popularand becomes more mainstream, it
starts to become moresusceptible to being correlated
again because of those peoplegetting margin calls and having
to rebalance and things likethat.
So it's very hard and that'swhy it's not easy and that's why
(11:07):
we have a whole industry thatwe're all in providing the tools
for investors to try and findthose diversifying allocations
in their portfolio.
Speaker 1 (11:19):
And going back to the causation points, presumably
something that is more likely tobe alternative if there are
mandates for what thoseinvestment strategies are
designed to take advantage of,and with that I'm obviously
segwaying to the carbon marketExactly.
Let's talk about that, becauseI think you and I have talked
about this in the past.
It's a growing part of themarketplace, right?
(11:41):
The correlation dynamics Ithink are fascinating, but I
want you to kind of first of allexplore with the audience that
point about if you're going togo for something that's
alternative, it has to besomething that almost has a
structural reason for it to bedifferent, exactly, exactly.
Speaker 2 (11:54):
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 likeBitcoin right when and you're
long gold.
Now, when people want to sellequities because they're getting
(12:14):
nervous about the performanceof equities or they think
equities are too expensive, theywill say, well, where else can
we put our money?
Maybe we want to put it intofixed income, but then, if
you're worried about the economyand stock price, maybe you're
worried about getting paid backon those bonds.
You don't want that either.
And so you say, well, I needsomething else, and that
something else historically wasgold.
(12:34):
So you would buy gold, youwould see stocks coming down,
you see gold going up.
Now you've got Bitcoin, which islike a digital gold.
I mean, everyone's got adifferent view.
My view is just simply, it's astore of value.
It's now big enough andestablished enough and liquid
enough that it does have thatcharacteristic.
So it's a little bit likeholding gold in a digital format
(12:55):
, and so you should start to seeBitcoin going up when stocks go
off.
But, of course, when people getnervous about stocks and they
feel like they need to trimtheir risk.
They also look at Bitcoin asrisk and trim that as well, and
so we're not seeing the realbenefits.
It's still.
I own some.
It's a good thing to have aspart of a diversified portfolio,
(13:17):
but it's not really doing thatdiversification thing that we
want it to do, because there'sno structural reason to really
hold it.
Same goes for gold.
So why do I really like carbon?
Well, high level, it's got a0.3 correlation, global carbon,
0.3 correlation to US equitiesincredibly low.
(13:38):
And when you look at theforecasts and the demand supply
for compliance carbon, you'vegot a very high potential upside
and it looks something likedouble the risk of equities but
double the returns with a 0.3correlation, and that is a very
magical blend of characteristicsfor something to put into a
(14:01):
portfolio with your goal, withyour bonds, with your equities.
But your question was aboutwhat structurally makes carbon
interesting.
Now this is a new asset class,so I could go in a few
directions explaining it, butlet me take the California
carbon market as an example toshow you just why the structure
(14:24):
is likely to maintain very lowcorrelations to equities.
How can they be similar?
Well, if the economy is doingbadly, stocks will do badly, and
just so you understand whatcarbon is in the simplest way.
About 25% of the global economyhas a carbon market.
We're not talking about ESG,we're not talking about planting
(14:48):
trees.
There is a traded commodity,essentially a permit that
companies have to buy thatrelates to the amount of CO2 or
methane that they're puttinginto the atmosphere.
This is a trillion dollarindustry.
Not everybody's heard of it.
It's massive and it's a hugepart of the economies of the
(15:08):
state of California, of theCanadian economy, the European
economy.
They are selling hundreds ofmillions of these credits to big
household name companies thatmust buy them by law.
So and please jump in if youwant me to pull back or speed up
or because it's a little bit ofa complicated space but
(15:29):
essentially they are sellingthese permits, which are kind of
like a commodity themselves,and the law backs that for every
ton of pollution that companyemits, they must buy one of
these credits and return it backto the government.
So the demand is mandated bylaw.
The supply of these credits.
(15:50):
They're auctioned by theEuropean Union, by the state of
California, by the UK.
The Chinese have a program, theJapanese have a program,
australia and New Zealand, theyall have the same mechanisms.
In the Northeast.
Here in New York we have aprogram that covers energy
production on the wholeNortheast and corridor there,
(16:12):
and so you have supply, which iskind of managed in the same way
as, say, the Fed managesliquidity, in that they can
tighten and ease, but we are onone tightening cycle until 2050.
So you have a mandated demand,you have a mandated supply.
The government policy has atightening supply mechanism that
(16:33):
reduces the amount of creditsbeing sold into the future.
And then in California there isa floor price that steps up
every year by whatever inflationis plus 5%.
So if we have 3% inflation, likewe're estimating now, that
means every year the floor pricegoes up by 8%.
And so you have a market with afloor that goes up 8%.
(16:56):
It has a ceiling price that isalso going up by 8%, and then
you have a tightening of thismarket every year out beyond
2030, out to 2045 is where theyhave their targets beyond 2030.
And that is designed to pushthat price higher.
And as the price pushes higher,what it does is catalyze more
(17:18):
capital into switches from highcarbon intensity to low carbon
intensity.
So you get this massivemultiplier effect in the economy
, in investment, in lower carbonindustry, whether that be
shipping, transportation, energyproduction, steel glass you
(17:41):
name it natural gas, both theusage and manufacturer.
So that's why this is different, because even in a bad economy,
when you might think riskassets are selling off, we have
a floor price and we have afloor price that ratchets up by
8%.
So when you enter something intothe market that can't be hedged
(18:03):
is a structural finger on thescale for a price of an asset,
that's something that's worthlooking at.
And when the prices align sofor instance, when California is
trading near the floor like itis right now, you have this very
asymmetric opportunity whereyour downside is the floor that
goes up by 8% and your upside isup to the ceiling, which is a
(18:26):
couple of hundred percent higher.
So, yeah, does that make sense?
You need to find something thathas a market structure that you
know, almost you know Imentioned if you found an
economy on Mars, you want tofind something that looks the
most like an economy on Mars.
So what's the furthest awayeconomy?
(18:47):
What's a commodity that peopleare going to need regardless of
economic cycle?
What's a?
What's a commodity that isgoing to be in more demand
versus its supply structurallyover the next 10 years.
Speaker 1 (19:00):
Those are the things you want to align with, and
carbon is one of those it'sinteresting I'm looking at on my
other screen the krbn etf inthe midst of the tariff tantrum
and yeah, it's true, for themost part it didn't really
respond the way broader equitiesdid, so clearly did act like a
(19:21):
diverse fire during that periodyeah, it did, it did and then.
Speaker 2 (19:24):
But then you've always got, um, you know that
curveball that comes in, whichis okay, so it's not responding
to tariffs.
Because of its structuraldesign the way Europe is
designed it has a marketstability reserve that is always
pulling down.
Essentially, it's like theopposite of quantitative easing
for this market that theEuropean government will take in
(19:46):
more of these credits if thesurplus is too high and keep
upward pressure on that price.
But then you kind of go aroundthe block again and you think,
well, okay, but if the tariffscause economic slowdown, then
that may cause less purchasingof credits in the future.
So it's important to note thatwhen you diversify, you're sort
(20:10):
of reducing the likelihood of of, you're reducing your risk in
theory and often it works verywell, but you can always have um
exposure to risks and new risk,and, and certainly any
investment always comes with itsown risks.
And so if you buy a diversifierthat performs terribly, um, it
(20:31):
may have diversified you, butmaybe 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 convincethem there's this riskless thing
that they can do.
But diversifying with trueassets, with assets with truly
sort of different return drivers, exposure to different factors,
(20:55):
are going to be beneficial.
And then, when you come to anenvironment that we're in now
and I think this is why we'reseeing this shift to
alternatives because anotherdefinition I think is incorrect
on alternatives is people think,well, it's just their private
assets, so you've got publicequities and then you've got
private equity is a diversifier,and I think the cat's out of
(21:18):
the bag a little bit.
Everyone's realizing now thatprivate equity is not really the
diversifier you think it is.
It's just the way it's markedmakes it seem like it has a
different sort of experience.
But that's really just down tohow they're valued, and I think
we're seeing in the publicmarkets more and more of these
(21:39):
private type assets.
So what I like to look for?
So we're seeing private equityand private credit getting into
ETFs now very interesting.
But I find things like carboneven more interesting, because
these are assets that theso-called you know the smart
money, you know the familyoffices, the endowments, the
folks that have a long timeline,they're comfortable committing
(22:03):
money to a long-term strategyand their portfolios can be, you
know, 40% or more alternativeassets, and so when you see that
what those folks are doing andthe mainstream tends to follow
them on a bit of a lag then Ithink it's quite exciting that
we're able to package thingslike carbon into an ETF so that
(22:26):
your audience, the traditionalfinancial advisor, can actually
put their smaller clients intothe sorts of allocations that
the big family offices andendowments have been doing for
the last 10 years.
Speaker 1 (22:39):
And mechanically it's doing it through the futures
side, right, Talk to me aboutthat.
Speaker 2 (22:43):
Yeah, yeah, I mean for our institutional clients,
we have a private fund that webuy the futures and take
delivery of the actual creditsthemselves.
But for our public offerings,krbn take delivery of the actual
credits themselves, but for ourpublic 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
(23:10):
year, everyone thinks, well,california sounds that, sounds
fantastic.
That's the thing I want.
It's great we have a fund thatdoes just that.
Kcca Gets you along thoseCalifornia 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 basketand that's where you really get
(23:33):
the correlation benefits in thatglobal fund.
But of course and I always saythis that the European market is
the biggest carbon market, it'sthe most stable, it's already
the tightest market, and so Ithink it's interesting to be
long the global, because beinglong just one gives you the
idiosyncratic risk of that onemarket versus the most
(23:56):
established market.
Europe is a great backbone.
So I love the KRBN, but so manyof our investors are interested
in KCCA right now.
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 thosemarkets.
We'll only have to put about20% of our capital with the
exchange.
So the other 80% of the capitalwe then get to invest in sort
(24:19):
of ultra short duration, ultrahigh quality fixed income, and
so we can earn another yield onthat money as well.
It's not leverage, we're justdown in very high quality
collateral and then we'regetting that exposure in the
futures market.
And that is worth noting,because when people try and
(24:39):
invest in oil or natural gasit's incredibly expensive.
You pay a management fee, butthe shape of the futures curve
is pricing in future prices.
It's called contango.
A lot of you know the term, butit just means that when the
prices in the future are muchmore expensive than the prices
in the front or the spot market,and so that's a challenge,
(25:00):
because if you think something'sgoing up but you're already
paying 20% more for it, thenit's a lot harder to make a
positive return.
So it's worth noting that whenyou subtract the risk-free rate
that we're earning on ourcollateral, we're only talking
(25:22):
about a percent or so of curveshape, so very effective to hold
futures here and that's why wedo it, because it's the most
liquid way to access this market.
And it's worth noting that thefutures traded close to a
trillion dollars last year.
About 70% of that is out ofEurope, california, uk, other
big chunks of that market.
But, yeah, it's a highly liquidinstitutional asset class, so
(25:42):
futures have been very efficient.
Speaker 1 (25:43):
Is there something to the idea of there being like an
active management component toit, as opposed to sort of an
indexation approach?
Speaker 2 (25:50):
Yeah, and this is the bit we haven't touched is what
do we think the performance hasbeen?
So it's interesting.
We had, you know, Californiahad a 30% year a couple of years
ago and Europe had 100% year orthe Global Fund had 100% year
back in 2021.
The challenge is that, becauseof the invasion of Ukraine,
(26:11):
which completely disruptednatural 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 camedown on that energy crisis we
actually had really, you know ithurt the price of carbon and
we're only now so 2022 through2024, we had a pretty rough time
in European carbon.
(26:31):
Likewise, in California, we hada delay in rulemaking where
they were going to implement anextension from 2030 to 2045 and
also implement a 20% increase intheir ambition, and that got
delayed for a year.
So we've actually had a coupleof tough years in carbon, and
where we are today is this sortof inflection point where
(26:52):
California is at its floor.
So its kind of base case, oreven, I should dare say, the
bear case, is this 8%, which anyof us would take 8% a year
return if there's very littledownside risk to that.
Because of the floor Europewe're trading around 70 euros a
ton, we're on our way back intothe 100 euro a ton range and all
(27:16):
the forecasts have thesemarkets returning, especially if
you take our global basket.
We think there's something likea 20% a year return, as these
markets kind of find their notjust the floor prices but their
sort of true upside potential20% a year through 2030 and
beyond.
So the return that the market'sforecasting here is very
(27:39):
attractive, and so to have thatpositive upside, I would almost
never say to someone you shoulddiversify for the sake of
diversifying.
You want to find things thatare really going to perform, but
also do it in a way that isn'tjust a levered version of the
regular stock market.
So that's what I think this is.
This is something with somerisk.
It's also got great returnexpectations and it has that low
(28:06):
correlation.
So what's exciting about thisisn't just that it's got a low
correlation, it's that it has avery high expected return.
That also comes with areasonable amount of risk, and
so that's why I call this.
I think this is the ultimatealternative.
When you stack it up againsthow you define an alternative.
(28:26):
Does it have independent return, Does it have a structure that
will support it through variouscycles?
Does it have an entirelydifferent cycle to it through
various cycles?
Does it have an entirelydifferent cycle to everything
else and does it have a lowcorrelation?
You start putting those thingstogether.
You get something.
You almost um, you make thatvenn diagram of all those things
.
I think that you have krbnright there in that, in that
(28:48):
little, in that very smalloverlap that can do all of those
things.
Speaker 1 (28:52):
Is there anything that could fundamentally alter
the carbon market politically?
I mean, obviously, with Trumpand him getting the EPA and kind
of a general sort of distastefor this sort of way of thinking
about the world?
Speaker 2 (29:07):
Yeah, well, definitely when people ask me,
what creates vol here?
What is the risk involved in aninvestment?
When I say risk, I don't meanwhat makes this go away, but
what creates volatility.
What will reduce these upsidenumbers that we're talking about
(29:29):
?
Driven market, and that's partof why it's got a low
correlation, because you'recorrelating to policy rather
than you know GDP growth orearnings per share or whatever
whatever other metric you'reusing to to analyze the stock
market.
And so when you have a so, forinstance, trump put out an
(29:53):
executive order and that talkedabout states' climate plans and
how that shouldn't be allowed toget in the way of US energy
independence.
Now, on one hand, of course,this is very important.
On the other hand, the federalgovernment doesn't have a right
to interfere with certainstates' policies, and the
(30:17):
California market has some volaround this exact period because
that is disconcerting forinvestors.
If you've got lack of clarityon policy, then that's going to
drive volatility in the market.
So that's exactly where the volcomes from in this market is
will they extend?
Will they tighten?
Will they get delayed in courtswith the federal government?
(30:40):
Will there be a reduction inemissions due to technological
advances?
That's going to reduce thedemand for carbon credits.
All of these things are feedinginto the price of carbon.
But here's why a lot of this isnoise and is causing
unnecessary vol.
(31:01):
But I almost sort of half jokethat if we didn't have this vol,
this investment wouldn't thereturns.
The only reason we're notcapturing these returns is
because of this uncertainty.
It's almost as if the you knowportfolio gods have said look,
this is designed to give you a20% a year return.
(31:22):
You can't have that for free,you have to have vol with it.
And somehow, through policy andpolitics and shifts in
sentiment around things likeenvironment, things like climate
, things like energy transition,you're getting all this
volatility.
So if you can stomach thevolatility, the end outcome is
(31:43):
actually a low of all outcome,which is these programs are
designed to be significantlyhigher by 2030 and beyond, to
2045, 2050, and so on.
So those are risks, but why?
I also don't think one.
Legally, these programs are allpart of law European law,
california law, quebec I'vementioned a lot of the other
countries have them.
(32:03):
These are ingrained in law andyou need law again to reverse
out of them.
But this is not.
This is pure capitalism.
This is the capitalist solutionto creating a price mechanism
that shifts people into greenerenergy, and so the way it does
that is it's they sell thesecredits and they make so much
(32:25):
money.
So Gavin Newsom just put outthe California budget, and to
balance California's budget,they need the revenues they get
from selling these permits, andso the California state
government is bipartisan supportfor this.
This is a revenue source forthe state, and this revenue
source is what pays for ourstate, and so it's too big to
(33:03):
fail.
This is not a nice-to-have ESGinitiative that people don't
like.
This is a core part of whereCalifornia raises revenue
burning coal, which makes thisprogram expensive for them,
because they'd rather keepburning cheap coal and not have
to pay for the permits the extrapermits they need because
they're burning coal.
But Europe, those countries whenthey look at the alternative,
which is we keep burning cheapcoal, but then we don't get all
these revenues from sellingthese credits, then how are we
(33:27):
going to continue, continue tothrive, and so these programs
are almost the perfect solution,and just to recap how they work
the governments sell a permitfor every ton of pollution that
comes out of an industrialcompany, those companies, and
these aren't egregious prices,it's it's not, it's not like
(33:48):
massively inflationary, but itis inflationary, but it's a
friction point.
You have to buy permits.
That cost money.
And any smart industrialist isgoing 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 weneed this many carbon credits?
Are there ways to moreefficiently run our business
(34:09):
where we can save money on thesecredits?
And then what they start torealize is well, why don't we
stop burning coal and startburning natural gas?
Because then we'll have to buyway fewer Natural gas.
When you burn, it has only halfthe emissions of coal.
Then they start to say well,actually it's cheaper to invest
in solar.
Or in fact we should startlooking at building nuclear
(34:29):
reactors instead of coal-firedplants, because it will be
cheaper.
And what happens is thegovernments make a revenue, the
companies start to innovate andinvest in better technology so
that they don't have to pollute.
And on the margins, where somepeople start to see more
expensive energy bills becausewe're switching up the food
(34:51):
chain.
Of course, as you switch up thefood chain and then you grow
and you scale, the cost comesback down again.
But in the interim there mightbe some friction points where
people will see higher energyprices.
But then what you do is youtake the revenues earned by the
program and you feed that backdown on those margins and you
subsidize energy at that end tothose people that need it
(35:13):
subsidized, and you actuallyhave an almost perfect solution.
And that's why these programsare growing Not so much in the
US, california and the Northeasthere are the only, and
Washington are the only programsthat are here now.
But when you realize that we doneed to make these changes, it's
inevitable.
This is the only way to do it.
(35:33):
You can't give subsidies topeople to go green or to switch
to EVs.
There's not enough money in theworld to do that.
But if you put a pain point, afriction point, then humans,
we're great engineers, we aregreat innovators.
You make something expensivefor us, we'll innovate our way
out of it, and so these programsare designed to rise and create
(35:59):
this massive flywheel ofinnovation and scaling, of
better technology.
And by design, they need thatprice to go up and we as
investors get to buy this assetand participate in its growth in
price.
So it's so unique that we getto be on this ride and up till
now, it's mainly the biginstitutions and big family
(36:20):
offices that have the access tothese markets that have been
able to participate in this.
But we've put it in an ETF formand you can get access to this
today in the same place you buythe S&P 500.
Speaker 1 (36:31):
Speaking of that, let's talk about pairing it with
the S&P 500 or just in general,core satellite.
Not investment advice, buttypically what do you see in
terms of the allocations,weightings, things like that?
Speaker 2 (36:41):
Yeah, I mean you'd be surprised, and maybe not so
surprised On the high end.
We've seen people up to about8% in this asset class and then
you really start to see theefficient frontier shifting out
to the left.
But of course that's quite abig, that's a big allocation.
So I think I mean we'vecertainly seen institutions that
have accounts or portfolioswhere they are up to 8% in our
(37:05):
global carbon fund or similarexposures, which I think is
quite surprising.
But that actually makes a lotof sense.
If you've already allocated tostocks, bonds and then
traditional real estate, gold,all the traditional things, this
is a very interesting way toallocate.
But generally we see this assort of a 2% to 4% allocation in
(37:26):
the portfolios that use it.
And you might say, well, what'sa classic portfolio that uses
it?
We're seeing this in some ofthose sort of longer-term,
forward-thinking portfolios.
It's just in the completelystandard portfolios.
What we've also seen is peoplesaying, well, long-term, we like
commodities, but we don't seeoil and gas in the future and
(37:50):
we're looking for that commodityreplacement.
So we found ourselves in anysort of impact or sustainability
aware portfolios.
We've seen people justreplacing commodities.
People don't want to buy, um,you know, necessarily metals,
industrials, um uh, agriculture,things that are expensive to
(38:11):
hold, commodities.
Commodities are expensive tohold, carbon is not, and so
we've seen people replacingcommodities with carbon.
And that's when you start torealize, that's when a 6%
actually starts to make a lot ofsense.
Speaker 1 (38:24):
I think the case is definitely compelling and the
alternative arguments obviouslyare very strong.
Strong, especially if we'regoing to be in a volatile
environment anyway.
You want to diversify yourvolatility sources as much as
possible.
Um, maybe a stupid question,but then you know, volatility
aside, why not, just ifsomebody's very aggressive, why
not just take a lever better onit?
(38:44):
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 tothat dreaded word from a
compliance perspective, current,guaranteed as possible, why not
just go very aggressive?
Speaker 2 (38:57):
yeah then.
But that's people, can people,that's uh, you know you can.
Uh, you can get at least twotimes leverage on on uh, on an
etf, and there's also optionsout there.
We have, uh, fairly liquidoptions on the global fund and
our California.
In fact we know some investorsdo get long our California
through buying calls.
So leverage is there.
(39:19):
But again, that's when.
Yeah, asset allocating to lowcorrelating diversified assets
is one thing.
Taking a levered bet on andbeing very concentrated is a
different, is a different thing.
So, um, certainly, I know in mypersonal account I've got I'm
probably overweight um, you knowI've got both the global and
(39:40):
the california products that Ihold and I'm probably overweight
the sort of standard umallocations.
But yeah, that's a.
That's a different um.
I'll leave the leverage for thepeople that want to.
If, if you want to tradesomething like the California
that, like I say, is tradingnear its structural floor and
therefore has arguably a lot ofvery heavy support and then a
(40:03):
free upside, that's potentiallya great levered bet.
But again, be very careful withleverage and I tend to prefer
to not be levered and just sizemy position right.
So if you're very positive onthis, have a bigger weight to it
.
But yeah, leverage is usuallywhere things unravel for people.
Speaker 1 (40:24):
Other than the carbon market, since I know
Craneshares obviously is verybig on the China side.
Is there an argument to me thatmaybe Chinese equity markets in
some way shape or form arealternative?
Speaker 2 (40:34):
Oh, for sure, For sure they are.
Yeah, I mean it's interestingbecause when you've got Chinese
companies that make most oftheir money in China like a lot
of the names that we have inKWeb joking aside, that is as
close to when I was joking aboutcould you invest in the Martian
(40:57):
economy it starts to feel likethat.
If you've got 1.4 billion peoplethat have their own money,
spending their own money withthese companies that make most
of their money from these people, and it's all inside China,
that is very isolated from otherdrivers that are driving the
other economies, and so I thinkthat's, I think looking at China
(41:21):
as a diversifier is is exactlyas makes complete sense, and I
think I think even us seeking tohave to become experts in
carbon in managed futures.
We've got an inflation hedgeproduct as we diversify.
I think that's where it comesfrom, from our China DNA, that
that is also arguably theultimate alternative, and you've
(41:45):
got an economy that's growingfaster than most of the rest of
the world, is second behind theUS, and valuations in China are
so much lower than thevaluations on US stock.
If we have any sort of you knowand we're sort of seeing, we're
going through the process, butas we see improvements in the
(42:05):
geopolitical space, I think thiswill be exactly where a lot of
alternative dollars will end up,and so they should.
Speaker 1 (42:13):
Luke, for those who want to learn more about the
carbon funds and green shares ingeneral, what would you
recommend and maybe talk througha little bit about the broader
suite?
Speaker 2 (42:22):
Yeah, yeah.
So as a firm, craneshares.
Cranesharescom is where you'llfind everything, and we kind of
characterize ourselves, as youknow and and you've probably all
seen brendan ahern either hereor he was on fox business
yesterday and or last week anduh, constantly on bloomberg and
cnbc we're everything for china,we, we, we've got the the
(42:45):
deepest bench of china expertshere and we have a a daily
newsletter that goes out oninvesting in China, called China
Last Night, and then sort of asthe carbon equivalent.
So we've got China, we've gotalternatives, and then, within
the alternatives, we have a realfocus on climate and we have
climate markets now, which is aweekly that we put out that
(43:06):
focuses on these markets.
You can sign up for any ofthese.
You'll see them.
You go to cranesharescom,you'll see our blogs that you
can sign up for at the top andyou'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 reallyhealthy alternatives lineup and
there's some great, greatproducts in there, and you'll
(43:28):
see that we've got some greatpartner sub-advisors as well
that we work on to give us thatdiverse lineup.
So we've got a lot of in-housecapabilities, and then we've got
some excellent sub-advisorsthat are always very happy to
get on and talk to clients aboutthese strategies.
But that's what people arelooking for now.
You've got to start to thinkabout being diversified At some
(43:51):
point.
Just being along the S&P 500isn't going to cut it.
You're going to need someallocations that are getting
their upward momentum fromsomething else and with low
correlations those US equitiesand you start to see that
playing out.
I saw that the flows arestarting to point towards bigger
(44:17):
holdings that look more likecash than they do equities.
But of course, you still needsome return and you still want
to see.
If you start to see rates comeback down.
Then is that good for equities?
Is it good for fixed income?
You've got to have thosealternatives in there as well.
Speaker 1 (44:29):
From your lips to God's ears, because I think
everybody's waiting for anenvironment where it's not just
about the S&P, but certainly thecarbon market is an utility of
its own Everybody.
Please learn more aboutCraneshares on their website.
Make sure you follow LukeOliver also on X, and I'll see
you all in the next episode ofLead Lag Live.
Speaker 2 (44:46):
Thank you, luke, appreciate it.
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