Alternatives

Fight climate change and earn profits by investing in carbon credits, the innovative market-based solution that rewards businesses for reducing their carbon footprint

In this article, we will talk about how to invest in carbon credits. Diversification and asset allocation, in general, are key components of portfolio theory if you want to become an investor.

Carbon credit investing is becoming increasingly popular.

In fact, J.P. Morganrecently invested $500 million in timberland (P.S. it wasn’t for the wood).

So, what actually are Carbon Credits?

Carbon credits are tradable permits that allow companies or individuals to offset their carbon emissions by investing in projects that reduce greenhouse gas (GHG) emissions.

Each carbon credit represents one tonne of CO2 or its equivalent GHG emissions that these projects have avoided or reduced.

Carbon credits aim to create a market-based mechanism that incentivizes GHG emissions reductions by allowing organizations or individuals to offset their greenhouse gas emissions while encouraging investment in carbon reduction projects.

From an investing standpoint, Carbon credits are an alternative investment like wine or real estate because of their illiquid nature and hard-to-value asset.

Many countries have adopted the use of carbon credits as a part of their climate policy framework.

What Is Carbon Credit Investing?

Carbon credit investing and trading involves buying and selling credits, stocks, mutual funds, or ETFs that represent a reduction in greenhouse gas emissions.

It can allow investors to support sustainability efforts and earn a profit. There are numerous advantages and risks of investing in carbon credits.

And while the carbon credit market is fairly nascent compared to traditional stock and bonds, it’s an industry that is worth taking a closer look at.

What Are The Advantages?

Investing in carbon credits can have several advantages, including:

Environmental Benefits

Carbon credits represent a reduction in greenhouse gas emissions, which can help mitigate the effects of climate change and global warming. By investing in carbon credits, you are contributing to a more sustainable future.

Potential for financial returns

Carbon credits can be bought and sold in various markets, and their value can fluctuate based on supply and demand. If you invest in carbon offsets or credits that increase in value, you can earn a financial return on your investment.

Portfolio Diversification

Carbon credits provide a unique opportunity to diversify your investment portfolio. Because they are not directly tied to traditional financial markets, they can provide a hedge against market volatility.

What Are The Risks?

While investing in carbon credits or companies that invest in the reduction of carbon credits can provide an opportunity for investors to support sustainability efforts and earn a profit, there are several risks associated with carbon credit investing, including:

Market Risk

The value of carbon credits can be volatile and influenced by various factors like regulatory, market demand, and economic conditions in carbon markets.

Regulatory Risk

The rules and regulations surrounding carbon credit markets can change quickly, making it difficult to predict the future value of credits.

Fraud Risk

The carbon credit market is vulnerable to fraud, including creating fake credits or selling credits that do not actually represent a reduction of Co2.

Reputational Risk

Investing in carbon credits can expose individual companies and investors to reputational risks if they become associated with companies or projects that fail to meet environmental or social standards.

Technology Risk

Carbon credit markets rely on accurate measurement and verification of emissions reductions, which can be challenging and subject to errors or manipulation.

Liquidity Risk

Carbon credit markets can be illiquid, meaning that it may be difficult to find buyers or sellers of credits when needed.

How To Start Investing in Carbon Credits

If you are interested in investing in carbon credits, there are numerous ways to get started.

Ways to invest in Carbon Credits include:

• Carbon Capture Stocks
• Carbon Credit Mutual Funds
• Carbon Credit ETFs
• Carbon Credit Futures
• Carbon Credit Investment Funds

Carbon Capture Stocks

Carbon capture, utilization, and storage (CCUS) is a technology that captures carbon dioxide (CO2) emissions from industrial processes, power plants, and other sources and stores it in underground geological formations, among other uses.

A few companies are involved in carbon capture technologies, including some publicly traded stocks.

Here are a few examples:

Carbon Credit Mutual Funds

Carbon credit mutual funds are professionally managed investment vehicles that pool money from multiple investors to buy a portfolio of securities, including carbon credits.

The portfolio manager decides which carbon credit projects to invest in and manages the fund’s assets on behalf of the investors.

Carbon Credit ETFs

Another great way to invest in carbon credits is through Carbon credit ETFs (exchange-traded funds) are investment passively-managed products that expose investors to the carbon credit market. These funds invest in companies or projects that generate carbon credits through emission reduction initiatives, like renewable energy projects or energy efficiency programs.

ETFs are similar to mutual funds in that they invest in a basket of assets but are passively managed instead of actively managed like mutual funds.

Carbon Credit Futures

Carbon credit futures are a financial instrument that allows investors to speculate on the future price of carbon credits.

Futures contracts are agreements to buy or sell an underlying asset (in this case, carbon credits) at a specified price and date in the future.

Investing in carbon credit futures involves taking a position on the future price of carbon credits, with the goal of profiting from price fluctuations.

For example, an investor may buy a carbon credit futures contract if they believe that the price of carbon credits will increase in the future. If the price does, the investor can sell the futures contract higher than they paid, realizing a profit.

Investing in carbon credit futures requires specialized knowledge and experience in futures trading and is generally not for beginners.

Carbon Credit Investment Funds

Carbon credit investment funds are investment vehicles that enable investors to invest in a diversified portfolio of carbon credits generated by various emission reduction projects worldwide.

These funds can invest in various projects, like renewable energy, energy efficiency, and carbon capture and storage initiatives.

The primary objective of carbon credit investment funds is to generate a return on investment while supporting sustainable development and helping to reduce greenhouse gas emissions.

These funds typically invest in verified and certified carbon offset projects, which means that the carbon credits they generate are real and can be used to offset carbon emissions.

Carbon credit investment funds can take various forms, such as mutual funds, exchange-traded funds (ETFs), or private equity funds. The investment strategy and portfolio holdings can differ from fund to fund, depending on the fund’s objectives, investment style, and asset allocation strategy.

One advantage of investing in a carbon credit investment fund is that it exposes investors to the growing carbon market, without needing specialized knowledge or resources.

Carbon credit investment funds can also provide diversification benefits to a portfolio and help investors to align their investment goals with their environmental values.

The Bottom Line

Investing in carbon credits can be a way to support and promote carbon reduction efforts while potentially earning a financial return, but it is important to approach it like any other investment; with caution and thorough research.

Frequently Asked Questions

Do you need a lot of money to invest in carbon credits?

The amount of money required to invest in carbon credits can vary widely, depending on a range of factors, including market prices, minimum investment requirements, and the goals of the investor.

Currently, in global carbon markets, the price of carbon credits ranges from a few dollars to several hundred dollars per ton of carbon dioxide equivalent (CO2e).

Secondly, the minimum investment required to participate in carbon credit markets can vary depending on the platform or exchange used. Some platforms may require a minimum investment of several thousand dollars, while others may have no minimum investment requirement.

Finally, the level of investment will also depend on the goals of the investor. If an investor’s goalst the carbon emissions of a small business or personal activities, they may only need to purchase a relatively small number of carbon credits.

However, if an investor is looking to offset the carbon emissions of a large corporation or engage in more significant carbon trading activities, they may need to invest much more.

Interested in Alternative Investing? This guide will walk you through everything you need to know.

What Are Alternative Investments?

An alternative investment is any asset that falls outside traditional equity,  fixed-income or cash and does not trade on a stock exchange.  

Most individuals who invest in alternatives do so with the broader goal of providing diversification to their investment portfolio through non-correlated returns and lower volatility than traditional investments.

How Do Alternative Investments Work?

Because alternative investments do not trade on a stock exchange, they are considered illiquid investments, meaning you cannot easily buy or sell your investment.

Most alternative investments are only open to accredited investors and have high minimum investments. 

And generally, because the assets are not publicly traded and valuations are subjective, they tend to have much higher fees than equity investing.

Types of Alternatives

While there is no definitive definition of alternative investments, some of the most common types of alternative assets include:

• Non-traded real estate. It can be a private REIT or individual commercial real estate property. The main difference is that non-traded real estate is not publicly traded and, therefore, not easily bought or sold.
• Investment Grade Wine. Investment-grade wine has become an increasingly popular alternative asset due to its robust and non-correlated returns to the stock market. Just a decade ago, the United States accounted for only 1% of the wine market in 2011 but now accounts for one-third of the global sales.
• Structured Products. They are derivatives packaged into a bond-like structure and sold to institutional and retail investors. The underlying performance of a structured product can be linked to the returns of an underlying asset like stocks, bonds, interest rates, or commodities.
• Art. Once only available to the uber-wealthy who bought and sold physical pieces of work for $10 million+, there has now been an increase in the popularity of buying shares backed by art. While this concept seems strange initially, but it already exists in other asset classes like real estate and commodities. Art investing is a $17 trillion market with the returns to prove it. Between 1995 and 2020, contemporary art has outpaced returns on the S&P 500, returning 14% vs 9.5% for the S&P 500.
• Private Equity. Private-equity funds aim to acquire usually private or sometimes public companies to sell them at a profit and return capital to investors.
• Hedge Funds. are pooled investment funds that trade liquid assets like stocks and fixed income in addition to illiquid assets. Hedge fund investment strategies can vary but typically seek to produce returns while mitigating downside risk.
• Liquid Alternatives. Are publicly traded ETFs or mutual funds that provide hedge fund-like strategies such as long/short, event-driven, relative value

The demand for alternatives is robust. According to J.P. Morgan Asset Management, alternative investing fundraising has increased substantially over the past decade. In 2011, alternative assets fundraising was $400 billion; in 2021, fundraising increased nearly 3-fold to $1.4 trillion in 2021.

Who Can Invest In Alternatives?

Historically this asset class was only open to institutional investors like pension funds or ultra-high-net-worth individuals, who had access to alternatives through the private banking arm of large banks.

However, after the 2012 passage of the JOBs Act, investing in alternatives became more accessible because the new law made the legal requirements for selling alternative investments to the public less onerous.

Since then, a wide variety of platforms have popped up, enabling everyday investors to invest like the ultra-wealthy. However, many platforms still require investors to be accredited investors, meaning they have an income of $200,000 or a networth greater than $ 1 million, excluding their primary residence.

What are the Advantages of Alternative Investments?

Alternatives offer unique advantages that are not provided in publicly traded markets.

Enhanced Returns

An analysis done by Morgan Stanley from (Data as of Jan 1, 1990, to Dec 31, 2021) shows that a portfolio of 80% stocks and 20% alternatives had an annualized return of 10.8%, while a portfolio of 100% stocks during that same period had returns of 10.64%.

Reduced Volatility

Compared to traditional investments, alternatives rely less on broad market trends and more on the strength of each specific investment, highlighting how adding alternatives can potentially reduce a portfolio’s overall risk. According to J.P. Morgan Asset Management, a portfolio of 80% equity and 20% bonds had a volatility of 12.54%, while a portfolio of 50% equity, 20% bonds, and 30% alts had a volatility of 9.36%.

Higher Yield

Alternative assets have the potential to deliver higher yields than you can earn in other parts of the market. For example, direct lending offers an estimated yield of 8.6%. Meanwhile, the U.S. High Yield bonds are forecasted to deliver 5.5% a year, investment grade bonds are expected to return 3.0%, while equities average 1.4%. These numbers highlight now investors can seek above-average yields outside the traditional equity and fixed-income market.

Broader Investment Opportunity

There are approximately 10x more private companies than publicly traded companies in the U.S. This means investors are missing out on a sizeable investing opportunity.

What are the Disadvantages of Alternative Investments?

While alternative investments can provide a wide range of benefits, there are some drawbacks investors need to be aware of.

Higher Minimum Investment

While there is no hard and fast rule for the minimum amount you need to invest in alternatives, minimum investments start at $10,000.

Limited Liquidity

It may be challenging to sell your alternative investment. While some platforms that offer alternatives may provide liquidity, they may be infrequent and not guaranteed.

Longer Lock-Up Periods

Meaning shares or interests may not be able to be redeemed/sold daily. This helps allow for exposure to less liquid assets. 

Higher Fees

Alternatives can have management fees between 1.5% and 2% of invested assets, while the average Exchange Traded Fund has a fee of 0.42%, and the average mutual fund has a fee of 1.42%.

No External Price Verification

Because there is no active market, you cannot open your brokerage price and view the latest bid/offer, making valuations challenging. Many alt platforms will often provide valuations on at least a quarterly basis, but investors cannot verify asset prices on a whim.

How To Invest in Alternative Investments

Unless you are a private bank client, which requires investable assets of $10 million or more, the number of platforms that offer alternative investments is still limited compared to stock trading platforms.

However, over the past decade, there has been an increasing number of alternative investment platforms. If you want to invest in alternative investments, there are an increasing number of niche investing platforms that cater to specific alternative assets:

How to invest in wine: Vinovest or Vint

How to invest in real estate: Fundrise or Groundfloor

How to invest Art: Masterworks

How to invest in Hedge funds, Private Equity, Private Credit: Yieldstreet

Who Should Invest in Alternatives?

      Alternative Investments are good for…

• Individuals looking to add diversification and reduce volatility in their investment portfolio.

      Alternative Investments are not good for…

• Investors with a short-term investing horizon or may need to liquidate their position early.

How to Use Alternatives As Part of Your Investment Strategy

Alternatives should be used for an outcome-oriented approach. The first step is to identify the challenge you are trying to address, e.g. income, capital appreciation, or diversification. Once the challenge is identified, you should allocate funds to the said asset that should provide the desired solution.

For example, if your goal is income generation, you may want to consider investing in private credit.