Gold has long played a prominent role in diversified portfolios. Historically, it has delivered strong long-term returns, at times been used by investors as a potential inflation hedge, and offered diversification* benefits through low correlation to equities and traditional risk assets. Over multiple market cycles, investors have allocated to gold with the objective of enhancing diversification. We believe these characteristics have been brought into sharper focus by gold’s more than 100 percent rally over the past two years (as measured by the LBMA Gold Price PM Index),¹ amid broader discussions around equity market valuations, de-dollarization trends, and heightened geopolitical uncertainty.

This strength, however, creates a challenge for investors. Gold is trading at or near all-time highs, more than 35 percent above its 200-day moving average and approximately 150 percent above its long-term 10-year average.¹ By many measures, gold appears more extended than even U.S. equities. At these levels, we believe investors may question how gold could behave going forward. This may lead some allocators to explore whether other institutional asset classes offer similar diversification and inflation-sensitive characteristics, alongside their broader return profiles.

Today, global regulated carbon markets are exhibiting many of the same portfolio characteristics as gold. Carbon has grown into a liquid, institutional asset class, with over $1 trillion in annual traded value, increasing participation from major financial institutions, and expanding coverage from global banks and research desks.² It may surprise investors that KRBN's index has outperformed the S&P 500 over both the past five years and in 2025.³ Carbon has also demonstrated low correlations to equities, gold, and other traditional risk assets, as reflected in the historical correlation data shown below, reinforcing its role as a diversifying* allocation.

Importantly, while equities and gold trade at or near all-time highs, several major carbon markets remain well below prior price peaks. Moreover, the market is shaped by a declining annual emissions cap, creating a program that systematically reduces available supply and creates engineered long-term scarcity that supports price pressure, while preserving flexibility for compliance entities to trade allowances and invest in the lowest-cost emissions reductions. In some jurisdictions, there is also a downside level that is explicitly linked to inflation. This combination of scale, institutional adoption, low correlation, and structural supply dynamics may drive growing recognition of carbon as a strategic alternative allocation.

Is Carbon a Strategic Alternative Gold?

To function as a true alternative allocation, an asset class must contribute meaningfully to portfolio outcomes across three dimensions: return potential, risk, and correlation to core holdings. For many portfolios, U.S. large-cap equities may represent the core growth allocation. The objective of alternatives, therefore, is not simply to generate returns but to improve portfolio efficiency by delivering attractive risk-adjusted returns with low correlation to equities and traditional risk asset classes.

Carbon has increasingly met this definition. Over multiple time horizons, KRBN's Index has delivered risk-adjusted returns comparable to U.S. equities, while maintaining meaningfully low correlation to equity markets. Based on historical data, carbon has exhibited a Sharpe ratio broadly comparable to the S&P 500 (see table below), while showing a correlation to the S&P 500 of approximately 0.3.^1,4 This combination has historically been cited as supporting both return characteristics and diversification, helping improve overall portfolio construction rather than simply adding incremental risk.

Importantly, carbon is not a single, homogeneous commodity, unlike gold. Regulated carbon is comprised of multiple distinct regional systems, each governed by its own policy framework, supply trajectory, and compliance dynamics. These markets have historically exhibited low correlations to one another, further enhancing the diversification benefits of a global carbon allocation (see table at end).

This dispersion in performance returns was clearly visible in 2025. The UK carbon market was among the strongest performers with +76% return in British Pounds and +93% in US Dollar (USD) terms, outperforming gold's 67%. The European carbon allowances delivered returns of 16% locally, but 32% in USD terms, beating US equities, which were up 18%. California carbon was the laggard, experiencing a 15% drawdown for the year, highlighting the differing drivers of the various sub-markets, and yet it remains one of the most closely watched markets in the group. Another strong performer was the new entrant, Washington State, with 34% return. With these different attributes, the blended global carbon basket in KRBN returned 23% for the year, compared to 18% for the S&P 500.¹ This internal diversification across jurisdictions highlights differences in regional market dynamics that may be considered in diversification discussions.

Why such strong performance?

There is a relatively fixed amount of refined gold in circulation, and adding to this supply is slow, capital-intensive, and constrained by geology, making gold supply relatively inelastic. Any sustained increase in demand can therefore potentially translate into higher prices for a finite pool of available metal, although outcomes can vary. Today, investors are seeking diversification away from elevated equity valuations, de-dollarization trends, and rising geopolitical risk, for which gold has historically served as a hedge. As a result, demand has increased relative to a structurally constrained supply.

Carbon operates on a similar fundamental mechanism, but with important differences. While gold’s scarcity is geological, carbon’s scarcity is regulatory. By design, in regulated carbon markets, governments explicitly set and progressively tighten supply caps. At the same time, carbon demand is directly linked to real economic and industrial activity, as compliance entities must purchase allowances in proportion to their emissions. As economies grow, industrial output expands, or new sectors are brought under carbon regulation, demand for allowances rises mechanically. Unlike gold, where higher prices eventually may encourage additional mining activity over time, carbon supply is deliberately reduced over time through policy. This reflects a policy-driven mechanism of tightening supply relative to demand, which can drive structural scarcity directly into the market over time.

Why Carbon Now?

While we believe carbon’s long-term characteristics make it compelling as a strategic alternative, the current point in the market cycle could strengthen the case for allocation today. Across major regulated systems, policy-driven supply reductions, tightening allowance balances, and price floor mechanisms can create structural conditions that differ from traditional commodities and other asset classes.

In Europe, the world’s largest carbon market is entering a period of tightening supply within an already ambitious system. Allowance availability is scheduled to decline steadily over the coming years, and the market mechanism is in place to actively reduce surplus inventory. As a result, cumulative surpluses that currently exceed 800 million tonnes are expected to fall toward minimal levels by the end of the decade based on current EU regulation, which can create a structurally tighter market environment.⁵ In California, after a period of policy uncertainty, the state has moved to extend its carbon market through 2045 and is advancing new policy proposals aimed at tightening supply beginning in 2026.⁶ A key differentiator is California’s built-in auction reserve price that sets a minimum price at which allowances can be sold at auction, where this floor increases by 5 percent plus inflation each year. In other words, this creates a downside floor level that is structured to increase over time as per the market’s regulations.⁷

The UK market is under consideration for linkage with the EU ETS, which could see UKA prices converging closer to the European market. Washington State and the northeastern U.S. RGGI program also operate under constructive policy frameworks that are designed with similar long-term supply-constraint dynamics.

While carbon markets, like all traded assets, remain influenced by sentiment and macroeconomic conditions, they are also shaped by explicit regulatory mechanisms that steadily reduce supply and tighten market balances. These structural features reflect non-cyclical elements in carbon markets compared with traditional commodities and financial assets.

Liquidity, Market Depth, and Institutional Access

Another important parallel between carbon and gold lies in how carbon markets behave as financial assets. Like many real assets, carbon offers exposure to underlying supply and demand constraints. However, traditional commodities such as oil, natural gas, or agricultural products often involve significant physical storage costs, delivery constraints, and seasonal dynamics, which can make long-term positioning expensive even when accessing these markets through futures.

Carbon markets, by contrast, do not involve physical storage or delivery in the same manner. As a result, their cost considerations may differ from those of physically delivered commodities. This structure has been discussed alongside diversification* characteristics of traditional commodities, based on historical observations.

From a market structure perspective, carbon and gold are also increasingly comparable. As noted in Carbon Hunters, by Professor Richard Sandor, often referred to as the pioneer of cap-and-trade markets, futures open interest, in number of contracts, in carbon and related environmental contracts now surpasses the open interest of gold futures in 2025, albeit still a lower dollar value.⁸ The five markets contained inside KRBN also now trade $907 billion, underscoring the growing scale and liquidity of the asset class.

ETFs and Market Adoption

Gold’s prominence as a strategic allocation has also been driven by the expansion of exchange-traded funds, with more than $51 billion of inflows into gold ETFs over the past 12 months, and well over $250 billion now held across physical gold ETFs globally.¹ Similarly, the development of carbon ETFs has played a critical role in opening regulated carbon markets to traditional investors by removing regulatory, operational, and access barriers. Through the ETF structure, investors can now gain exposure to global carbon markets in a manner similar to how gold ETFs transformed access to gold bullion. KRBN and KCCA from KraneShares represent two of the first, largest US-listed ETFs providing exposure to carbon prices.⁹

Conclusion

For investors who already allocate to a gold position, carbon has been discussed as a strategic alternative. And, for those who have missed gold’s recent rally or are cautious about adding gold exposure at elevated levels, carbon may offer access to similar portfolio characteristics, including historically uncorrelated returns and potential inflation hedging, within a market governed by long-term policy frameworks. In its own right, carbon has seen an increased allocation among institutions that are utilizing it as a diversifier* relative to traditional markets.

As global carbon markets continue to institutionalize, tighten, and expand in scale, carbon could be positioned as a strategic alternative asset class. In this context, carbon may offer investors a differentiated way to pursue diversification and real-asset exposure, with structural features that reflect differences in market structure within modern portfolio construction.

At KraneShares, we offer the largest ETFs in the US market with our flagship global solution, the KraneShares Global Carbon Strategy ETF (Ticker: KRBN), holding EU, California, UK, Washington, and RGGI, plus our California-specific, the KraneShares California Carbon Allowance Strategy ETF (Ticker: KCCA), and Europe-specific, the KraneShares European Carbon Allowance Strategy ETF (Ticker: KEUA).⁹ Please reach out to us at [email protected] for more information or a meeting with our experts.

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For KRBN standard performance, top 10 holdings, risks, and other fund information, please click here.
For KCCA standard performance, top 10 holdings, risks, and other fund information, please click here.
For KEUA standard performance, top 10 holdings, risks, and other fund information, please click here.

*Diversification does not ensure a profit or guarantee against a loss. KRBN, KCCA, and KEUA are non-diversified funds. The statement regarding diversification refers to sector exposure, not regulatory diversification under the Investment Company Act of 1940.

Government plans may not be implemented as described, which could impact markets.

References to institutional investors are included solely to describe the investment landscape and do not imply endorsement, validation, or suitability of any investment strategy for retail investors.

Citations:

1. Data from Bloomberg as of 12/31/2025. Past performance does not guarantee future results. See defintion for LBMA Gold Price PM Index below.
2. Data from Bloomberg as of 12/31/2025. The five largest markets collectively traded over $900 billion in 2025. 
3. Data from Bloomberg as of 12/31/2025 based on a 5-year return of +102.2% and +22.0% in 2025 for the S&P Global Carbon Credit Index; US equities refer to the S&P 500 Index, with a 5-year return of +96.0% and 2025 return of +17.9%.
   
   The S&P Global Carbon Credit Index tracks the most liquid segment of the tradable carbon credit futures markets, including futures contracts on European Union Allowances, U.K. Allowances, California Carbon Allowances, the Regional Greenhouse Gas Initiative (RGGI), and Washington Carbon Allowances (WCA), with pricing data from ICE Futures Pricing. 
   
   The S&P 500 Index is a stock market index tracking the stock performance of 500 leading companies listed on stock exchanges in the United States. Past performance does not guarantee future results.
4. Data from Bloomberg and S&P Indices as of 12/31/2025.
5. ING Think, "Falling allowance supply to tighten EU carbon market," December 8, 2025.
6. California Air Resources Board, Resources, "CARB Proposes Updates to Cap-and-Invest Program," retrieved 2/17/2026.
7. California Cap-and-Invest Program and Québec Cap-and-Trade System ,"2026 Annual Auction Reserve Price Notice," Issued on December 1, 2025.
8. Richard Sandor, "Carbon Hunters: Reflections And Forecasts Of Climate Markets In The 21st Century," September 9, 2025.
9. Data from Bloomberg as of 12/31/2025. Largest in terms of assets under management (AUM) listed on US exchanges. Past performance does not guarantee future results.

Definitions:

Bloomberg Barclays US Aggregate Bond Index (”The Agg”): A broad base, market capitalization-weighted bond market index representing intermediate term investment grade bonds traded in the United States. Inception date: January 1, 1986

LBMA Gold Price PM Index: The global benchmark price for unallocated gold delivered, IBA operates electronic auctions for spot, unallocated loco London gold.

S&P GSCI Crude Oil Index: Provides a publicly available benchmark for investment performance in the crude oil market. Inception date: May 1, 1991

MSCI US REIT Index (daily price return USD): A free float-adjusted market capitalization weighted index that is comprised of equity Real Estate Investment Trusts (REITs). Inception date: June 20, 2005

S&P GSCI Index: The S&P GSCI is the first major investable commodity index. It is one of the most widely recognized benchmarks that is broad-based and production weighted to represent the global commodity market beta. The index is designed to be investable by including the most liquid commodity futures, and provides diversification with low correlations to other asset classes.

Total return: The overall percentage gain or loss on an investment over a given period, including both price appreciation and any income (e.g., dividends or interest).

Annualized return: The average yearly rate of return earned on an investment over a specified time period, expressed as if it were compounded annually.

Annualized volatility: A measure of the investment’s price fluctuations over a year, typically calculated as the standard deviation of returns and scaled to an annual basis.

Carbon allowances (referenced in the correlation monthly table): Top 5 carbon allowance markets by constituent trade volume. The Index is used since the index start date July 25, 2019. From 11/30/2016 to prior to the index start date, 60% and 5% were respectively assigned to EUA futures prices (current year and next year December vintages) using Intercontinental Exchange daily published settlement prices, 20% and 5% were respectively assigned to CCA futures (current year and next year December vintages) using IHS Markit OPIS’s daily Carbon Market Report published prices, and 10% was assigned to RGGI (current year December vintage) using IHS Markit OPIS’s daily Carbon Market Report published prices. Prior to 11/30/2016, 60% and 5%, respectively, were assigned to EUA futures prices (current year and next year December vintages) using Intercontinental Exchange daily published settlement prices and 35% was respectively assigned to CCA futures (current year December vintage) using IHS Markit OPIS’s daily Carbon Market Report published prices. For the two ranges developed prior to the index start date, Intercontinental Exchange and IHS Markit OPIS’s Daily Carbon Market Report publish daily pricing for each contract vintage for all relevant days when the futures trade.

Allowances: Tradable compliance permits issued under cap-and-invest programs that grant the holder the legal right to emit one metric ton of CO₂ (or CO₂-equivalent), with total supply constrained by a declining regulatory cap.

Correlation: Correlation measures how closely two investments move in relation to each other, with high correlation meaning they often move together and low correlation meaning they move more independently.​

De-dollarization: De-dollarization is the process of countries and investors reducing their reliance on the U.S. dollar in trade, reserves, or investments.​

Upside asymmetry: Upside asymmetry means an investment has more potential for gains than for losses relative to the risk taken.​

Risk-adjusted return: Risk-adjusted return measures how much return an investment delivers relative to the amount of risk taken, allowing fair comparisons between different assets.​

Sharpe ratio: The Sharpe ratio is a metric that shows how much excess return an investment provides for each unit of risk (volatility) it takes on.​

Market Stability Reserve (MSR): The Market Stability Reserve is a mechanism in the EU ETS that automatically adds or removes allowances from the market to keep supply and demand more balanced.

Banked inventory (of allowances): Banked inventory refers to carbon allowances that have been saved rather than used and can be carried over for future compliance.

Cap-and-trade program: A cap-and-trade program is a system where a government sets a limit (cap) on total emissions and allows companies to trade emission permits within that limit.

Price floor: A price floor is the minimum price at which a product or asset is allowed to trade, below which transactions cannot occur.

Auction reserve price: The auction reserve price is the minimum bid price set in carbon allowance auctions, ensuring allowances are not sold below a certain level.

Tiered price containment levels: Tiered price containment levels are pre-set price points in a carbon market where additional allowances can be released or other measures triggered if prices rise too high.

CPI (Consumer Price Index): CPI is an index that tracks changes in the prices of a basket of common goods and services and is widely used to measure inflation.​

Contango: Contango is a market condition where futures prices are higher than the current spot price, often because of storage and financing costs.​

Backwardation: Backwardation is a market condition where futures prices are lower than the current spot price, often reflecting tight current supply.​

Roll drag: Roll drag is the loss (or reduced return) that can occur when an investor repeatedly sells expiring futures contracts and buys more expensive longer-dated ones.​

Carry costs: Carry costs are the expenses of holding an investment over time, such as storage, insurance, or financing costs for commodities.​

Futures contract: A futures contract is a standardized agreement to buy or sell an asset at a set price on a specific future date, traded on an exchange.