Integrating Carbon Assets into Portfolio Strategies: Opportunities and Considerations
- Marie-Laure Mikkelsen
- Mar 17
- 8 min read
Climate Investing Series Part III: Carbon & Your Portfolio - Strategies & Considerations.
This blog series explores the methods and rationale for integrating carbon assets into asset allocation strategies. From direct investments in carbon credits to indirect exposure through green companies and funds, we’ll examine how carbon assets can help reduce risk, align with decarbonization goals, and capture growth opportunities in the low-carbon economy. Understanding this emerging asset class is key to building resilient and future-proof portfolios.
Emissions Trading Systems (ETSs) have emerged as a proven and efficient form of carbon pricing, playing a crucial role in mitigating climate change on a large scale. For investors, these new financial instruments represent an attractive asset class with well-understood risk premium drivers, offering both financial returns and environmental benefits. Over the past decade, carbon markets have evolved from a niche concept to a critical tool for financing the global transition to renewable energy and net-zero systems. As the world grapples with the escalating impacts of climate change, these markets are becoming increasingly vital in driving decarbonization efforts. For investors, this shift presents both challenges and opportunities. Carbon allowances have become liquid, fungible assets, giving rise to a full-fledged derivatives market. Futures, forwards, and options now allow investors to gain exposure to carbon prices, making carbon assets a strategic addition to portfolios.
Why Carbon Assets Matter
Carbon allowances, traded under regulated Emissions Trading Systems (ETS), operate on a large-scale, transparent, and economically driven framework for reducing emissions. These allowances are critical for industries and governments aiming to meet emissions reduction targets. On the other hand, carbon credits, issued through voluntary carbon offset or removal projects, enable individuals and corporations to achieve their carbon accounting objectives and contribute to global decarbonization efforts. Together, carbon allowances and credits form the foundation of a new asset class: carbon assets. Carbon assets are an emerging, idiosyncratic asset class with a distinct risk-return profile. Their value is tied to the price of carbon emissions and the global economy’s decarbonization rate, making them lowly correlated with traditional asset classes. This unique characteristic offers significant diversification benefits for investors.
Key Features of Carbon Markets:
Compliance Markets (CCM): Regulated by governments, these markets issue emissions allowances. Prices are influenced by regulatory adjustments to supply.
Voluntary Markets (VCM): Driven by corporate and individual demand for carbon offsets, these markets are more diverse and less regulated.
Carbon assets also provide a unique opportunity to align portfolios with global climate goals while achieving potential financial returns. Whether through carbon credits, green companies, or ESG-focused funds, integrating carbon assets into a portfolio can help manage regulatory risks, support the energy transition, and drive long-term value. In broad terms, investors concerned about carbon have two main avenues:
Invest in pure-play decarbonization companies or transition enablers: Focus on companies directly involved in renewable energy, electric vehicles, or other green technologies.These companies are at the forefront of the energy transition and offer growth potential.
Minimize the carbon intensity of portfolios through carbon credits and other instruments: Use carbon credits and other instruments to offset emissions and reduce the overall carbon footprint of the portfolio.This approach helps manage regulatory risks and supports the energy transition.
How Carbon Markets Work
In an Emissions Trading System (ETS), the price of carbon is determined by supply and demand. Governments constrain the supply of carbon credits to meet climate goals, which is expected to drive prices higher over time. This creates a structural incentive for companies to reduce emissions and invest in cleaner alternatives.
The European Union Emissions Trading Scheme (EU ETS), established in 2005, is of the oldest, largest and most mature carbon market- Since then, global carbon markets have grown significantly, reaching a trading value of 956 billion in 2024, up from 909 billion in 2023 and up from 220 billion in 2018 (source: Refinitiv). This growth is driven by the expansion of emissions coverage, improved accessibility, and increasing liquidity.
The CCA (California Carbon Allowance), RGGI (Regional Greenhouse Gas Initiative Allowance), and UKA (UK Allowance) are the other most important carbon allowances in the global carbon markets. Their liquidity, regulatory backing, and growth potential make them key instruments for investors looking to participate in the transition to a low-carbon economy. Whether for portfolio diversification, risk management, or alignment with sustainability goals, these carbon allowances offer compelling opportunities.
A New Commodity Frontier
The development of carbon markets mirrors the evolution of traditional commodity markets, whether soft commodities like wheat and coffee or hard commodities like gold and copper. However, carbon markets have one critical distinction: the supply of carbon credits is controlled and limited by governments. This supply is carefully calibrated to align with national emissions reduction targets, making carbon markets a unique and strategically vital asset class.
For companies, the stakes are high. If they fail to meet regulated emissions caps—which tighten annually—they face two choices: pay increasingly higher prices for additional carbon credits or incur heavy fines and penalties. This dynamic creates consistent demand for carbon credits, particularly from industries that continue to emit at higher levels.
Like other commodities, the price of carbon is influenced by external factors, such as changes in economic conditions. For example:
If GDP falls, industrial activity slows, reducing demand for carbon credits.
If GDP rises, increased production drives higher demand for credits.
As carbon markets continue to mature, they represent not just a tool for emissions reduction but also a growing investment opportunity. With supply constrained and demand influenced by both regulatory and economic factors, carbon credits are poised to become a cornerstone of the global transition to a low-carbon economy.
Benefits of Carbon Assets in a portfolio
Like other commodities, the global carbon market has experienced fluctuations due to macroeconomic conditions, geopolitics, and market-specific pressures. However, the long-term opportunity remains compelling as governments worldwide accelerate their efforts to achieve net-zero emissions by 2050. According to the Institute of Chartered Financial Analysts (CFA), carbon assets have exhibited attractive historical returns and a low correlation with traditional asset classes, making them a potentially valuable addition to a diversified portfolio.
Remarkable Performance of Carbon Assets
The European Union Emissions Trading Scheme (EU ETS) serves as a reliable proxy for the global carbon market, being the oldest and most mature system of its kind. Its trading unit, the European Union Allowance (EUA), represents the right to emit 1 ton of CO2. Over the past decade, EUA prices have shown a remarkable upward trend, driven by policy reforms, economic activity, and increased investor interest. From lows of €5-8 per ton in 2017 to €85 per ton in 2023, EUAs have evolved into a valuable and liquid asset class. As the EU continues to tighten emissions caps and pursue ambitious climate goals, carbon allowances are expected to remain a strong investment, offering both financial returns and environmental benefits.
Strong Performance Over the Short Term: The recent performance of EUAs is nothing short of extraordinary. From 2017 to 2023, the price of EUAs increased by 10.6x, representing an average annual growth rate of over 55%. This exceptional growth underscores the potential for carbon assets to deliver strong returns as global decarbonization efforts intensify.
Steady Growth Since Inception: Since the launch of the EU ETS in 2005, EUAs have delivered an average annual return of approximately 8.8%. This steady growth reflects the impact of policy reforms, such as the introduction of the Market Stability Reserve (MSR), as well as the EU’s commitment to achieving net-zero emissions by 2050. The increasing demand for carbon allowances, driven by stricter emissions targets and growing investor interest, has further supported this upward trajectory.
A comparison of risk-adjusted return
Low Correlation with Traditional Assets
Historical data from ICE (Intercontinental Exchange), Refinitiv, and S&P Global Commodity Insights highlights a key advantage of carbon assets: their low correlation with traditional asset classes like equities, bonds, and commodities. This independence from broader market trends makes carbon assets a powerful tool for portfolio diversification and risk management. By incorporating carbon assets, investors can reduce overall portfolio volatility and enhance risk-adjusted returns, particularly during periods of market uncertainty.
Correlation against major assets, Jan 2014 –March 2024 Historical data from ICE (Intercontinental Exchange), Refinitiv, and S&P Global Commodity Insights
Carbon assets are more than just mechanisms for reducing emissions—they represent a strategic investment opportunity. The unique characteristics of carbon allowances, including their low correlation and strong historical performance, make them an attractive addition to portfolios. As carbon markets expand globally and regulatory frameworks strengthen, demand for carbon allowances is expected to rise, further solidifying their value as a distinct and forward-looking asset class.
Correlations of top 4 carbon allowances scheme to other asset classes ;
The CCA (California Carbon Allowance), RGGI (Regional Greenhouse Gas Initiative Allowance), and UKA (UK Allowance) correlation to other asset classes remain historically low.
Results are calculated monthly and assume immediate reinvestment of all dividends.
Liquidity
The EU ETS is the largest emissions trading scheme in the world, covering 45% of the EU’s CO2 emissions and involving over 10,000 installations, including power plants, manufacturers, and airlines. These entities must purchase EUAs for every ton of CO2 they emit, creating a highly liquid market. In 2021, the trading volume for EUAs reached nearly $700 billion, ensuring that investors can buy or sell carbon allowances with minimal liquidity risk.
The liquidity of carbon markets is expected to grow further due to:
The progressive implementation of new carbon markets worldwide.
The expansion of coverage in existing markets.
Rising carbon prices driven by stricter emissions targets.
If all compliance carbon markets reached the liquidity levels of the EU ETS, the global trading value could exceed $4 trillion.
Volatility and Risk Management
Carbon assets, like EUAs, are more volatile than traditional assets such as stocks or bonds but less volatile than other energy commodities. On average, EUAs exhibit an intraday volatility of 2.9%, placing them in the “risky asset” category. However, this volatility can be managed by adopting a medium-to-long-term investment horizon. Holding carbon assets for several years not only dampens the impact of short-term price fluctuations but also enhances their environmental impact by supporting long-term decarbonization efforts.
EUA Intraday Volatility
Historical data from ICE (Intercontinental Exchange), Refinitiv, and S&P Global Commodity Insights
The rise of Emission Trading Scheme highlights the growing importance of carbon markets in the global transition to a low-carbon economy. With their strong financial performance, liquidity, and environmental impact, carbon allowances offer a unique opportunity for investors to align their portfolios with sustainability goals while achieving competitive returns. As the world moves closer to net-zero emissions, carbon assets are poised to play an increasingly critical role in both financial and environmental strategies.
Conclusion
Carbon assets represent a unique and strategic investment opportunity, combining strong financial performance, low correlation with traditional assets, high liquidity, and the potential to support global climate goals. As carbon markets continue to mature and expand, they offer investors a compelling way to diversify portfolios, manage risk, and capitalize on the transition to a low-carbon economy.
Whether through Emission Trading schemes, carbon credits, or other carbon-related instruments, integrating carbon assets into a portfolio can deliver both financial returns and environmental impact. With the EU and other jurisdictions strengthening carbon markets and driving demand for allowances, carbon assets are poised to become an increasingly valuable component of forward-looking investment strategies.
or carbon allowances is expected to grow, further enhancing their value.
Disclaimer: Please note that articles may contain technical language. For this reason, they may not be suitable for readers without professional investment experience. Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may make different investment decisions for different clients. This article does not constitute investment advice. It is provided for information purposes only and does not constitute an invitation to invest. Please seek advice from your investment advisor before investing.
Yorumlar