Over the past few years there has been a proliferation of new exchange traded funds (ETFs) and exchange traded notes (ETNs) focusing on clean technology, renewable energy and most recently carbon emission.
One such carbon product is the iPath Global Carbon ETN (NYSEARCA:GRN) which began trading on July 8, 2009. GRN is small with a market capitalization of $3.53 million and an average trading volume of 1,586 shares per day. GRN has a year to date return of -18.51%. GRN is classified as a commodity asset class with a commodity type of carbon allowances. GRN is linked to the Barclays Capital Global Carbon Index. The index tracks the European Union Emission Trading Scheme (EU ETS) and the United Nation’s Kyoto protocol Clean Development Mechanism (CDM). The EU ETS and CDM are the two largest carbon emission markets. The iPath Global Carbon ETN is an alternative investment product that is designed to appeal to individuals who want to include a carbon emission component to their portfolio.
Conceptually, carbon emissions represent a new and possibly interesting asset class that could be used to diversify risk. One way to look at the risk return tradeoff is by using a capital asset pricing model (CAPM). The CAPM is one of the cornerstones of modern portfolio theory. Using daily data from July 8, 2008 to November 17, 2009 a two factor CAPM model was estimated relating the daily returns on GRN to the daily returns on the S&P 500 and the daily returns on the front month West Texas Intermediate crude oil contract.
The empirical estimation turned up a market beta of 0.19 and an oil beta of 0.25. This means that a one percent increase in the S&P 500 increases GRN by 0.19 percent. A one percent increase in oil futures increases GRN by 0.25 percent. These results indicate that the iPath Global Carbon ETN is not very sensitive to movements in the S&P 500 or crude oil prices. This is encouraging from a risk diversification perspective and points to the possibility of using carbon finance products to offset market risk.
According to the World Bank’s State and Trends of the Carbon Market 2009, the overall global carbon emissions market in 2008 was valued at $126 billion and this value was almost double the value for 2007. Carbon emission markets are still in their infancy but as the global recession subsides and carbon trading continues to expand around the world, the demand for carbon finance products like carbon emissions ETNs should grow.
Disclosure: No positions